The race to attract innovation and investment that is being observed in recent years has generated the need for legal reform and introduction of incentives for the promotion of Cyprus as a favorable jurisdiction for this market.
As part of the efforts, the framework of the National Policy Statement for the Enhancement of the Entrepreneurial Ecosystem in Cyprus has amended the Income Tax Law to include certain tax relief provisions for enterprises that have qualified as innovative, and their investors.
In order to qualify as innovative, a small and medium-sized enterprise (SME) must meet the following criteria:
- Its operations are carried out in the Republic of Cyprus, and
- At the time of the investment, it is an unlisted SME having a business plan (only if it has no financial records) for its risk finance investment and fulfils at least one of the following conditions:
- It does not operate in any market; or
- It has not been operating in any market for more than seven years following their first commercial sale; or
- It requires an initial risk finance investment which, based on a business plan prepared in view of entering a new product or geographical market, is higher than 50% of their average annual turnover in the preceding five years.
Risk-finance investment is defined as equity and quasi-equity investments, loans including leases, guarantees or a mix thereof, to eligible undertakings for the purposes of making new investments and also includes follow-on investments.
To qualify as innovative, an enterprise should acquire a statement provided by an independent auditor confirming that the research and development expenditure represent at least 10% of its total operating costs -
- In at least one of the three years preceding the granting of the aid, or
- In the case of a startup enterprise without any financial history, in the audit of its current fiscal period.
In the absence of audited financial statements, as is the case with start-ups, the Ministry of Finance approval may be provided on the basis of a business plan, describing the ability to develop new or clearly improved products, services or processes with high technological or industrial risk, which are characterized as innovative in their field.
A business will automatically cease to be considered an innovative SME if, at any time, the total amount of risk finance exceeds €15 million. The innovative SME should not be listed on the Cyprus or any other Stock Exchange.
Both the SME and its investors are eligible for certain deductions. This is in line with the motivation of these incentives, which is essentially to promote Cyprus as an innovation and start-up hub, and encourage investment in these businesses.
Certified innovative SMEs enjoy a corporate tax deduction for scientific research expenditure or R&D expenditure, if incurred for the use and benefit of the business.
Any such expenditure that is of a capital nature may be deducted from taxable income equally in the year incurred and in the following five years (i.e. over a total of six years), unless it falls under an asset class for which a different useful economic life (capital allowance rate) is provided.
In terms of investor incentives, a qualifying investor who makes a risk-finance investment in an innovative SME may deduct the costs of the investment from their taxable income, subject to the following limitations:
- Percentage Limit: The tax deduction is limited to 50% of the investor's taxable income in the year in which the investment is made, as calculated before allowing for this deduction but after allowing deductions for life insurance premiums and contributions to provident and other approved funds.
- Annual Limit: The total deductible amount may not exceed EUR 150,000 per year.
- Carry forward: The remaining investment cost not claimed as tax deductible may be carried forward and deducted from the taxable income of the subsequent five years, subject to the aforementioned restrictions.
This tax incentive takes effect from 1 January 2017. This means that any qualifying investment being made to an innovative company after 1 January 2017 and before 30 June 2024 should be declared by the investor in their Income Tax Statement in that year.
Certain exclusion clauses that may restrict the deductibility of the expense, if the investor does not maintain the investment for a minimum period of three years, or if the tax authorities consider that actions have taken place that exceed the maximum ceilings set by the rules, also apply.
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.