Cyprus – Notional Interest Deduction Scheme

By way of Circular No. 2016/10 issued by the Cyprus Tax Authorities on the 1st August 2016, further information and clarifications were given as to the application of this Scheme and the interpretation of its various terms and definitions, which are expected to provide valuable guidance as to the actual application and implementation by the Cyprus Tax Authorities. It should also be noted that the Circular also provides actual practical examples for reference.

The key provisions are summarized below.

A. What is the Notional Interest Deduction Scheme

The introduction of the Notional Interest Deduction Scheme was aimed to level the playing field on the tax treatment between companies funded with debt as against companies funded with equity. As a further objective, the Notional Interest Deduction Scheme was aimed to encourage growth in Cyprus-based companies and to strengthen their equity base. The disparity occurring was that companies being funded by way of a debt (typically a loan) would deduct accrued interest expenses leading to lower imposition of tax, which was not available to companies which were being funded by way of equity. With the introduction of the Notional Interest Deduction Scheme, the Cyprus taxpaying company which is funded with equity may now also claim a deduction of the notional expense computed as a percentage of any equity introduced after 2015.

B. Meaning of “New Equity”

As per the provisions of the Circular, “New Equity” under the Notional Interest Deduction Scheme is indicated by way of various examples and scenarios, and can also include capitalization of realized reserves and new equity in the form of assets.

C. Definition of the “Reference Interest Rate”

“Reference Rate” is defined under the Circular to mean the yield rate of the 10-year government bond of the State in which the new capital is invested, increased by 3%, having as a minimum the yield rate of the 10-year government bond of the Republic of Cyprus applicable on 31 December of the year preceding the tax year for which NID is claimed increased by 3%. The Cyprus Tax Department will post an announcement on its website of the reference rate of selected states for Notional Interest Deduction purposes at the beginning of every tax year. The reference rates are determined by the Ministry of Finance based on the yield of the 10-year government bond of the respective states.

D. The principle of “Matching”

With reference to the calculation of the maximum Notional Interest Deduction allowed to be claimed under the Scheme, the Circular has introduced the ‘’matching’’ principle.

Under this “matching” principle, the new equity introduced should be matched with the taxable income that arises from specific assets or group of assets or activities, as a result of the introduction of this new equity for the purposes of the Notional Interest Deduction scheme.

In reference to assets relating to the same activity, these may be grouped as follows:

  • Assets with the same reference rate, for which Notional Interest Deduction is restricted to 80% of taxable income generated by the use of new equity.
  • Assets with the same reference rate for which Notional Interest Deduction does not exceed (and therefore is not restricted to) 80% of taxable income generated by the use of new equity.

If it is not possible for the new equity to be matched to assets or a group of assets or activity, the new equity can be apportioned to unmatched assets or group of assets or activity, in proportion to their cost.

E. Anti-Abuse Provisions

The Circular clearly states that each case will be examined on its own merits and that no Notional Interest Deduction will be allowed if, pursuant to the view of the Tax Commissioner, the transaction takes place without any substantial economic or commercial purposes, but instead it appears that its principal target is to erode the tax base.

View as PDF

Categories