The Cyprus House of Representatives approved on 5 June 2020 certain amendments to Section 9(B) of the Income Tax Law (‘the Law’) regarding the provisions for application of the Notional Interest Deduction (NID). The amendments were enacted into law upon publication in the Official Gazette of the Republic on 16 June 2020.
The NID first came into effect as of 1 January 2015 and allowed for Cypriot companies (or foreign companies with permanent establishments in Cyprus) carrying out business activities to claim a notional tax deduction against taxable income generated through the application of ‘new’ equity introduced on or after 1 January 2015.
The EU Code of Conduct Group (“the Group”) has recently carried out a review of NID regimes of all EU member states from a harmful tax perspective. The amendments to Section 9(B) of the Law are largely based on the recommendations of the Group. Further to these amendments, it is expected that the Group’s review of the Cyprus NID regime will be positively finalised.
- Full details regarding the Cyprus NID can be found in our Information Sheet 130.
- The reference rates for calculation of the NID for 2020 can be found here.
In a nutshell
The amendments to the NID provisions are summarised as follows:
- With effect from 1 January 2020, the use of the Cyprus 10-year government bond as a minimum rate in determining the NID reference rate is abolished. In addition, the premium applied on top of the 10-year government bond yield is increased to 5% (instead of 3%).
- With effect from 1 January 2021, the capitalisation of reserves that existed prior to the introduction of NID will no longer be considered as new equity, regardless of whether such equity is related to new assets used in the business.
- The wording of Section 9(B) of the Law has been amended so as to better express the matching of new equity with the net taxable profit arising from such new equity.
1. Reference NID rate
NID is a notional tax allowable deduction that can be claimed as from 1 January 2015 by Cypriot tax resident companies (or by Cypriot permanent establishments of foreign companies) carrying out business activities against their taxable income, provided that such income is generated through the application of new equity (explained in Part 2 below). NID is calculated by applying a reference interest rate to the new equity.
Up to 31 December 2019, the reference interest rate was equal to the higher of:
- the yield of the 10-year government bond of the country in which the new equity was invested as at 31 December of the year preceding the year of assessment, increased by 3%, and
- the yield of the 10-year government bond of the Republic of Cyprus as at 31 December of the year preceding the year of assessment, increased by 3%.
As of 1 January 2020:
- the Cyprus government 10-year bond yield will no longer be used as a minimum for the purpose of calculating NID. Only the yield of the 10-year government bond of the country in which the new equity is invested will be taken into account
- the premium which is added on top of the aforementioned yield is now 5% (instead of 3%).
The Law clarifies that in case where the country in which the new equity is invested has not issued any government bond up to and including 31 December of the year preceding the year of assessment, then the NID will be calculated with reference to the yield of the 10-year government bond of the Republic of Cyprus as at 31 December of the year preceding the year of assessment (increased by 5%).
2. Definition of ‘new equity’
The Law defines ‘new equity’ as capital introduced in the business on or after 1 January 2015. Prior to the amendments, any equity added to the business on or after 1 January 2015 and derived (directly or indirectly) from capitalisation of reserves that existed at 31 December 2014 was not considered as new capital, unless such capital related to new business assets, i.e. assets which did not exist prior to 1 January 2015.
As of 1 January 2021, the aforementioned exemption is abolished. From this date onwards, ‘new equity’ will be strictly defined as equity introduced in the share capital of a business on or after 1 January 2015. Thus, any new capital deriving from reserves existing as at 31 December 2014 will not be eligible for NID, regardless of whether such new capital is related to new assets used in the business.
3. Matching of new equity with taxable profit
The wording of Section 9(B) of the Law has been amended so as to explicitly clarify that, with retrospective effect from 1 January 2015:
- NID is capped to 80% of the net taxable income arising from the application of the new equity
- In case where a tax loss is incurred from the introduction of new equity, no NID is available in the relevant year
- The 80% restriction applies separately to the taxable profits generated from each individual business asset financed by the new equity.
Prior to the amendments, the Law simply stated that the amount of NID could not exceed 80% of the ‘chargeable income’, and that in case of a ‘tax loss’, no NID was allowed. Thus, there was no clear matching between the new equity and the taxable profit (or tax loss) generated through the application of that new equity.
Notwithstanding the above, the methodology that has been applied in practice by tax authorities since 2015 was in any case to match new equity with the net taxable income generated from such new equity, in accordance with the guidance provided in the Tax Department’s Circular 2016/10.