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Cyprus Companies Notional Interest Deduction (NID)

 

 

Cyprus Companies, Cyprus financing companies, Cyprus Notional Interest Deduction (NID) on new equity, new Cyprus taxation advantages and illustrative examples

The introduction of notional interest deduction will further strengthen the setting up of Cyprus companies and especially financing companies, investment companies and Cyprus Alternative Investment Funds – AIFS).

Cyprus Companies are often used to finance other associated foreign companies. This is achieved by setting up a Company in Cyprus in order to finance other associated companies.

According to Cyprus new taxation laws, Cyprus companies that originally financed by own funds shall be given notional Interest deduction (NID). This will mean a reduction of the overall effective tax rate of a Cyprus Company depending on the level of Cyprus Company capitalization. The notional Interest deduction (NID) will be granted annually for as long as capital is used in the Company.

The new Cyprus taxation law on Cyprus Notional Interest Deduction (NID)

Equity. New equity can be introduced either in the form of cash or in kind. Where new equity will be introduced in the form of assets (in kind), the sum of these may not exceed the market value. Assets must be fully documented. Notional interest deduction (NID) will be given on new capital (share capital and share premium to the extent that they have been paid) issued from 1st January 2015.

Interest. Notional interest deduction (NID) will be calculated on the amount of new share capital / share premium the same way as with interest on loans. The rate of notional interest deduction (NID) is defined as the 10 year government bond yield (at December 31 of the year preceding the tax year) of the country in which the new equity is invested, increased by 3% and having as a lower limit the 10 year Cyprus government bond increased by 3%.

Notional interest deduction (NID) is deducted from taxable income but it cannot exceed 80% of taxable income (as defined for tax purposes) before deducting Notional interest deduction (NID).

The Cyprus notional interest deduction (NID) applies to companies that are tax residents of Cyprus and to companies which are not resident in Cyprus but have a permanent establishment in Cyprus.

The above will be applicable retrospectively as from 1 January 2015.

Cyprus Company illustrative example (In this case a Cyprus Company used as a Cyprus financing company)

– New equity is introduced in the Cyprus Company (CypCoA) in a form of capital

– The Cyprus equity is used to finance other associated foreign companies ForCoB i.e. by granting an interest bearing loan to foreign Company

– Associated foreign company will use the funds to finance its operations

– Cyprus Company receives income in a form of interest from foreign Company

– Cyprus Company pays dividends to foreign investor

Cyprus financing company – Cyprus taxation structure

 

 

 Illustrative example 1 of a Cyprus Company (In this scenario Cyprus financing company)

New equity is introduced in the Cyprus Company in a form of capital €10m. The equity consist a mixture of share capital and share premium fully paid up

Cyprus Company grants an interest bearing loan to foreign Company. The other foreign company jurisdiction 10 year government bond is 0.5% and the the Cypriot 10 year government bond is for example 5.5%.

Cyprus Company receives income in a form of interest from foreign Company at the rate of 10%

CYPRUS COMPANY A (IN THIS CASE CYPRUS FINANCING COMPANY)

 

STATEMENT OF FINANCIAL POSITION

 

 

Assets

 

 

Loan receivable

 

10.000.000

Equity                                                

 

 

Share Capital

 

10.000.000

 

 

 

INCOME STATEMENT

 

 

Interest received (10m x 10%)

 

1.000,000

Taxable income before Notional Interest Deduction

 

1.000.000

Cyprus Notional Interest Deduction is:

 

 

The higher of:

 

 

3.5% Foreign government bond rate + 3% X 10m

350.000

 

8.5% Cyprus government bond rate +3% X10m

850.000

 

And the lower of:

 

 

8.5% Cyprus government bond rate + 3% X10m

850.000

 

80% of taxable income i.e. X 1.000.000

800.000

800.000

Net interest income after Notional Interest Deduction

 

200.000

Cyprus tax at 12.5%

 

25.000

Effective tax on interest received

 

2.5%

 

Illustrative example 2

New equity is introduced in the Cyprus Company in a form of capita€10m. The equity consist a mixture of share capital and share premium fully paid up.

Cyprus Company grants an interest bearing loan to foreign Company. The other foreign company jurisdiction 10 year government bond is 0.5% and the Cypriot 10 year government bond is for example 4%.

