Cyprus: Cyprus Tax Law: New Non Domiciled Rules And Notional Interest Deduction

This summer brought some very significant amendments to the Cyprus tax laws, further enhancing Cyprus' favourable tax regime. On 17 July 2015, the following laws were amended:

  1. The Special Defense for Contribution law No. 117(I) of 2002 as amended;
  2. The Income Tax Law No 118(I) of 2002 as amended; and
  3. The Capital Gains Tax Law No. 119(I) of 2002 as amended.

New Non Domiciled Rules

The new non domiciled rules were introduced to further entice corporate executives and high net worth individuals (currently entitled to a 50 per cent tax exemption of personal income tax for a five year1 period where income exceeds €100.000) to take up residency in Cyprus.

The Special Contribution for Defense Law (the SDC Law) imposes tax on income (dividends, interest, rental income) received from within or outside of Cyprus by individuals who are considered to be tax residents of Cyprus. An individual is considered to be a tax resident of Cyprus if he/she physically spends at least 184 days in Cyprus during the tax year.

The SDC Law has now been amended to incorporate the non domiciled rules exempting the income (whether actual or deemed) of persons who are not considered to be domiciled in Cyprus from payment of special contribution for defense tax, even if they are considered to be tax residents of Cyprus.

An individual can be considered as domiciled in Cyprus either (i) by domicile of origin; or (ii) by domicile of choice. In order to understand the concept of "domiciled in Cyprus" one must look to the Wills and Succession Law Cap. 195.
In accordance with the Wills and Succession Law:

  • A person at any time can have either the domicile which he/she acquired at birth (domicile or origin) or the domicile which he/she acquired or maintained as a result of actions taken by him/her (domicile of choice).
  • For a legitimate child, which was born when the father was alive, the domicile of origin of the child is the domicile of origin of the father, at the time the child was born.
  • For a legitimate child, which was born after the father died or in the case of an illegitimate child, the domicile of origin in the domicile of origin of the mother, at the time the child was born.
  • A person may acquire a domicile of choice with his establishment in any country outside Cyprus with the intention of the permanent or indefinite residence in such a country.
  • A domicile of choice is maintained until abandoned in which case a new domicile of choice is acquired or the domicile of origin is reinstated.

For the purposes of the SDC Law only, an individual who has a domicile of origin in Cyprus as described above may still be considered not to be domiciled in Cyprus if:

  • He/she had the domicile of origin in Cyprus on the basis of the Wills and Succession Law but has obtained a domicile of choice in another country, provided he was not a tax resident of Cyprus for at least 20 years before the tax year in which he became a tax resident of Cyprus.
  • He/she has not been a tax resident of Cyprus for a period of 20 years prior to the introduction of the amendment to the SDC Law.

Notwithstanding the above, an individual who has been a tax resident of Cyprus for at least 17 years out of the last 20 years prior to the tax year will be considered to be "domiciled in Cyprus" and as such will be subject to special contribution for defence from the 18th year.

Notional Interest Deductions

The House of Representatives introduced a Notional Interest Deduction (NID) regime on corporate equity in an effort to encourage the injection of new equity capital into corporate structures rather than interest bearing and interest free loans (currently entitled to a tax deduction), effectively deleveraging the economy.

NID is allowed on new equity funds introduced into a Cyprus tax resident company and which are used for the operations of the company. The NID will be calculated on the basis of a "reference interest rate" which is equal to the yield on the ten year government bond of the country where the new funds are invested, plus three per cent with the minimum rate being the yield on the ten year government bond of Cyprus (currently around five per cent) plus three per cent.

It is important to understand the meaning of "new equity" in this context. New equity means any equity introduced into the business after 1 January 2015 including both share capital and share premium to the extent that it has been fully paid but does not include capitalisation of reserves resulting from the revaluation of movable and immovable property.

In order for NID to apply, the subscription price paid for the issue of shares must either be by cash or in kind. If consideration is in kind it cannot exceed the market value of the assets contributed with the valuation being subject to the satisfaction of the Director of Inland Revenue.

It should be noted that NID granted on new equity cannot exceed 80 per cent of the taxable profit of the company for the year preceding the deduction. If the company has made a loss, then the NID will not be available.

The Income Tax Law includes a number of anti-avoidance provisions aiming to:

  • Restrict the re-characterisation of old equity into new equity which would lead to claiming notional interest twice on the same funds through the use of multiple companies or arrangements lacking valid economic or commercial reasons.
  • Restrict claims of NID in case where the amounts of new capital of a business carried out by a company resident of Cyprus is derived directly or indirectly from amounts of new equity of another business carried out by a company resident of Cyprus so as to ensure that the deduction is granted only to one of these companies. 
  • Reduce claims of NID in the event that amounts of new equity are derived directly or indirectly from loans for which a discount regarding interest has been granted, so that the amount of interest deduction on the new equity is reduced by the amount of the interest deduction granted to the other company.
  • Ensure that the NID is calculated as if no company re-organisation has taken place.
  • Limit claims for NID from equity that existed prior to 1 January 2015 which are presented as new equity.

Capital Gains Tax Law

The Capital Gains Tax Law has been amended, exempting any capital gains from the disposal of immovable property purchased between 17 July 2015 and 31 December 2016 from tax. This exemption covers both land and buildings but does not cover property acquired as a result of a settlement of debt.

Footnotes

1 It should be noted that this is expected to be increased from five years to ten years. 

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.

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