Starting from 2015 Cyprus companies and non-resident companies with a permanent establishment in Cyprus can apply the notional interest deduction (NID).
Notional interest deduction is a type of a tax deduction from the taxable income of a company which is calculated according to the following formula:
NID = “new equity” * “reference rate”
In order to apply the NID a company shall use “new equity” to generate its taxable profit. New equity is any equity that was contributed to a company as from 1 January 2015. New equity shall be introduced to a company in the form of paid up share capital or share premium and can be either in cash or in kind. In case the assets are contributed in kind, the amount of new equity shall correspond to the market value of the asset, i.e. to be substantiated.
The “reference rate” is the yield of the 10-year government bond (“Bond’s rate”) of the country where the funds are employed, plus 3%. The reference rate, however, shall not be less than the Cyprus Bond’s rate plus 3%.
The applicable Bond’s rate is determined as of 31 December of the year, preceding the tax period, where the NID is applied. For example, to apply NID in 2018, the Bond’s rate as of December 31, 2017 shall be used.
The Cyprus Tax Department yearly publishes Bond’s rates. For instance, the Bond’s rate of Cyprus as of the 31st of December 2018 is 2.302%. In case of the UK the Bond’s rate is 1.275% and in case of Italy the Bond’s rate is 2.739%. Since the UK Bond’s rate is lower than the Cyprus one, if a company employs its funds in the UK, it should rather apply the Cyprus Bond’s rate instead of the UK Bond’s rate.
As a result of the emission of new shares, the company has attracted EUR 1 000 000 of “new equity”. The company employs such new equity to conduct its business activity in Cyprus and gained EUR 300 000 of profit. The company has also incurred expenses in the amount of EUR 200 000. Consequently, the taxable income of the company is EUR 100 000. Now we should calculate the amount of NID which the company may expect in 2019 as a result of attracting new equity in the amount of EUR 1 000 000:
NID = EUR 1 000 000 (new equity) * 5.302% (2.302% (Cyprus Bond’s rate) + 3%) = EUR 53 020
As a consequence of the NID application, the company has the right to deduct EUR 53 020 from its taxable income of EUR 100 000. Therefore, the taxable income of the company is EUR 46 980, which is 50% less than it was before the application of the NID.
The NID may be used each year insofar as the new equity is not diminished and is further used by a company to receive income.
The maximum deduction cap, which may be achieved with the use of the NID, cannot exceed 80% of the taxable profit of a company, calculated prior to the application of the NID. This means that the effective corporate tax rate of a Cyprus company which applies the NID may reach 2.5%.
The NID does not apply if a company has tax losses, nor the NID can create a tax loss, nor increase losses, which can be carried forward.
The tax authority has the right to refuse the application of the NID, if it suspects that a company’s business operation or certain activity did not have any economic goal but to use the NID.
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