Article 9B of the Income Tax Law together with Circular 2016/10 is effective since 1 January 2015. The objective is to harmonize the tax treatment of equity financing and debt financing at an effort to encourage Companies to use equity financing and hence reduce dependence on debt financing and increase Cyprus Companies competitiveness. NID applies to Cyprus Tax Resident Companies and Cyprus Permanent Establishments of non-resident Companies.
New equity is defined as paid up (either in cash or asset(s) in kind) share capital and share premium issued as from 1 January 2015. NID interest rate is defined as the yield on 10 year government bonds of the jurisdiction where the funds are employed plus 3%.
C.Further explanations and Circular 2016/10 clarifications
New equity – For the asset(s)-in-kind to be contributed for the new equity, the value of the new equity cannot be higher than the market value of the asset(s) to be contributed. Independent valuation is required by the tax authorities. However if there is an active open market of the asset(s) to be contributed then the independent valuation is not required. In addition, the tax authorities do not require independent valuation if any of the following apply:
- Asset(s) were recently acquired from un-related person(s);
- The new shareholder was not previously related in any way with the Company;
- The valuation is not complex.
In relation to the new equity, Circular 2016/10 also clarifies the following in relation to what can be considered to be qualified as new equity:
- Ordinary, preference, redeemable and convertible shares of any class;
- In case the share capital has not been paid, but an interest bearing receivable has been recognised;
- New equity issued against reserves created as from 01.01.2015;
- New equity issued against reserves created before 01.01.2015, in case the new equity funds are used to finance new business asset(s);
- New equity funds are used to repay loans payable and other credit instruments.
Circular 2016/10 also provides further clarifications in relation to permanent establishment and Companies that change their tax residency to Cyprus.
NID Interest rate – As mentioned above this is the yield on 10 year government bond of the jurisdiction where the funds are directly used (invested) plus 3%. There is a minimum rate which is the yield on 10 year Cyprus government bonds plus 3% and the reference date is the 31 December of prior tax year.
Based on Circular 2016/10, NID interest rate is specified in accordance with Bloomberg yield curve. The tax authorities will publish on a yearly basis the NID rates of various jurisdictions on its website.
Capital Reduction – In case of capital reduction then this is considered to be done out of the equity associated with the assets/ activities being distributed. In addition, in case the assets/ activities are cash or assets/ activities not associated with any equity, then the capital reduction is considered to be done in the following priority:
- New equity not associated with specific assets/ activities creating taxable income;
- New equity not associate with specific assets/ activities creating non-taxable income and
- Old equity.
NID is deducted in the same way as interest expense on normal loan payables. As clarified by circular 2016/10, the period that a Company is allowed to benefit from the deduction is from the date that the new shares issued were used for the Company’s taxable activities until the date that these new shares ceased being part of the capital (i.e. through capital reduction). There is a cap that can be deducted and the deduction cannot exceed 80% of the taxable profits (as these have been computed prior to NID). Any unused NID due to the 80% cap is lost.
In order for a Company to be able to claim NID, it requires to define the assets/ activities that the Company invested in by the issue of the new shares together with the taxable profits that were created from these.
The effective tax rate is as low as 2.5% if maximum NID is available.
E.Practical Application – Steps required for computing NID deduction
- Define each asset financed by the new shares;
- Define the taxable profits gained from each asset financed by the new shares;
- Compute the available NID per asset (capped to 80% of taxable profit gained from the asset) and the total available NID (capped to 80% of the total taxable profits/ losses gained from all assets);
- The following priority order is required to be followed regarding allocation of new shares: (a) Direct matching of new shares to specific asset (b) Apportionment of new equity to non-business assets and assets not creating taxable income (c) Pro-rata apportionment of remaining assets/ activities.
NID provides tax incentives for new investments through existing or new Cyprus Companies and permanent establishments. Correct structuring/ planning of your business may result to benefit the maximum of the provisions of the specific law and ultimately be charged as low as 2.5% of effective tax rate.