Cyprus Thin Capitalisation & Interest Deduction Limits 2026

Cyprus is unusual among EU jurisdictions in that it does not impose a fixed debt-to-equity thin-capitalisation ratio. That fact alone has made it a popular location for leveraged holding and financing companies for decades. But "no thin-cap rule" does not mean "unlimited interest deduction". Two parallel regimes still discipline how much interest a Cyprus company can deduct: arm's-length transfer pricing on intra-group debt, and the ATAD-derived interest limitation rule capping net interest at the higher of 30% of tax-EBITDA or EUR 3 million per year.

This article walks through both regimes as they apply in 2026, with a worked example for a typical leveraged Cyprus holdco, the interaction with the Notional Interest Deduction, and the audit triggers that the Cyprus Tax Department most often pursues.

Overview: no thin-cap ratio, but limits still apply

When advisors say "Cyprus has no thin-cap rule", they are technically correct: there is no statutory provision in the Income Tax Law N.118(I)/2002 that fixes a maximum debt-to-equity ratio (such as the 1.5:1 ratios seen in some other European systems).Income Tax Law N.118(I)/2002 (as amended) — no statutory debt-to-equity ratioInstead, the deductibility of interest in Cyprus is policed by two more modern mechanisms working together.

The first is the arm's-length principle in Article 33 of the Income Tax Law, which since 2017 has been actively used by the Tax Department to challenge non-commercial pricing on intra-group loans. The second is the interest limitation rule transposed from Article 4 of the EU Anti-Tax Avoidance Directive (Directive (EU) 2016/1164), introduced into Cypriot law by Law 63(I)/2019 and in force from 1 January 2019.Council Directive (EU) 2016/1164 (ATAD), Article 4

Why Cyprus has no formal thin-cap rule

Historically, the absence of a thin-cap ratio was a deliberate policy choice. Cyprus positioned itself as a financing hub within EU groups, and a fixed debt-to-equity rule would have undermined that proposition. With the OECD/G20 BEPS Action 4 and the EU ATAD bringing the EBITDA-based interest limitation rule into general use across the Union, the policy gap closed: Member States no longer needed a domestic ratio because the EBITDA cap performs the same function and is harmonised across the bloc.

Cyprus therefore did not introduce one when transposing ATAD. The result is a cleaner, more economically meaningful test: a Cyprus company can run with a very high debt-to-equity ratio in principle, provided the interest is priced commercially and the net interest expense fits inside the EBITDA cap or the EUR 3 million safe harbour.

Arm's-length pricing of intra-group interest

Article 33 of the Income Tax Law codifies the arm's-length principle in line with the OECD Transfer Pricing Guidelines.Article 33, Income Tax Law N.118(I)/2002 (arm's-length principle)Since the 2022 transfer-pricing reform, intra-group financing transactions must be supported by a Local File where the aggregate annual value of financial transactions with related parties exceeds the relevant threshold. From 1 January 2026 that threshold for financial transactions is EUR 10 million per annum — below which a simplified summary information table is still required, but the full Local File obligation does not bite.

The Cyprus Tax Department's simplified-measure circular for back-to-back financing provides a deemed-arm's-length minimum return of 2.5% (before tax) on the value of loans receivable funded by financial instruments — a useful safe-harbour for pure on-lending arrangements. For substantive financing, full TP analysis and benchmarking is expected. For the full picture, see our Cyprus transfer pricing guide.

ATAD Article 4: the interest limitation rule

The interest limitation rule (often shortened to "ILR") limits the deductibility of a company's exceeding borrowing costs in any given tax year to the higher of:

• 30% of the taxpayer's tax-EBITDA; or
• EUR 3 million.

The taxpayer applies the more favourable of the two limbs. A Cyprus company with EUR 2 million of net interest expense is fully within the safe harbour regardless of its EBITDA. A Cyprus company with EUR 10 million of net interest expense must rely on the EBITDA limb to deduct anything above EUR 3 million.ATAD Article 4(1) and (3) — interest limitation rule

Exceeding borrowing costs explained

"Exceeding borrowing costs" (EBCs) is a defined term. It captures:

EBCs equal these borrowing costs less taxable interest income (and economically equivalent taxable income). Where a Cyprus company has taxable interest income equal to or greater than its borrowing costs, EBCs are zero and the cap has nothing to bite on.

The EUR 3 million safe harbour

EBCs of up to and including EUR 3 million in a tax year are not restricted by the rule. This is a hard threshold, not a deduction — it is the size of the safe-harbour cushion.ATAD Article 4(3)(a) — EUR 3 million safe-harbour threshold

For Cyprus groups, the EUR 3 million is applied to the aggregate EBCs of the Cyprus group, not per taxpayer. This stops groups from splintering financing across multiple Cyprus SPVs to multiply the safe harbour. Group composition for these purposes broadly mirrors the consolidated-accounting perimeter.

