According to Article 9 of the Income Tax Act, in order to find the taxable income of each person, all expenses that this person wholly and exclusively undertook for the acquisition of the taxable income, will be deducted. Two issues that require special attention are (i) whether all interest paid by a company on borrowings and other financial facilities is allowed as expenses and (ii) what happens if a company makes both taxable and exempt transactions (for example, profits from commercial sales of shares and other titles).
Allowed interest
The interest on loans used to finance activities of the company resulting in a taxable income, is allowed. For example, the interest of loans used to fund obtaining a building or any other fixed assets used in the company, is allowed. Regarding the international companies engaged in financial activities or providing loans, payable interest is permitted provided that no specific profit margin exists. A circular stating what the expected profit margin is, has not yet been issued. In practice, margins of 0.125% -0.35% are acceptable depending on the amount of the loan.
Not allowed interest
The IRD has recently issued a circular to clarify and uniform the implementation of legislation regarding the deduction for interest that is payable on loans relating to assets which the IRD consideres that are not used in the company. The provisions of this legisltation are analyzed below.
The restriction of interest takes place regardless of whether a specific loan has been provided and applies for a period of seven years from the date of acquisition of the asset. The IRD considers that the assets for which the restriction is applied are private powered vehicles (as defined by the Road Transport Department), shares in public or private companies, land and buildings, yachts, paintings, etc. which are not used in the company and which do not generate taxable income. The titles generating income on such securities and bonds do not fall into this category and there is no restriction on interest. The amount of interest is calculated on the reduced cost of acquisition of the asset multiplied by the percentage of the cost of borrowing for the company. There are exceptions to the limitation of interest where the company has acquired the assets of a product registration capital or interest-free loan from shareholders.
It is emphasized that the IRD considers that the market shares in a subsidiary or other company is an asset of the company and it is for this reason that it applies the restriction. The affected taxpayer has every right to disagree with the position of the IRD and to take legal action for decision making, since all the relevant decisions of the Cypriot courts are very old and related rules were in force before 2003.
Allocating expenses and deductions
In the case of companies operating exempted and taxable transactions, the IRD has issued a circular to allocate costs. So from each income category, any direct or indirect related costs, such as income and proportion of overhead costs which have not been allocated to each of these categories already, are being deducted.
I n practice two methods are admissible for allocating overhead costs. These two methods are (i) the method based on gross income from all business activity (Profit and Loss method) and (ii) the method based on cost of acquisition of assets (Balance Sheet method). The most appropriate method for each case should be chosen and applied consistently each year.
