Entity
Notional Interest Deduction
Notional Interest Deduction: short answer
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The notional interest deduction allows a Cyprus company to deduct a notional return on new equity introduced from 2015 onwards, capped at 80 percent of the taxable profit generated by that equity. It puts equity funding closer to debt funding, which is deductible.
| What qualifies | New equity introduced on or after 1 January 2015 |
|---|---|
| Basis of the deduction | A reference rate applied to the qualifying new equity |
| Reference rate | The ten-year government bond yield of the state where the equity is invested, plus a premium, subject to a floor |
| Cap | 80 percent of the taxable profit derived from the assets financed by the equity |
| Effect on losses | Cannot create or increase a tax loss |
| Anti-abuse | Arrangements without genuine commercial purpose can be disregarded |
A company funded by a shareholder loan deducts the interest. The same company funded by share capital historically deducted nothing. The deduction narrows that gap without removing the difference.
The problem it addresses
Tax systems generally treat debt and equity differently, and the difference is not neutral.
A company funded by a loan pays interest, and that interest is ordinarily deductible against taxable profit. The same company funded by share capital pays dividends, and dividends are not deductible. The result is a structural bias towards debt, which is why highly leveraged structures have historically been attractive for reasons that have nothing to do with the underlying business.
The notional interest deduction addresses that bias. It allows a Cyprus tax resident company to deduct a notional return on qualifying new equity, as though the equity had been borrowed. No interest is actually paid and no cash leaves the company; the deduction is computed and taken against taxable income.
How it is calculated, and where the limits bite
The deduction is the reference rate multiplied by the qualifying new equity.
New equity means equity introduced on or after 1 January 2015, whether as share capital or share premium, and whether contributed in cash or in kind. Equity that was already in the company before that date does not qualify, which is the first limit and the one most often overlooked.
The reference rate is the yield on the ten-year government bond of the state in which the new equity is invested, plus a premium, subject to a floor. Because the rate follows where the funds are deployed rather than where the company sits, financing an operation in a higher-yield jurisdiction produces a higher deduction.
The cap is 80 percent of the taxable profit derived from the assets financed by that equity. This is the limit that decides how useful the deduction actually is. It is measured against the profit those particular assets generate, not against the company's total profit, so equity deployed into something unprofitable produces little or no deduction however large the sum.
Anti-abuse, and why it matters here
The deduction is attractive enough that it invites arrangements designed solely to generate it: circular contributions, capitalising existing intra-group loans, or moving equity between related companies to create qualifying amounts more than once from the same funds.
Anti-abuse provisions address arrangements that lack genuine commercial purpose or that are put in place principally to obtain the deduction. In practice this means the introduction of equity should have a business reason that can be stated independently of its tax effect, and the funds should be genuinely new to the group rather than recycled within it.
This is a documentation question as much as a structuring one. Where equity is introduced to fund a specific acquisition, expansion or asset, recording that at the time is straightforward. Reconstructing the rationale several years later, during an examination, is not.
Common questions
Is any interest actually paid?
No. The deduction is notional. Nothing leaves the company; a computed amount is deducted against taxable income as though the equity had been borrowed.
What limits the size of the deduction?
A cap of 80 percent of the taxable profit derived from the assets that the equity financed. Because it is measured against those assets rather than total company profit, equity deployed unprofitably produces little deduction regardless of the amount.
Can it create a tax loss?
No. The deduction cannot create or increase a loss, and any unused amount is not carried forward.
Technical definition
A deduction from taxable income equal to the reference interest rate multiplied by the new equity introduced into a Cyprus tax resident company on or after 1 January 2015. The reference rate is the yield on the ten-year government bond of the state in which the new equity is invested, plus a premium, subject to a floor. The deduction is capped at 80 percent of the taxable profit derived from the assets financed by that equity.
Practical implications
Because the cap is expressed against the profit generated by the financed assets, the deduction is only as useful as the profitability of what the equity funded. It cannot create or increase a loss, and equity introduced before 2015 does not qualify.
Common misconceptions
Two recur. That the deduction applies to all equity, when it reaches only new equity introduced from 2015 onwards. And that it can be claimed by capitalising an existing shareholder loan without substance, when anti-abuse provisions address arrangements without genuine commercial purpose.