The Notional Interest Deduction is a powerful tax instrument provided by Cyprus to local and international companies that allows these companies to reduce borrowed funds and generate tax-efficient returns on new (qualifying) capital.
The Notional Interest Deduction Regime (or NID) has been introduced into Cypriot legislation to harmonize the equity financing tax regime with the debt financing tax regime, promote capital-intensive investments in Cyprus, and as additional support for small and medium-sized businesses.
In 2015 the Income Tax Law (Section 9B) was amended. In accordance with this amendment, the tax-resident companies in Cyprus as well as foreign companies conducting business with a permanent establishment in Cyprus, from 1st January 2015 have the right to reduce the amount of their taxable income received from raising new capital for the company by the amount of “notional” interest expenses.
How is NID determined?
The notional interest expense is calculated by multiplying the base NID rate and the cost of new capital:
NID = Base NID rate X new capital
However, the following conditions and restrictions apply:
- NID is capped at 80% of the taxable profit of the company until NID is deducted.
- NID cannot be applied in case of losses from the use of new capital.
- Unused NID cannot be credited against the profits for future years.
- NID applies not only in the year of the capital injection but also for all the subsequent tax years, as long as new capital remains.
- New capital can be contributed in cash or in the form of other assets - in this case, the amount of new capital will be equal to the market value of the assets agreed with the tax authorities.
- NID is deductible in the same way as the actual interest expense (i.e. only if it is used to fund most types of business assets).
- NID is not available in relation to capitalization of reserves, revaluation of assets, or for the companies enjoying reorganization incentives included in the tax legislation. Also, NID can be rejected if the tax authorities consider that the transaction has no economic or commercial purpose.
How is the base NID rate determined?
The base NID rate is the sum of the 10-year government bond rate of return of the country in which the assets financed with new capital are located (prior to January 1st 2020 the highest of the 10-year government bond rates of the country in which the assets are located was used, and 10-year government bonds of Cyprus) and a premium of 5% (before January 1st 2020 the premium was 3%). The bond yield rates used in the calculation of the base NID rate are the same as the 10-year government bond rates of the country in which the new capital assets are located, in effect on 31st December of the year prior to the valuation year.
New capital for NID purposes
New capital is defined as one of the following:
- Any paid-up share capital (common, preferred, redeemable and convertible) and/or share premium added after January 1st, 2015.
- Loans payable converted to the issued share capital.
- The shareholder credit balance converted to the issued share capital.
- The non-refundable equity contribution converted to the issued share capital.
- Any realized reserves that existed prior to 01/01/2015 and were converted to the issued share capital will qualify as new capital only if it can be proven that the reserves were used for the tax-exempt assets prior to the conversion and after the conversion, the reserves will be used for the assets of taxable activities.
New capital can be invested in the company either in cash or in kind. If new capital is in the form of an asset, the new capital should not be higher than the market value of the asset.
From January 1, 2021 “new capital” will be strictly defined as the capital contributed to the authorized capital of a business starting from January 1, 2015.
Therefore, any new capital derived from the reserves that existed on December 31, 2014 will not be eligible for participation in NID, regardless of whether such capital is related to new assets used in the company's business. The company's reserves created from January 1, 2015, or “new” reserves, will retain the right to “capitalize” into qualifying capital if certain conditions are met.
NID calculation example
Here is an example of calculating NID amount that will be used in calculating taxes, based on the following specified values:
- The company has introduced new capital in the amount of €1,800,000.
- Base NID interest rate (bond yield + premium) was 8.5%.
- Taxable income (Before NID) was €500,000.
NID = Base NID rate Х New capital = 8.5% Х €1,800,000= €153,000,
Since NID doesn’t exceed 80% of the profits earned before NID is applied, the entire amount received will be deducted from the taxable profits.
The taxable income after applying for NID will be €347,000.
Amazon Corporate & Immigration Services can help you analyze and evaluate your company’s capital and the asset structure in terms of NID deduction.