Download Interest Income and Expenses: Accounting and Tax

Interest Income and Expenses:
Accounting and Tax Treatment
ACCOUNTING TREATMENT
A Cyprus Company is generating interest income that derives from fixed deposits, bank current
accounts, loans receivable and investments in bonds – debentures. In the other hand, a Cyprus
Company is generating interest expense from bank overdrafts, loans received to finance
acquisition of fixed assets or working capital and debentures issued by the Company to third
parties.
In accordance with the IAS 18 “Revenue recognition”, the interest is recognized in the accounting
books of the Company on a time basis i.e. the interest will be accrued from the date the funds
were granted up to the end of the accounting period or settlement date if the loan was repaid
during the accounting period.
The interest, either income or expense, is written off to the Statement of Comprehensive Income
(Profit and Loss). The only exemption to the rule is in the case of interest expense incurred in
relation to loans granted in order to finance the acquisition or construction or production of a
qualifying asset. This is covered by the IAS 23 “Borrowing Costs”. Qualifying asset is an asset that
takes substantial period of time to get ready for its intended use or sale. In such a case, the interest
expense is capitalized i.e. it is included in the cost of the asset. The capitalization of the interest
commences when the expenditures for the asset are being incurred, the borrowing costs are
being incurred and the activities necessary to prepare the asset for its intended use or sale are in
progress. The capitalization ceases when the asset is ready for its intended use or sale.
Classification in the Financial Statements
The classification of the interest income in the Financial Statements is directly related to the
Company’s ordinary activities. If the Company’s principal activity is that of investing in debentures
and fixed deposits, then the interest will be classified within the turnover. If the Company’s
principal activity is trading in goods then the interest will be classified within the finance income.
The same classification treatment exists for the interest expense where in the case of an
investment Company, the interest expense will be recognized within the cost of sales. In the case
of a trading Company, the interest expense will be recognized within the finance costs.
The issue of classification is based on the discretion of the preparer of Financial Statements and to
the level of understanding of the Company’s core activities.
TAX TREATMENT
The interest income is subject to tax in Cyprus based on whether is classified as active or as
passive. Active interest is the interest which is directly or indirectly related to the Company’s
principal activity. Passive interest is the interest which is not related to the Company’s principal
activities.
The active interest is subject to 10% corporation tax and exempts from special defence
contribution.
The passive interest is subject to 15% special defence contribution in isolation and exempts from
corporation tax.
CPV Corporate Services Limited
21, 28th October Street • 1st Floor • Office 104 • Engomi 2414 • Nicosia - Cyprus Tel: +357 22028472
• Fax: +357 22028473 • [email protected]
www.cpvcorp.com
It is easily understandable from the above that the active interest is taxed at a lower rate and thus
it is more advantageous from the point of view of the tax payers therefore an effective tax
planning is needed. Companies carrying out investment activities should not be involved in any
other form of activities so as to enable the interest to be classified as active. In the other hand,
trading and service providing Companies should not be involved in investment activities where, in
such a case, the interest will be classified as passive and thus taxed at a higher rate.
The interest expense is generally treated as deductible for tax purposes if it was incurred wholly,
exclusively and necessarily for the Company’s business. The only exemption to the rule is in the
case of interest incurred for the acquisition of investment. In such a case, the interest is not tax
deductible. However, recent amendment in the law came into effect as from the fiscal year 2012
onwards, gave the ability to the taxpayers to treat the interest expense as tax deductible in the
case of acquisition of wholly owned subsidiaries either directly or indirectly provided that the
assets of the subsidiary are business assets.
Back to Back loans
Companies acting as financial intermediaries within a group i.e. they receive a loan from a
related Company and grant this loan to another related Company in the group, then an
acceptable profit margin on the interest should apply. The tax commissioner has accepted the
following minimum profit margins:
Amount of Loan in Euro
Less than 50m
50m – 200m
More than 200m
Interest bearing loan
0,35%
0,25%
0,125%
Interest free loan
Minimum 0,35% in
all cases
The above mentioned margins are applicable only when the borrowed funds were granted as
finance to a related party within a time period of six months and these funds were given by
another related party or in the form of loan by a credit institution.
The margins will not apply if the funds were raised by a Cyprus Company through issue of share
capital and from the date when a liability in relation to the funds borrowed or lent by a Cyprus
Company is settled or written-off.
It should be noted that neither the write-off, nor waiver of loans, which fall under these
arrangements, should affect the Company’s taxable profits i.e. the write off as bad debt of a loan
receivable will be treated as non-tax deductible and the waiver of a loan payable will be treated
as tax free income.
In all other cases, the arm’s length principle applies where the interest rate should be in line with
the market interest rate so as not to trigger the transfer pricing provisions of the Cyprus Income Tax
Law.
We trust you will find this article very transparent and valuable for your needs.
Please feel free to contact us should you need any clarifications.
Olesya Rybkina Chrysanthou
Managing Director
CPV Corporate Services Limited
21, 28th October Street • 1st Floor • Office 104 • Engomi 2414 • Nicosia - Cyprus Tel: +357 22028472
• Fax: +357 22028473 • [email protected]
www.cpvcorp.com