CyprusLiving

In respect of my “private wealth management” I am mostly a bond investor and I buy and sell bonds infrequently myself, typically at the US or German stock exchange and in quite many cases intend to keep them (“buy and hold”) in order to generate interest income.

Of course, such income is liable to defense contribution. However, the question arises in how to compute “income”.

Bonds typically pay interest once a year and the payment dates – although fixed - overall are set rather randomly.
It is very clear, that if I am holding a bond “for ever and a day”, defense is to be paid on any such payment received.
However, a problem arises if and when bonds are bought or sold.

The value of a bond investment (ignoring market movements) rises from the day of a payment of interest. Assuming that a bond pays 12% interest p.a., the value rises approx 1% every month until the date of the next payment because a buyer does not have to hold it (this providing his money to the lender) for a full period and on the next payment date he will be entitled to the full interest for the full year.

In the UK and other places, this value is represented by trading bonds on the basis or “dirty prices”. The dirty price of a bond will decrease on the days coupons are paid, resulting in a saw-tooth pattern for the bond value. This is because there will be one fewer future cash flow (i.e., the coupon payment just received) at that point. On the other side, the value of a bond rises from that date because it increasingly incorporates the expectaytion for an interest payment. I would assume that most people with a UK background will consider the increase in the dirty price a “capital gain” and not subject the gain to defense in the first place, although this is not correct.

In Germany and the US, most bonds are traded on the basis of “clean prices”. The “clean price is the price of a bond excluding any that has since issue or the most recent coupon payment. From this follows, that upon purchasing a bond I have to pay accrued interest separately as much as I receive such accrued interest when I sell a bond.

The question now is, how to treat accrued interest paid and received here in Cyprus.

It is rather simple in a tax system as in Germany. Here the investor just adds all the “normal” interest received during the period (say a year) and adds all accrued interest received in the process of having sold bonds. He then deducts all accrued interste paid in the acquisition of further bonds during that year. If, in a given year, the investor has invested a lot of extra money into bonds at large, he may well end up in a situation where he has (in that period) paid more accrued interest than he has received in interest payments, accrued or other. This leads to a tax loss which can be carried forward to the next year because at some point in time his total interest received will by far exceed interest paid – unless he keeps injecting fresh money progressively.

In Hungary – and I believe to have learnt from earlier conversations, in Cyprus – the authorities look at things in a different way.

Here, it seems, authorities do not look at the total difference between interest paid and interest received during a period. Instead, it seems, they look at things in a “instrument by instrument” fashion. That means establishing for every bond one holds, what has been received in regular interest and maybe accrued interest received in selling. Then, at the first point in time at which for that bond regular or accrued interest is received, the investor deducts the accrued interest paid for that bond at the time of acquisition.
This means, that payment of accrued interest can be deducted from the income from a particular bond, even if that payment has been in a previous period.

Maybe an example helps:

Most bonds only pay interest once a year. For almost every bond that I have bought in the second half of 2010 I probably had to pay accrued interest. For these bonds it is rather likely that their first “coupon day” was in 2011. So to establish earnings in a meaningful way, I would have to deduct the accrued payment paid in 2010 from the interest received in 2011. For any further interest payment from that bond no such deduction would occur.

I wonder if you would be kind enough to confirm the correct way of working out my liability:

• Either add all interest received during the (half-) year and deduct all accrued interest paid (i.e. even for bonds which have yet to deliver a regular interest payment)
• Or establish bond by bond the appropriate earning, meaning that form every first regular payment received deduct the accrued interest paid even if in another period.

Two more questions if I may:
• I am also holding Cypriot Government Bonds. Is it true that interest received from them is exempt from defense (for me as an individual)?
• I find the following in one of your brochures: In case that foreign tax was paid on income subject to special contribution, this can be given as an allowance against the special contribution payable on the income, irrespective of the existence of a double taxation relief with the foreign country. Does this mean that the total of foreign tax deducted at source can be offset against my total defense liability or does that have to be looked at instrument by instrument (stock by stock) such that I will not receive the full allowance and only save the hypothetical Cypriot tax which otherwise I would have to pay?

Many thanks

Peter

Peter,

I think the situation can be made very simple...

As I understand it, Special Defence Contribution (SDC) is payable on interest received from cash, or fixed interest deposits i.e. bonds and on dividends received. Your bond provider or asset manager should provide you with an annual statement of income from either interest or dividends. Any capital gain from asset growth is not subject to SDC.

I cannot comment on any liability on Cypriot government bonds. If you need to look at this in more detail I think you need an accountant or tax consultant to advise.

All the best

Thanks, Mark, for a helpful answer,

interest and dividend income for a period is easy to establish. All that comes under (simplifying) "intertest received". However, I would expect to be able to offset "interest paid" against that. Not in the sense of interest paid for a loan taken out to fund speculation but the accrued interest paid in the qcquisition of bonds - either when re-investing after a sale or a maturity, or when injecting/investingf resh cash.

The question is, can interest paid be offset only for the individaul bond (then one would hav eto allow to offeset interest paid from a previous period) or is it the net out of total interest received and interest paid during a period.

For this I have not found an (English language) answer on the net yet....