Cyprus Notional Tax Deduction (NID) is a deduction against taxable profit calculated by applying a "reference interest rate" to new equity injected into companies and used by companies for the performance of its activities under certain conditions and constraints. The notional tax deduction in Cyprus enables businesses to deleverage and realise a tax efficient return on new equity, an incentive encouraging companies and investors to increase equity.
On the 18th of July 2016, the Cyprus Tax Department published the Interpretation and tax Practice for the new "Article 9B" of the Income tax Law 116(1)2015 for the Notional Interest Deduction on new equity with effect from 1st January 2015.
Based on the Article 9B, "NID" is a deduction against taxable profit calculated by applying a "reference interest rate" to the new equity injected into companies and used by companies for the performance of its activities under certain conditions and constraints.
This deduction should not exceed 80% of the taxable profit that arises from the introduction of new equity as determined on the basis of the Income tax Law. The right to claim NID applies to Cyprus Tax Resident Companies and Cyprus Permanent Establishments of non- resident companies.
The circular provides the legal basis for the NID, analyses definitions, explains underlying concepts and basic principles. It also provides provisions with practical application and examples provided for better understanding and implementation of the legislation.
New equity is considered to be represented by shares of any class (including ordinary, preference, redeemable and convertible shares) paid in cash or in kind as well as share premium that have been issued and redeemed on or after 1st of January 2015.
Unpaid share capital for which a corresponding requirement has been recognised which is attributable to interest or deemed to be is subject to Income tax law and it is considered to be paid-up capital for the purposes of the circular.
In the case of a Cyprus resident Company with the head offices being outside the Republic of Cyprus, the share capital and the share premium for the purposes of Article 9B will be determined on the basis of their legal characteristics.
The Circular clarifies that the following may qualify as a new equity:
- Issue of new share capital by way of capitalisation of realised reserves created after 01.01.2015.
- Issue of new share capital by way of capitalisation of realised reserves that existed on 31.12.2014 if it is proved that are related to new assets generating taxable profit
- Issue of new share capital from conversion of loans payable and other debt instruments such as bonds, debt securities or the shareholders credit balance
- Issue of new share capital by conversion of non-reciprocal capital contribution
As per the legislation, the NID rate is the 10-year government bond yield, where the funds are invested plus a 3%. There is a minimum rate which is the yield on the 10-year government bonds of the Republic of Cyprus plus 3% and the reference date is the 31st of December of the prior tax year.
Anti–Avoidance Provisions and Practical Application
The Circular provides anti – avoidance provisions and practical examples dealt with by the circular as of below:
- The matching concept: Method of calculating the taxable income based on the principle of correlation. Identifying new equity that directly financed specific assets
- Pro-rata basis: Method of calculating the notional interest on pro rata basis including three basic stages
- Interest rate yield on the 10-year government bond in which new funds are invested
- New equity of companies that are transferring their tax residence in Cyprus Republic
- New equity of Companies that are transferring their tax residence in Cyprus Republic, which on 31.12.2014 had a permanent establishment in Cyprus
- New equity of Permanent Establishment
- New equity stemming from the capitalisation of reserves that existed on 31.12.2014
- Introduction of new equity in the form of assets
- Limitation of Notional Interest Deduction by the amount of interest given to another company as a deduction for the financing of new equity
- Allowance of NID in case of reorganization
- Non-granting of NID to transactions without substantial economic or commercial purpose
Understanding the Circular through Examples
The guidance set out seven worked examples illustrating various hypothetical scenarios for better understanding of the legislation. It is important to note that the example(s) provide a brief guide only and it is essential that appropriate professional advice is obtained.
A simple example will help to illustrate the principles provided by Circular:
The Company "X" issues and receives new equity to €150m which is used to finance the purchase of three assets worth €50m each in three different countries. More details on the table below:
The 80% ceiling of the notional interest deduction calculates separately for each of the assets and as a whole for the total of new equity as follows:
Table – Example 1: Assets in three different countries, all of them being profitable
Result: The total maximum NID that can be claimed is the smallest of point (5) and (6) above, therefore €20,2m.
The Cyprus Tax Authorities introduced the Notional Interest Deduction to encourage inward investment, strengthen the economic robustness of Cypriot entities and preserve their competitiveness.
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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.