Cyprus Company receives income in a form of interest from foreign Company at the rate of 10%

CYPRUS COMPANY A (IN THIS CASE CYPRUS FINANCING COMPANY)

 

STATEMENT OF FINANCIAL POSITION

 

 

Assets

 

 

Loan receivable

 

10.000.000

Equity                                                

 

 

Share Capital

 

10.000.000

 

 

 

INCOME STATEMENT

 

 

Interest received (10m x 10%)

 

1.000,000

Taxable income before Notional Interest Deduction

 

1.000.000

Cyprus Notional Interest Deduction is:

 

 

The higher of:

 

 

3.5% Foreign government bond rate + 3% X 10m

350.000

 

7.0% Cyprus government bond rate +3% X10m

700.000

 

And the lower of:

 

 

7.0% Cyprus government bond rate + 3% X10m

700.000

700.000

80% of taxable income i.e. X 1.000.000

800.000

 

Net interest income after Notional Interest Deduction

 

300.000

Cyprus tax at 12.5%

 

37.500

Effective tax on interest received

 

3.75%

 

 Illustrative example 3

New equity is introduced in the Cyprus Company in a form of capital €10m. The equity consist a mixture of share capital and share premium fully paid up.

Cyprus Company grants an interest bearing loan to foreign Company. The other foreign company jurisdiction 10 year government bond is 3.75% and the Cypriot 10 year government bond is for example 3.50%.

Cyprus Company receives income in a form of interest from foreign Company at the rate of 10%

 CYPRUS COMPANY A (IN THIS CASE CYPRUS FINANCING COMPANY)

 

STATEMENT OF FINANCIAL POSITION

 

 

Assets

 

 

Loan receivable

 

10.000.000

Equity                                                

 

 

Share Capital

 

10.000.000

 

 

 

STATEMENT OF FINANCIAL POSITION

 

 

INCOME STATEMENT

 

 

Interest received (10m x 10%)

 

1.000,000

Taxable income before Notional Interest Deduction

 

1.000.000

Cyprus Notional Interest Deduction is:

 

 

The higher of:

 

 

6,75% Foreign government bond rate + 3% X 10m

675.000

 

6.50% Cyprus government bond rate +3% X10m

650.000

 

And the lower of:

 

 

6,75% Foreign government bond rate + 3% X 10m

675.000

675.000

80% of taxable income i.e. X 1.000.000

800.000

 

Net interest income after Notional Interest Deduction

 

325.000

Cyprus tax at 12.5%

 

40.625

Effective tax on interest received

 

4.06%

 

Cyprus Taxation Consequences

–     Low or no withholding tax on interest payments due to the “favorable” Cyprus double tax treaty network or EU directives

–     Deductability of interest expenses in the borrowing company

–     Provided that one of the major business activities of the Cyprus Company is that of financing activities, the Cyprus Company will be taxed at a Corporation tax rate of 12,5%

–     Cyprus Notional Interest Deduction (NID) is deducted from interest income and therefore Interest income is taxable in Cyprus at an effective tax rate of 2.5% i.e. (20% X 12.5% – 80% is given as a notional interest deduction)

–     No withholding tax on dividend payments from Cyprus at all times

Conclusion and our views

–     The new law aims to harmonize the tax treatment of equity finance with the tax treatment of finance by borrowing (equal treatment). It aims also to further strengthen Cyprus companies’ competitiveness. Investors will now be financing their companies through equity instead through borrowings without entering in the process of creating complex corporate structures ‘back to back’ borrowing etc.

–     It is expected that there will be no law contradictions between EU and Cyprus as Notional Interest Deduction is already applied with success in other Member States. Furthermore legal advice was taken as to the compatibility with EU regulations and BEPS.

Since now the Cyprus companies will not have the need to redistribute interest in the form of ‘back to back loans’, Cyprus companies will now enjoy interest levied as beneficial owners. This will further enhance Cyprus Companies’ economic substance. This will also strengthen the position of Cyprus through its double tax treaties  network.

Similarly, Cyprus investment funds (Cyprus Alternative Investment Funds – AIFS) are expected to enjoy the new Cyprus taxation benefits

 

How PKF Can Help

We can review and evaluate your existing company structure taking into account the benefits of the new tax legislation.

Please contact us to share tax issues that concern you. All information is treated in strict confidence.

Contact details

Tel. +357 22 462727
Email: [email protected]

 

(Published: Oct. 2015) 

PKF / ATCO Limited is a member firm of the PKF International Limited network of legally independent firms and does not accept any responsibility or liability for the actions or inactions on the part of any other individual member firm or firms. This publication is for information purposes only and should not be considered as professional advice.