The benefits of financing business operations through equity in Cyprus
From 01 January 2015, Cyprus tax resident companies and permanent establishments of Non-Cyprus tax resident companies that inject new equity for the purpose of producing taxable income are entitled to deduct from their taxable profits, a notional interest deduction (NID).
Why was NID introduced?
NID was introduced to the Cyprus tax legislation to reduce corporate debt and encourage new capital investment in Cyprus. NID helps support small and medium-sized businesses and also aligns the tax treatment of equity finance with the tax treatment of debt finance.
NID provides the opportunity for companies with proper tax planning to reduce their tax rate in Cyprus from 12.5% down to 2.5%, thus gaining a significant tax advantage. NID increases the benefits of using a Cyprus tax resident company in the financing structures of international groups as a centre.
Who can benefit?
Any Cyprus tax resident company or permanent establishments of Non-Cyprus tax resident companies.
How is NID calculated?
NID = New Equity * NID Reference Interest Rate
What is considered as new equity?
New equity for the purposes of NID can be any form of paid up share capital or share premium, either in cash or in kind, contributed to the company from 01 January 2015, for the production of taxable income. In the case that new equity is contributed in the form of in kind, the company must ensure that the new equity value does not exceed the market value of the asset.
A few examples of new equity are listed below:
- Loans payable and other debt instruments converted into issued share capital;
- Shareholders' credit balance converted into issued share capital;
- Non-refundable capital contribution converted into issued share capital;
- Realised reserves created after 01 January 2015 converted into issued share capital;
From 01 January 2021, NID can no longer be claimed on equity arising from capitalisation of reserves existing on 31 December 2014. There is however an exemption to this rule. The exemption applies to the circumstances where the capitalisations of such reserves create new business assets that did not exist on 31 December 2014.
Where do we calculate the NID reference interest rate?
On 16 June 2020, an amending Income Tax Law was published in the official Gazette of Cyprus with respect to the NID. The amendment was made to announce new provisions and detailed clarifications.
NID reference interest rateuntil 31 December 2019 was the yield on the 10 year government bond (as of 31 December of the previous tax year) of the country in which the new equity had been injected in, increased by 3% premium. Up to this date, there was also a minimum reference rate, which was the yield of the Cyprus 10-year government bond plus 3% as at 31 December of the relevant year.
As of 01 January 2020, reference rate is calculated by adding a 5% premium to the 10-year government bond yield (as at 31 December of the previous tax year the NID is claimed) of the country where the new equity is employed. Also as of 01 January 2020, the minimum reference rate is not applicable anymore.
In the event that the country in which the new capital has been invested in does not issue government bond, then the reference interest rate will be the government bond yield of Cyprus as at 31 December of the relevant year, plus 5% premium.
Rates for 2021 are seen below:
|Column1 Country:||NID Reference Interest Rate 2021|
|British Virgin Islands||N/A||N/A|
|Isle of Man||0,985||5,985|
|United Arab Emirates||N/A||N/A|
Are there any restrictions to the formula?
There are a few key issues to keep in mind when calculating the NID. The amending law back in June 2020 has clarified that NID must not exceed 80% of the company's taxable income that was generated from the employment of the new equity. If a company has financed various business assets by the new equity, then the 80% restriction should be applied separately to the taxable income of each business asset.
In the event that a company has made a tax loss from the use of the new equity, then no NID is available.
- NID must be calculated every year since items such as reference rates and taxable income very from year to year.
- NID is notional; therefore there is no need for any accounting entry and no effect on the company's accounting profit/loss.
- In November 2020, the EU Code of Conduct Group (Business Taxation) and ECOFIN confirmed that the Cyprus NID regime has been evaluated as "not harmful" since its introduction- 1 January 2015.
With the correct tax planning, NID can offer a tax efficient alternative to debt financing while enhancing benefits of financing business operations through equity.
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.