A Game Changer for Financial Services and Fintech Businesses
Fintech companies in Cyprus have been rapidly growing and expanding in recent years, thanks to the country’s favourable business climate and regulatory environment. The government has implemented several policies and initiatives to foster innovation and entrepreneurship, and the fintech sector has been a significant beneficiary of these efforts. Thanks to its robust and business-friendly regulatory framework, Cyprus has emerged as a prominent financial services hub.
One tax benefit Cyprus offers, apart from a low corporate tax rate of 12.5% % and a streamlined regulatory framework that allows for quick and easy business registration and licensing, is the notional interest deduction (NID), which enables companies to reduce their taxable income by a certain percentage of their equity.
By publishing an article on the NID regime, CX Financia aims to provide valuable insights and information to help companies navigate this tax incentive’s intricacies and make informed decisions about their tax planning and strategy.
What is Notional Interest Deduction?
- Notional interest deduction (NID) is a tax relief measure that allows a company to deduct a notional interest expense from its taxable income based on its equity.
- This deduction encourages businesses to finance their operations through equity rather than debt, improving their financial stability and reducing their debt servicing costs.
- Starting 1st of January 2015, new equity injected into a company as paid-up share capital or share premium is eligible for an annual notional interest deduction (NID). The NID deduction is calculated as an interest rate on the new equity and cannot exceed 80% of the taxable profit derived from assets financed by the new equity.
- To determine the interest rate, the yield on 10-year government bonds (as of 31st of December of the prior tax year) of the country where the funds are employed in the company’s business is considered, along with a 5% premium.
- The percentage of the NID that a company can claim depends on its business activity and the type of assets it holds. For example, companies engaged in financing activities can claim a NID of up to 80% of their tax-adjusted equity, while companies with intellectual property rights can claim up to 100%.
- For income tax purposes, interest expense incurred for the direct or indirect acquisition of 100% of the share capital of a subsidiary company is deductible, provided that the subsidiary company does not own any assets (directly or indirectly) that are not used in the business. However, if the subsidiary owns such assets, the interest expense deduction is limited to the amount related to assets used in the business. This rule applies to acquisitions of subsidiaries from 1st of January 2012.
- Since 1st of January 2017, the law has provided more comprehensive tax incentives in line with the General Block Exemption Regulation of the European Union to promote entrepreneurship and innovation in Cyprus. Under the new law, the innovative company must allocate at least 10% of its operating expenses on research and development in at least one of the last three years.
Key takeaways:
- NID applies to Cyprus tax resident entities and the permanent Cypriot establishments of non-resident entities.
- The rate of NID is determined by the higher of:
- The yield of the 10-year Cyprus government bond at the end of the previous tax year plus a margin of 5%; or
- The yield of the 10-year government bond in the country where the funds are employed within the company’s business at the end of the previous tax year, plus a margin of 5%.
An Example of NID Calculation
New equity is introduced in the Cyprus Company as capital €10m. The equity consists of a mixture of share capital and share premium fully paid up
New equity introduced €10,000,000
Cyprus Company grants an interest-bearing loan to a foreign Company. The other foreign company jurisdiction’s 10-year government bond is 3%, and the Cypriot 10-year government bond is, for example, 2%.
Loan receivable €10,000,000
Cyprus Company receives income in the form of interest from foreign Companies at the rate of 9%
| INCOME STATEMENT | |
|---|---|
| Interest received (10m x 9%) | €900,000 |
| TAX CALCULATION | |
| Cyprus Notional Interest Deduction is: | |
| The lower of: | |
| 8% (Foreign gov bond rate 3% + 5%) x €10m | €800,000 |
| 80% of taxable income, i.e. X €900,000 | €720,000 |
| Net income after Notional Interest Deduction (900,00 - 720,000) = €180,000 | |
| Cyprus tax at 12.5% x 180,000 = €22,50 | |
| Final Tax on interest received | 2.5% |
How Can Fintech Companies Benefit from NID Tax Incentives Boost Their Growth and Profits?
Fintech companies invest in technology and innovation to provide customers a wide range of financial products and services. They can benefit from NID in Cyprus because they often rely on equity rather than debt financing. This means that they do not have any interest expenses to deduct from their taxable income. However, with NID, they can still reduce their tax liabilities by deducting a notional interest expense based on their equity.
For example,
A fintech company in Cyprus has an equity of €1,000,000 and the NID rate is 3%.
The company can deduct a notional interest expense of €30,000 (3% of €1,000,000) from its taxable income.
If the company’s taxable income for the year is €500,000, it can reduce its tax liability by €30,000 and pay taxes on only €470,000.
In this way, NID can be a valuable tax incentive for fintech companies in Cyprus, helping them to reduce their tax liabilities and reinvest more capital into their businesses.
Benefits of NID
The NID provides several benefits to companies that operate in Cyprus, including:
- Lower tax liability: The NID can significantly reduce a company’s tax liability, increasing its profitability and cash flow.
- The lowest effective rate that may be achieved with the maximum deduction is 2.5% (12.5% CIT rate*(100% taxable – 80% taxable income/maximum NID deduction).
- Encourages equity financing: The NID encourages companies to finance their operations through equity, which can improve their financial stability and reduce their debt servicing costs.
- Attracts foreign investment: The NID is a special tax incentive that can attract foreign investors to establish operations in Cyprus, boosting the country’s economy.
Anti-Avoidance and Anti-Abuse Measures
Various anti-avoidance and anti-abuse measures have been implemented to curb the “non-commercial” use of the notional interest deduction (NID). These measures include the following:
- In double-tiered structures between Cyprus tax resident companies (such as Shareholder -> CoA -> CoB), the NID is only available to one of the companies (either CoA or CoB).
- Company reorganizations are disregarded for NID purposes.
- The tax commissioner can refuse to grant the notional interest deduction (NID) if :
- Some actions or transactions lacked substantial economic or commercial purpose and were done solely to obtain the NID or
- Suppose the new equity for which the NID is being claimed was derived from the capital before 1st of January 2015 and was presented as new capital through transactions with related parties with the primary intention of obtaining the NID. In that case, the commissioner can also deny the NID.
Final Thoughts
Combining innovative technology and favourable tax incentives like NID in Cyprus has created an ideal environment for fintech companies to thrive. By relying on equity financing and utilizing NID, fintech companies can reduce their tax liabilities and free up more capital to invest in their businesses, allowing them to innovate further and offer more diverse and convenient financial services to their customers. As the fintech industry continues to evolve and expand, we can expect to see more companies taking advantage of these benefits and contributing to the growth and development of this dynamic sector.
How can CX Financia Help?
There are multiple ways in which a Cyprus company or permanent establishment (PE) can benefit from this tax incentive. Our team is available to collaborate with you in exploring the optimal approach for structuring the funding of your business from a tax standpoint. Please feel free to reach out to us for further discussion.
At CX Financia, we provide data-driven, client-centred corporate and financial solutions to propel your organization forward. As your trusted partner, we take the hard work off your shoulders so you can focus on essential matters like fuelling your company’s vision and mission.
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