Cyprus Notional Interest Deduction (NID)
In September 2015, Cyprus introduced the Notional Interest Deduction (“NID”) regime. A new and powerful tax tool provided to business enabling them to create a return on new equity injected into a local business. The return is achieved by deducting a ‘notional’ interest expense from their taxable income subject to the value and the applicable reference rate.
Why was the Cyprus Notional Interest Deduction (NID) Introduced?
The legislator and the advisers realized that local business and entrepreneurs use financing arrangements rather than equity injections into operating business and as such this created an imbalance as to the treatment of equity finance and several companies being heavily geared rather than invested. In substance, the return on equity was not tax-deductible whereas the return of interest was and due to this deductibility a more interesting method of investment. Furthermore, the initiative aimed at promoting capital intensive foreign and local investments without necessarily leveraging the current business.
How does the Cyprus Notional Interest Deduction (NID) work?
Introduction to NID
In practical terms, an 80% deduction is afforded on the taxable profit generated by a Cypriot entity or up to the value of the new equity introduced into the Cyprus company.
|Without NID||After NID|
|Effective Tax Rate||12.5%||2.5%|
For the Cyprus Notional Interest Deduction to work new capital must be contributed to the Cyprus Company as from 1st of January 2015. Such new equity can be contributed to the company in cash or in-kind and in exchange for shares issued by the Cyprus company.
For in-kind contributions, care should be taken to evaluate and assess the market value of such assets since it is prohibited to increase the value of the assets. Effectively leading to an increase of the taxable bases.
NID Reference Interest Rate
The NID rate is the 10 year Cyprus government bonds as at 31st of December plus 3% premium. On the 30th of January 2019, the Department of Taxation issued an announcement to inform taxpayers of the 10 year Cyprus government bond rate for the year ended 31st of December 2018. Based on the announcement the NID reference Interest Rate for the year ending 31st of December 2018 is at 5.302% (2.302%-3%).
Historic NID Reference Interest Rates
|Country||Reference Rate 31/12/2018||Reference Rate 31/12/2017||Reference Rate 31/12/2016|
Cyprus Notional Interest Deduction Calculation
The department of taxation issued a circular providing seven practical numerical examples of NID calculations including one scenario whereby a Cyprus company issues new equity amounting to €150m and receiving funding of equal value. Thereafter the Cyprus company decides to use these funds to purchase three assets in three different countries as follows:
|#||NID Calculation||Asset 1 €m||Asset 2 €m||Asset 3 €m||Total €m|
|2||NID [New Equity x reference Rate]||7.2||6||9||22.2|
|3||Taxable profit after deduction direct and apportioned indirect expenditure||10||5||12||27|
|4||NID Cap (80% of the taxable profit [80% x (#3)]||8||4||9.6||21.6|
|5||Deductible NID for each asset [lower of (2) and (4)]||7.2||4||9||20.2|
|6||Taxable profit [(#3)-(#5)]||6.8|
The Cyprus entity may claim NID at the lower of the NID cap (#4) and Deductible NID for each asset (#5). The example assumes that the funding was available for the entire year and that the reference rates for each asset were Asset 1: 14.4%, Asset 2 12%, Asset 3 18%. For the interpretation of the Cyprus Notional Interest Deduction Regime understanding as provided by the Department of taxation visit this circular.
Common Structures Using NID
Foreign and local companies which would like to finance a project but prefer to avoid triggering tax leaks due to interposing entities can utlise the Cyprus Notional Interest Deduction (NID) to capitalize the financing vehicle followed by a loan or bond to the underlying operational entity.
Existing royalty income can be contributed to the Cyprus entity in exchange for shares. These shares qualify within the new equity definition and as such will allow the Cyprus Notional Interest Deduction to reduce the royalty income accordingly.