Cyprus Faces Tax Policy Shift: The End of the 12.5% Era for Multinationals

The days of the favorable 12.5% corporate tax rate for multinational corporations operating in Cyprus are coming to an end. Multinationals and other large-scale companies with revenues exceeding €750 million are bracing for the implementation of the European Union’s Directive (EU) 2022/2523, known as "Pillar 2." This directive introduces a global minimum tax rate of 15%, targeting multinational enterprise groups and large-scale domestic groups with annual revenues above the threshold. Affected entities will need to file their first tax returns for the financial year 2024 by June 2026, signaling a significant shift in Cyprus’s tax framework, long considered a cornerstone of its attractiveness for foreign investment.

The directive stems from a 2021 agreement by around 140 OECD member countries, which established the principle that multinational profits should be taxed at a uniform minimum rate, regardless of where they are declared. In October 2024, the European Commission referred Cyprus, along with Spain, Poland, and Portugal, to the Court of Justice of the European Union for failing to transpose the directive into national law by the deadline of December 31, 2023. Following this legal action, Cyprus’s Ministry of Finance submitted a harmonization bill, which was approved by the Council of Ministers on October 9, 2024. The bill is now under review in Parliament.

Concerns have arisen among business and professional associations about the impact of the tax rate increase, with fears that companies may relocate from Cyprus. During consultations, associations demanded measures to mitigate potential negative effects on businesses. However, the Ministry of Finance revealed that only two organizations—the Institute of Certified Public Accountants of Cyprus (ICPAC) and the Cyprus Shipping Chamber—provided feedback during the public consultation phase.

According to the Ministry, around 1,900 Cypriot entities, identified through 2021 and 2022 data, will be affected by the new tax rate. The implementation is expected to increase state revenues by €200–€250 million annually from 2026, though there are concerns about the potential for business losses. Despite these fears, some stakeholders remain optimistic. Marios Tanousis, CEO of Invest Cyprus, and Antonis Fragoudis, Director of Business Development and Economy at the Federation of Employers and Industrialists (OEB), expressed confidence that the change would not lead to significant corporate departures. Tanousis stated, “We do not expect that the future application of the 15% tax rate for the affected entities will cause serious problems,” a sentiment echoed by Fragoudis, who noted that any corporate relocations would likely be minimal.

For Tanousis, aligning with the directive is essential to safeguarding Cyprus’s international reputation. “It is particularly important to note that Cyprus must and must fully harmonize with the European directives, as otherwise there is a risk of negative impacts on its image and reputation,” he emphasized. Finance Minister Makis Keravnos supported this view, warning that failure to harmonize could tarnish Cyprus’s reputation and lead to economic repercussions, including possible downgrades by credit rating agencies.

As part of a broader strategy to address the impacts of the directive, Tanousis recommended incorporating the tax changes into a comprehensive tax reform plan, which could include targeted incentives for sectors like health and education. He highlighted the potential for tax deductions or exemptions for businesses in these areas, citing the example of university hospitals or clinics with advanced medical equipment as developments that could strengthen Cyprus’s healthcare sector. The OEB also proposed reassessing the global tax framework to ensure fairness and a level playing field. In an October letter to the Finance Ministry, the organization argued that Cyprus should advocate for simultaneous global adoption of the minimum tax rate. However, Keravnos dismissed this proposal, stating it lacked a legal basis under EU law.

To refine its approach, the Ministry of Finance reviewed practices in other EU countries, including Germany, Italy, and Ireland, which provide refundable tax credits to support research, innovation, and development. Such measures could serve as a model for Cyprus to attract investments while complying with the directive.

The shipping sector poses particular challenges under the new regime. While the directive exempts international shipping income due to the sector’s unique economic cycle, it does not explicitly exempt ship management income, which remains subject to the 15% tax rate. Despite efforts by Cyprus to secure broader exemptions for ship management, these were unsuccessful due to the global nature of the rules.

Looking ahead, the Ministry of Finance intends to evaluate potential incentives to offset the directive’s impact and foster investment. By 2025, it plans to reassess and implement measures that align with the new rules while maintaining Cyprus’s attractiveness for businesses. “The key is to ensure that we are always in line with European directives, while at the same time protecting foreign investments and providing the necessary incentives to attract young people,” Tanousis concluded.

As Cyprus prepares for this significant shift, its ability to adapt while maintaining its competitive edge will shape its role in the global investment landscape.

By fLEXI tEAM