On 16 June 2020, amendment provisions on the Income Tax Law (N.66(I)/2020) were published in the Cyprus Government Gazette relevant with the application of the Notional Interest Deduction (NID).
The NID is a theoretical interest expense and has the same tax treatment as usual interest expense.
The NID is calculated by multiplying the amount of the “New Equity” introduced into the company, with the “Reference Interest Rate” subject to an annual cap of 80% of the taxable profits arising from the “new equity”.
Eligible for NID are the Cyprus tax resident companies and Cyprus permanent establishments (PEs) of non-tax resident companies provided that “New equity” is introduced into the business, which will be used by such business for the purpose of generation of taxable income.
A. Reference rate
Up to 31st December 2019
The reference rate was equal to the 10-year government bond yield of the country in which the funds raised from the new equity are invested, increased by 3%.
The 10-year government bond yield used for the calculation of the NID was the rate as at 31st of December of the previous year, of the year in which the NID is claimed.
The minimum reference rate was the yield of the Cyprus 10-year government bond (as at 31st of December of the relevant year) plus 3%.
From 1st January 2020
The new reference rate is the yield of the 10-year government bond (as at 31st of December of the year preceding the tax year the NID is claimed) of the country in which the funds from the new equity are invested, increased by 5% (previously was 3%) and there is no minimum reference rate.
In the event where the country in which the new equity is invested has not issued a government bond up to and inclusive the 31st of December of the year preceding the tax year the NID is claimed, the reference rate will be equal to the Cyprus 10-year government bond yield plus 5%, of the year preceding the tax year the NID is claimed.
B. New Equity
New Equity, based on the existing provisions, is defined as the “equity introduced” into the company on or after the 1st of January 2015 and used for the generation of taxable income, but which do not include amounts derived from the capitalisation of “old equity” meaning the capital existing at 31st December 2014.
An exemption to this rule is when the new business assets arise from the capitalisation of such “old equity” did not exist on 31st December 2014.
According to the recent amendments, “New Equity” is now defined as the “equity introduced” into the company on or after the 1st of January 2015 and used for the generation of taxable income. Therefore, the NID cannot be claimed on equity arising from the capitalisation of “old equity” irrespective of whether such equity is funding new business assets.
This new provision is applicable as from 1st January 2021.
C. Restriction of 80%
The amending Law, specifies that for calculating the 80% restriction, the relevant taxable profits are those related with the new equity introduced. Further, it clarifies that the 80% restriction applies to the taxable profits which derive separately from each business asset that is financed by the new equity.
In case where tax losses arise from the injection of new equity into the business, no NID should be granted in the relevant tax year.
The amendments for the 80% restriction will apply retrospectively as from 1 January 2015.
In the light of the upcoming deadline of the 31st July 2020 for the submission of the 2020 provisional tax declaration, it is imperative for the taxpayers to take into account the recent developments of the Income Tax Law while performing the 2020 NID calculations.
Partner – Tax Department
Senior Associate – Tax Department