The House of Representatives is currently reviewing draft legislation which will introduce parts of the EU Anti-Tax Avoidance Directive (ATAD) into local law. The upcoming changes, which are expected to come into effect from 1st January 2019, relate to the introduction of:
- interest deductibility limitations;
- Controlled Foreign Company (CFC) rules; and
- General Anti-Abuse Rules (GAAR).
We aim to cover the rules relating to CFC and GAAR in our next newsletter.
In addition to the above, it is expected that the final outstanding sections from the ATAD (i.e. exit taxation and intra-EU hybrid mismatches) will be transposed into local law later in the year and come into force from 2020 onwards.
B. Interest limitation
Currently, interest expense is tax deductible, subject to certain conditions (e.g. arm's length principle). Based on the upcoming amendments, an interest limitation rule will be introduced which will limit the percentage of the taxpayer's borrowing cost to a maximum of 30% of the taxable Earnings before Interest, Tax, Depreciation and Amortization (EBITDA).
1. Calculation of deductible interest
Exceeding borrowing costs (being the excess of borrowing costs over interest income and other economically equivalent taxable revenues) are expected to be deductible up to the higher of 30% of taxable EBITDA or €3 million. The latter is a threshold that allows the taxpayer to deduct fully exceeding borrowing costs up to €3 million each year.
For a group of Cypriot tax resident companies, the limit of €3 million will apply for the total borrowing costs of the group.
We would like to clarify that the rule applies similarly to interest under intra-group and third-party loans, as there is no distinction on the deductibility based on who is the lender/creditor.
Taxable EBITDA is the total of net taxable income (in accordance with the Cypriot income tax laws), as adjusted by the exceeding borrowing costs, the depreciation and amortization of fixed assets and intangibles and the notional deduction arising from Intellectual property (IP) Box regime (i.e. 80% on qualifying IP profits). Losses brought forward from prior years are not taken into consideration in determining the EBITDA.
As a result, exempt income such as dividends, capital gains and their related costs are ignored for the purpose of calculating the taxable EBITDA.
2. Exclusion of certain exceeding borrowing costs
The upcoming amendments include a grandfathering clause according to which interest on loans that were in effect before 17 June 2016 can be excluded from the borrowing cost definition. However, the grandfathering provisions will not apply to any subsequent amendments of such loans.
The suggested law also excludes interest on certain loans subject to conditions (e.g. such as loans related to long term public infrastructure).
3. Exemption because of level of equity
When the taxpayer is a member of a consolidated group for financial accounting purposes, upon request, the taxpayer may deduct the whole amount of its exceeding borrowing costs, provided that it can demonstrate that the ratio of its equity over its total assets is higher or at least equal than the equivalent ratio of the group.
4. Exclusion of stand-alone entities and financial undertakings
The upcoming amendments are expected to exclude standalone entities (a taxpayer not being part of a consolidated group for financial accounting purposes) from the scope of the interest limitation rules.
The upcoming amendments are also expected to exclude financial undertakings (such as credit institutions, insurances, pension institutions, Alternative Investment Funds, etc.) from the scope of the interest limitation rules.
5. Carry forward of exceeding borrowing costs
The upcoming amendments are expected to permit the carry forward of exceeding borrowing costs of a tax year to the next 5 tax years.
In addition, a five-year carry forward of unused interest capacity is expected to be included. The unused interest capacity does not take into consideration the limit of €3 million.
In the event where within the same three-year period there is a change in the ownership and a considerable change in the activities of the Company, the excess borrowing costs prior to the change(s) cannot be carried forward.
Although the above comments are based on the draft legislation which is currently under review by the House of Representatives, no material adjustments are expected as the draft legislation is based on the requirements of the ATAD.
As mentioned above, we expected that once the above is approved by the House of Representatives, it will be effective from 1st January 2019.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.