Notional Interest Deduction
The Cyprus Tax Department has recently announced the official 2017 reference rates to be used for Notional Interest Deduction (NID) purposes. Specifically, Article 9B of the Income Tax Law of 2002 as amended provides for a notional interest deduction for tax purposes on new equity capital injected into Cyprus resident companies or permanent establishments of foreign companies in Cyprus as from 1st of January 2015, provided the new equity funds are used for business purposes.
The above-mentioned provision allows for a tax benefit through a Notional Interest Deduction (NID) on new equity. The provision, not only reduces the effective tax of the Cyprus company by up to 80%, but it also effectively tackles the topical tax issue of being the ‘beneficial owner of income’, especially in the cases of loans granted by the Cyprus company.
The advisable and beneficial practice following the NID provisions is that instead of engaging the Cyprus company through a back-to-back loan arrangement, one can take advantage of the NID provisions and grant out a loan through own funds that were introduced in the share capital of the Cyprus company. The outcome of the above could be proven very beneficial as it could entitle Cyprus companies to receive NID and at the same time to tackle the issue of beneficial owner of income test on interest received by the borrower.
Notional Interest Deduction (NID)
Equity introduced to a company as from 1 January 2015 (new equity) in the form of paid-up share capital or share premium may be eligible for an annual notional interest deduction (NID). The annual NID deduction is calculated as the new equity multiplied by the NID interest rate. The relevant interest rate is the yield on 10 year government bonds (as at December 31 of the prior tax year) of the country where the funds are employed in the business of the company plus a 3% premium (subject to a minimum amount which is the yield on the 10 year Cyprus government bond as at the same date plus a 3% premium). For 2018 the minimum relevant NID interest rate is 4,881% (6,489% for 2017). A taxpayer may elect not to claim all or part of the available NID for a particular tax year. Certain anti-avoidance provisions apply.
The whole amount of interest expense if the subsidiary does not own (directly or indirectly) any assets not used in the business. A restricted amount of interest expense is allowed to the extent the subsidiary owns (directly or indirectly) assets used in the business. It is expected that as from 1 January 2019 an interest limitation rule will apply in accordance with the EU relevant Directive.
The NID deduction cannot exceed 80% of the taxable profit derived from the assets financed by the new equity (as calculated prior to the NID deduction).