Cyprus: Notional Interest Deduction (NID) – Tax Advantages On New Equity For Companies

Last Updated: 20 June 2016
Article by Charles Savva

Earlier in 2016 it was announced by the Tax Department that the 10-year bond rates of 2015 tax year will form the basis of Notional Interest Deduction (NID) for 2015 tax year for Cyprus, Romania, Russian, Germany and India.

The NID measure was introduced and enforced as from 1 January 2016.This reflects the broad objective of the measure, which was to align the tax treatment of financing a company with equity with the tax treatment of financing with debt in order to allow companies to strengthen their capital structure without giving up the benefit of tax-deductible interest payments.

NID in brief

It is an annual tax allowable expense, calculated as a percentage of new equity introduced in a company from 1 January 2015 onwards. A company can claim this annual tax expense indefinitely until there is a share capital/premium reduction or redemption of preference shares.

Objective of the NID

Is to reduce corporate debt by increasing the attractiveness of equity from a tax perspective, creating a tax lowering effect to many companies. Furthermore, the introduction of the NID enhances the international attractiveness of the Cyprus tax system as the effective tax rate can now be minimized from 12.5% to as low as 2.5%.In particular for equity intensive activities (e.g., group financing, intellectual property, etc.)

Who it applies to

Cyprus tax resident entities and the Cypriot permanent establishments of non-resident entities.

What is "new equity?"

New equity is defined as new capital injections into a company, either in the form of paid-up share capital or share premium.

How is the NID rate determined?

The rate of the NID is the higher of:

1) The yield of the 10 year Cyprus government bond at the end of the previous tax year (i.e. for 2015, as at 31 December 2014) plus a margin of 3%, or

2) The yield of the 10 year government bond in the country where the funds are employed within the business of the company, at the end of the previous tax year, plus a margin of 3%.

NID is calculated using the formula below

Notional interest deduction = notional interest rate (official bond rate+ 3%) x adjusted equity

Country

Official Bond rate

Cyprus

5.037%

Germany

0.54%

India

7.86%

Romania

3.57%

Russia

13.73%

Important note:

Actual NID is restricted to 80% of company's taxable income of the year,as calculated before the inclusion of the NID in the tax computation. Any amount restricted cannot be carried forward.

Furthermore, the taxpayer has the right not to claim the whole amount of the NID (e.g. when there are unused tax losses brought forward which expire, or tax losses available from other group companies). Similar to the Cap, any unutilised amounts cannot be carried forward.

For countries having lower bond rate than Cyprus the base rate for calculation purposes will be the Cypriot bond rate (5.037%+3%)

Basically determined bond rate> Cypriot bond rate +3%

Anti-avoidance measures:

Several anti-avoidance and anti-abuse measures have been introduced in order to restrict the "non-commercial" use of the NID.

1) In case of double tiered structures (Shareholder -> CypCoA -> CypCoB) the NID is available to only one company (either CypcoA or CypCoB).

2) If an entity within the group has claimed in Cyprus an interest expense deduction on funds used to finance new equity, then the NID is reduced by that interest expense. For example, CypCoA borrows at 5% and uses the proceeds to inject new equity in CypCoBCypCoB can only claim NID of 3.02% for the year 2015.

3) Company reorganisations are ignored for the purposes of the NID.

4) The Commissioner of Taxation may decide not to grant the NID, if:

a) He considers that actions or transactions have taken place without substantial economic or commercial purpose, which aim at granting the NID; or

b) The new equity, for which a claim for NID is made, was derived from capital that existed prior to 1st January 2015 and which is presented as new capital through actions or transactions with related parties, with the main purpose of granting the NID.

Tax planning opportunities

There are significant tax planning opportunities arising from the introduction of the NID.

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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Charles Savva
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