Under the Anti Tax Avoidance Directive (ATAD - interest limitation rule as transposed in the Cyprus Income Tax Law), exceeding borrowing costs shall be deductible in the tax period in which they are incurred only up to 30% of the taxpayer’s earnings before interest, tax, depreciation and amortisation (EBITDA), as adjusted in accordance with the rules concerned.
Exceeding borrowing costs refer to the amount by which the deductible borrowing costs of a taxpayer exceed taxable interest revenues and other economically equivalent taxable. In essence, they consist of the net interest expense and are defined as “interest expenses on all forms of debt, other costs economically equivalent to interest and expenses incurred in connection with the raising of finance, including, without being limited to, payments under profit participating loans, imputed interest on instruments such as convertible bonds and zero coupon bonds, amounts under alternative financing arrangements, such as Islamic finance, the finance cost element of finance lease payments, capitalised interest included in the balance sheet value of a related asset, or the amortisation of capitalised interest, amounts measured by reference to a funding return under transfer pricing rules where applicable, notional interest amounts under derivative instruments or hedging arrangements related to an entity's borrowings, foreign exchange gains and losses on borrowings and instruments connected with the raising of finance, guarantee fees for financing arrangements, arrangement fees, as well as similar costs related to the borrowing of funds” that are in excess of any financial income (i.e. interest and interest equivalents).
The legal provisions transposed include opt outs in relation to:
- a de minimis threshold (exceeding borrowing costs up to EUR 3 million can be deducted)
The threshold will concern deductible borrowing costs (i.e. costs that have been incurred wholly and exclusively for the production of income); in the case of exceeding borrowing costs in excess of the threshold, the limitation (i.e. at 30% of tax adjusted EBITDA) will apply only on the excess amount.
- a standalone entity exemption (not being part of a group of companies)
A company is treated as a standalone entity if it is not part of a consolidated group for financial accounting purposes and has no associated enterprise or permanent establishment.
- grandfathering of loans concluded before 17 June 2016
The grandfathering applies to the extent where the terms of the loans in question have not been modified since the cut-off date; i.e. in case of a subsequent modification, the grandfathering would not apply to any increase in the amount or duration of the loan, but would be limited to the original terms of the loan.
- an exclusion from scope of long-term infrastructure projects which are considered to provide, upgrade, operate and/or maintain a large-scale asset that is in the interests of the general public.
The interest limitation rules will also not apply to financial undertakings (credit institutions, insurance/reinsurance companies, occupational retirement pension funds, EU social security pension schemes, Investment Firms, AIFs and AIFMs, UCITs funds and UCITs management companies, OTC derivative counterparties – “CCPs”, central securities depositories -“CSDs”, and securitisation special purpose entities -“SSPEs”).
The implementing law also provides for a group equity ratio carve-out in that, where the taxpayer is a member of a consolidated group for financial accounting purposes, the taxpayer may be given the right to fully deduct its exceeding borrowing costs if it can demonstrate that the ratio of its equity over its total assets is equal to or higher than the equivalent ratio of the group and subject to the following conditions:
(i) the ratio of the taxpayer's equity over its total assets is considered to be equal to the equivalent ratio of the group if the ratio of the taxpayer's equity over its total assets is lower by up to two percentage points (2%)
(ii) all assets and liabilities are valued using the same method as in the consolidated financial statements, prepared in accordance with acceptable accounting standards.
Taxpayers may carry forward exceeding borrowing costs and unused interest capacity which cannot be deducted in the current tax period, for a maximum of five years.
Under the option provided by the Directive, Cyprus has opted to allow the interest limitation rule to apply cumulatively at the level of a Cyprus group, as this is defined for group-relief purposes. In this respect, the results of all the members of the Cyprus group will be assessed cumulatively, i.e. the calculation will consist of (i) the tax-adjusted EBITDA of all the group members cumulatively and (ii) the borrowing costs of all the group companies cumulatively, i.e. the calculation for EBCs will be carried out on the basis of group results and the equity carve-out will also be applied on a group basis with a reallocation of the EBCs to companies.
The interest limitation provisions raise a number of questions and key pointers for our clients; in essence, clients should be monitoring their borrowing costs irrespective of whether financing is obtained by related or third parties, the jurisdiction and location of the lender, or even the treatment of the interest income in that jurisdiction.
Margarita Liasi, Principal, KPMG Limited, firstname.lastname@example.org
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