The 30% tax-EBITDA cap

Where EBCs exceed EUR 3 million, the EBITDA-based limb kicks in. Tax-EBITDA is computed as taxable income before:

• the interest limitation itself;
• tax depreciation and amortisation; and
• exceeding borrowing costs.

Crucially, items of income that are exemptfrom Cyprus corporation tax are excluded from the EBITDA base. That is significant for Cyprus holding companies, where most of the income tends to be exempt dividends from subsidiaries and exempt capital gains on the disposal of shares. A pure holding company can therefore have a tax-EBITDA close to zero, meaning its EBITDA-derived deduction limit is also close to zero — and it falls back on the EUR 3 million safe harbour alone.

For IP-box companies, the position is more nuanced: the 80% notional deduction on qualifying IP income reduces the taxable base, but the underlying IP income is not, strictly speaking, "exempt" in the ATAD sense — only the 80% deduction is. The remaining 20% of net qualifying IP profit flows into the tax-EBITDA figure normally.

Worked example: a leveraged Cyprus holdco

Consider Cyprus HoldCo ("CyHold") financing the acquisition of a European operating group. In 2026 it reports:

• Exempt dividends from EU subsidiaries: EUR 12,000,000
• Taxable management-fee income from the same subsidiaries: EUR 2,000,000
• Operating costs (Cyprus payroll, audit, office): EUR 400,000
• Tax depreciation: EUR 100,000
• Interest expense on third-party acquisition debt: EUR 5,500,000
• Taxable interest income on intercompany loans receivable: EUR 1,000,000

The interest limitation analysis:

Note how the exempt EUR 12,000,000 of dividend income is stripped out of the EBITDA base. If the dividends had been taxable, tax-EBITDA would be EUR 18,200,000 and the 30% limb would deliver EUR 5,460,000 of capacity — more than enough to deduct the full EUR 4,500,000 of EBCs. The exempt-income carve-out is what bites holding companies.

Interaction with the Notional Interest Deduction

The Notional Interest Deduction (NID) is one of the most important pieces of the Cyprus financing toolkit. It allows a deemed interest deduction on qualifying new equity, capped at 80% of taxable income generated by the assets funded with that new equity. Because the NID is by definition not interest paid on debt, it is outside the definition of borrowing costs under Article 4 of the ATAD.

The practical consequence is that a Cyprus company can simultaneously claim:

• The NID on new equity used to fund part of its assets.
• An interest deduction on third-party or related-party debt funding the rest of its assets, subject to arm's-length pricing and the EBC cap.

Where a structure runs close to the EUR 3 million safe harbour or the 30% EBITDA limb, deliberately substituting some debt for equity (and claiming NID on the resulting capitalisation) is one of the cleanest ways to bring net interest within the cap without sacrificing leverage on the rest of the balance sheet.

Common mistakes and audit triggers

1. Forgetting that exempt income is stripped from EBITDA.Modelling EBITDA off the accounting figures (including exempt dividends) overstates the deduction capacity. Always rebuild EBITDA on a tax basis.
2. Treating each Cyprus SPV as having its own EUR 3 million safe harbour. The threshold is aggregated at Cyprus-group level.
3. Pricing intra-group loans off thin air.The arm's-length principle requires benchmarked, documented pricing — not a round 5% chosen because it "feels right".
4. Missing the carry-forward. Disallowed EBCs may be carried forward five years. Tracking them separately from ordinary tax losses (under the Cyprus corporate tax framework) is essential.
5. Ignoring defensive withholding tax. Interest paid to related parties in low-tax jurisdictions can be denied deduction andsubjected to outbound WHT, irrespective of the ATAD cap.
6. Confusing NID with borrowing cost. NID is a deduction, not interest. It belongs nowhere in the EBCs calculation.

How to structure debt cleanly

For most leveraged Cyprus structures, four principles produce a defensible, durable position in 2026:

1. Right-size the leverage. Where possible, keep group-level Cyprus EBCs at or below EUR 3 million per year. The safe harbour does the heavy lifting.
2. Document the arm's-length pricing. Maintain a Local File for any related-party financing above the 2026 threshold, with contemporaneous benchmarking.
3. Plan around exempt income. If the Cyprus entity is a pure holding company, recognise that its tax-EBITDA will be low and lean on the safe harbour rather than the 30% limb.
4. Capitalise where leverage is excessive. Substituting debt for equity supported by the NID often produces a better net-tax position than fighting the cap year after year.