Introduction

In today’s competitive and transparent international tax landscape, jurisdictions must offer sophisticated and compliant incentives to attract and retain investment. Cyprus, long recognized as a leading international business centre, has proactively adapted its tax framework to meet both domestic and global demands.

A key development in this direction is the Notional Interest Deduction (NID) regime, introduced in 2015 to encourage equity financing over debt. By offering a tax deduction on new equity similar to interest on debt, the NID levels the playing field between debt and equity, strengthens corporate balance sheets, and aligns with OECD Base Erosion and Profit Shifting (BEPS) recommendations.

The NID regime is part of Cyprus’s broader strategy to enhance its business-friendly environment while fully adhering to EU and OECD standards. Carefully designed to provide tangible tax benefits without facilitating abuse, the NID is a valuable tool for companies seeking efficient and compliant tax structures.

This article outlines the legal framework, mechanism, practical application, and strategic advantages of the Cyprus Notional Interest Deduction.

What is the Cyprus Notional Interest Deduction?

The Cyprus Notional Interest Deduction (NID) allows Cyprus tax-resident companies and permanent establishments of non-resident companies to claim a tax deduction on new equity introduced into their business.

The deduction is intended to simulate an interest expense, treating equity financing in a manner similar to debt financing for tax purposes. The NID applies only to “new equity” — that is, capital introduced after 1 January 2015 — and only to the extent that it is used for generating taxable income.

The aim is to incentivize businesses to strengthen their capital structure, reduce debt dependency, and operate on a more stable and sustainable financial basis.

Legal Framework

The Cyprus Notional Interest Deduction (NID) is governed by Article 9B of the Income Tax Law (Law No. 118(I)/2002, as amended). Introduced on 1 January 2015, the NID regime was designed to promote equity financing and to modernize Cyprus’s corporate tax framework in line with international best practices, including the OECD BEPS Action Plan.

The NID applies to:

• Companies that are tax residents of Cyprus, whether engaged in local or international activities;
• Permanent establishments (PEs) in Cyprus of non-Cyprus tax-resident companies.

To qualify for the NID, new equity must be used for business purposes that generate taxable income. New equity employed to generate exempt income, such as dividend income under the participation exemption, does not qualify for the deduction.

The legislative provisions are supplemented by Circular No. 2016/10 issued by the Cyprus Tax Department, which provides further guidance on qualifying new equity, the calculation method, and documentation requirements.

Following detailed review, the NID was assessed by the EU Code of Conduct Group (Business Taxation) and approved by the ECOFIN Council as “not harmful” in November 2020. This validation ensures that the regime complies fully with EU principles on fair taxation, transparency, and substance requirements.

Companies seeking to benefit from the NID must maintain proper documentation to demonstrate the introduction and use of new equity, and ensure full compliance with both the legislative and administrative requirements.

Mechanism of NID

The Cyprus NID allows companies to deduct a notional interest expense on qualifying new equity introduced after 1 January 2015. The main features of the mechanism are:

1. Definition of New Equity

“New equity” includes:

• Paid-up share capital (ordinary, preference, redeemable, or convertible shares);
• Share premium;
• Conversion of loans or other debt instruments into share capital;
• Shareholder credit balances converted into share capital;
• Non-refundable capital contributions;
• Realized reserves (post-2015) converted into share capital.

Equity arising from asset revaluations or capitalization of pre-2015 reserves does not qualify.

2. Reference Interest Rate

The NID is calculated by applying the yield of the 10-year government bond (of the country where the equity is used) plus a 5% premium. If no bond is available, the Cyprus bond yield is used.
The relevant yield is that in force on 31 December of the year preceding the relevant tax year.

3. Deduction Cap

The NID is capped at 80% of the taxable profit generated from the new equity before applying the deduction. This prevents the deduction from creating or increasing tax losses.

4. Annual Application

The NID must be claimed annually, provided that the new equity remains employed in generating taxable income. Unused deductions cannot be carried forward or backward.

5. Matching Principle

The NID must correspond to the specific income-producing activities financed by the new equity.

6. Anti-Abuse Provisions

To maintain integrity, the NID regime includes:

• General Anti-Abuse Rule (GAAR): Disregards NID claims lacking real economic substance.
• Specific rules preventing artificial reclassification of old equity as new equity.

Practical Example

Consider a Cyprus tax-resident company that introduces €10 million of qualifying new equity during 2024, used for income-generating assets in Cyprus.

For the tax year 2025:

• Reference Interest Rate: 10-year Cyprus bond yield at 2.98% + 5% premium = 7.98%
• Taxable Profit before NID: €2,000,000

Step 1: Calculate the NID

• €10,000,000 × 7.98% = €798,000

Step 2: Apply the Deduction Cap

• 80% of €2,000,000 = €1,600,000

Since €798,000 < €1,600,000, the full €798,000 is deductible.

Step 3: Determine Final Taxable Income

• €2,000,000 – €798,000 = €1,202,000

Step 4: Calculate Tax Liability

• €1,202,000 × 12.5% = €150,250

Effective Tax Rate

• (€150,250 / €2,000,000) × 100 = 7.51%

This example demonstrates the significant reduction in effective taxation achieved through the NID regime.

Conclusion

The Cyprus Notional Interest Deduction (NID) represents one of the most innovative and strategic tax incentives available within the Cypriot corporate tax system. By aligning the tax treatment of equity financing with that of debt, the NID allows businesses to strengthen their capital base, improve their financial stability, and achieve significant reductions in their effective corporate tax rates. Its design encourages sound financial practices while ensuring full compliance with EU and OECD standards on fair taxation and anti-avoidance.

Beyond its technical benefits, the NID enhances Cyprus’s reputation as a leading international business centre, offering companies a transparent, predictable, and efficient tax environment. Businesses operating in or through Cyprus can utilize the NID to optimize their financing structures in a way that is both commercially advantageous and internationally respected.

At Polycarpos Philippou & Associates LLC, we are committed to helping our clients maximize the advantages of the NID regime by providing tailored legal and tax advice, ensuring compliance with all legislative and regulatory requirements. For further information or to discuss how the Cyprus Notional Interest Deduction can be incorporated into your company’s tax strategy, please do not hesitate to contact us.