Cyprus Notional Interest Deduction (NID)

Introduction

Generally, companies can be financed via debt, equity or a mixture of both.

On the one hand, debt generates interest expense, which is usually a tax-deductible expense for the borrower. Equity on the other hand is associated with dividends, which are not deductible for tax purposes. This creates an incentive for companies to be funded via debt as opposed to equity, since debt creates certain tax advantages. The Cypriot Notional Interest Deduction provisions (NID) aims to fix this imbalance by introducing a servicing cost on equity.

In simple terms, a Cyprus company financed with new equity is eligible to claim an annual expense like interest. This deduction, if properly structured, can significantly reduce the taxable profits of a Cyprus company to an effective tax rate as low as 2,5%. The NID deduction can be claimed in perpetuity provided the new capital funds are in use to produce taxable income. It is to be noted, that the NID deduction does not trigger any accounting entries as the deduction is made purely for tax purposes.

How Notional Interest Deduction is calculated

NID is calculated by multiplying the New Capital introduced in the company with a Reference Rate. By way of a restriction, the NID deduction cannot exceed 80% of the taxable income generated via application of the new capital funds and the total income generated by all the assets and activities resulting from New Capital funds.

What is New Capital

From 1 January 2021

“New Capital” is defined as equity introduced into the business on or after 1 January 2015. As of 1 January 2021, the NID can no longer be claimed on equity arising from the capitalization of pre-existing reserves (reserves existing on 31 December 2014).

New Capital generally represents shares of any type and class issued and paid after January 2015. The following may also be considered as New Capital funds:

  • Unpaid share capital for which the company has recognized the claim of the receivable.
  • Issue of share capital by the capitalization of reserves created after January 2015.
  • Issue of share capital by conversion of loans payable and other lending products.
  • Issue of share capital by conversion of non-refundable capital contributions.

Asset contributions and the resulting issue of share capital can also be recognized as New Capital subject to the fulfillment of certain conditions.

Until 31 December 2020

“New Capital” represents equity introduced into the business on or after 1 January 2015, excluding equity created from the capitalization of reserves existing on 31 December 2014 (pre-existing reserves), unless the equity created from the pre-existing reserves is invested in (business) assets earning taxable income which did not exist on 31 December 2014.

The Reference Rate

From 1 January 2020

Reference rate is the yield rate of the 10-year government bond of the country in which the new capital has been invested, increased by a premium of 5% and there is no minimum reference rate. The yield rate to be used is the one which was in effect on 31 December of the year prior to the tax year.

Where the country in which the new equity is employed/invested does not have an issued 10-year government bond as at 31 December of the relevant year, the reference rate is the Cyprus 10-year government bond yield plus 5%.

The Cypriot Tax Department is publishing the 10-year government bond yields for selected countries on an annual basis. You can find the relevant rates here. In case the yield rate for any country is not published, the taxpayer can obtain the yield from Bloomberg.

Until 31 December 2019

Reference rate is the yield rate of the 10-year government bond of the country in which the new capital has been invested, increased by a premium of 3%. The yield rate to be used is the one which was in effect on 31 December of the year prior to the tax year. In case that the Cypriot 10-year bond rate (plus the 3% premium) results to a higher reference rate, the taxpayer can use the higher rate.

The Cypriot Tax Department is publishing the 10-year government bond yields for selected countries on an annual basis. You can find the relevant rates here. In case the yield rate for any country is not published, the taxpayer can obtain the yield from Bloomberg.

Relevant Information

Matching Concept
For the purposes of claiming the NID deduction, the Cyprus company needs to maintain a schedule of the New Capital introduced, the application of those new funds (e.g. loans provided, acquisition of business assets etc) and the taxable income generated by each asset or activity. In the case where the New Capital funds cannot be linked with a particular asset or activity, the NID should be calculated on a pro-rata basis in a particular way.

To whom NID applies
NID can be claimed by all Cyprus tax resident companies and Permanent Establishments of non-resident companies. NID can also be applied to companies redomiciling to Cyprus on or after January 2015 as well as companies shifting their management and control (i.e. tax residence) to Cyprus.

Anti-avoidance provisions
Certain anti-avoidance and limitation provisions exist, including a general anti-avoidance rule whereby the Tax Commissioner may disallow the deduction of NID in case that actions or transactions took place without any commercial reasoning other than the intention to erode the tax base.

Contact Us

Feel free to contact us should you require any clarifications in relation to the Cypriot NID regime.

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