New tax incentives granted for investment in innovative SMEs

Introduction

Cyprus’ House of Representatives approved the introduction of revised tax incentives for investment in innovative businesses.

The new incentives granted for investment in innovative SMEs are effective from 1 January 2017 for a three-year period and replace the previous incentives that were available to investors until 31 December 2016.

Tax incentive

According to the new provisions of Article 9A of the revised income tax law, a “qualifying investor” that makes a “risk-finance investment” in an “innovative small and medium-sized enterprise (SME)” may deduct the costs of the investment from his/her taxable income.

A qualifying investor can invest either directly in the innovative SME or indirectly via an “investment fund” or an “alternative trading platform” (ex. Emerging Companies Market of Cyprus Stock Exchange). Both terms are explicitly defined in the law and needs to hold his/her investment for a minimum period of three years, otherwise the Commissioner of Taxation may disallow the tax deduction.

Limitations

• The tax deduction is limited to 50% of the investor’s taxable income in the year in which the investment is made
• The total deductible amount may not exceed EUR 150,000 per year
• The remaining investment cost not claimed as tax deductible may be carried forward and deducted from the taxable income of the subsequent five years, subject to the aforementioned restrictions

Definitions

• Qualifying investor: qualifying investor is an individual that is deemed to be independent from the enterprise. An investor is deemed to be independent, if he/she is not an existing shareholder of the enterprise, unless he/she is a founder of a new enterprise
• Risk-finance investment: risk-finance investment is an “equity investment” or a “quasi-equity investment” or a “loan”, or a combination thereof, and includes finance leases and guarantees. A risk finance investment may be the initial investment in the enterprise or a “follow-on investment”. The above terms are explicitly defined in the law
• Follow-on investment conditions: 
  - The total amount of risk finance investment may not exceed EUR 15 million (A business will automatically lose its innovative SME status, if at any time, the total amount of risk-finance investment received exceeds EUR 15 million)
  - The possibility of a follow-on investment must have been foreseen in the original business plan submitted to the authorities
  - The enterprise receiving the follow-on investment may not be linked with another undertaking as outlined in Article 21(6)(c) of the EU state aid rules (Regulation 651/2014).
• Innovative small and medium-sized enterprise (SME): an SME will qualify as an innovative SME if it meets the following requirements:
  - It operates in the Republic of Cyprus
  - It has been approved by the Cyprus Ministry of Finance or other authority as a qualifying innovative SME
  - At the time of the investment, it is an unlisted SME (unless it is listed on an alternative trading platform) that has a business plan for its risk-finance investment and fulfils at least one of the following conditions:
  1. It has not been operating in any market
  2. It has been operating in any market for less than seven years following its first commercial sale
  3. It requires an initial risk-finance investment which, based on a business plan prepared in advance of a new product offering or the entering of a new geographical market, is higher than 50% of its average annual turnover in the preceding five years

Process for obtaining approval as a qualifying innovative SME

To be approved as an innovative SME, the company must submit an application to the authorities, along with a statement from an independent auditor confirming that the R&D expenses (which may also include any capitalized R&D expenses) represent at least 10% of the total operating expenses of the enterprise in at least one of the three tax years preceding the tax year in which the investment was made; or, in the case of a start-up enterprise without any financial history, based on the audited financial statements or in the absence of audited financial statements, in accordance with a business plan that the authorities are entitled to request.