In this article, we will explain special defence contribution on bank interest and the situations when it may or may not apply.
What is special defence contribution?
Despite its awkward name, special defence contribution (SDC) is simply a type of direct tax imposed on only three types of income: interest, dividend and rent. To clear any doubts, it should be noted that special defence contribution and income tax are governed by completely different taxation laws. Special defence contribution is based on the Special Defence Contribution Law 117(I)/2002 with rates that are flat (either 10% or 3%) no matter what your total income is. On the other hand, income tax is covered by the Income Tax Law 118(I)/2002 with tax rates that are progressive.
Who pays special defence contribution on bank interest?
All individuals who in a given fiscal year accumulate over 183 days of physical presence in Cyprus are subject to special defence contribution on interest. The technical term "tax residence" denotes the status of those persons and is determined independently from civil residence, permanent residence or citizenship. Furthermore, it is important to point out that for individuals, interest income is taxed only under special defence contribution and not under income tax law, under which it is exempt.
So, when a Cyprus tax resident receives interest on bank deposit, the bank will pay the net amount of interest and remit the 10% of special defence contribution to the Cyprus Inland Revenue Department. If the bank is not in Cyprus than the Cyprus tax resident has to declare the interest income (form IR.1) and pay the 10% tax less any tax withholdings made by the foreign bank.
Who does not pay 10% special defence contribution on bank interest?
If you are not a tax resident of Cyprus, then you should not pay any special defence contribution. However, in order your Cyprus bank does not deduct 10% from your interest, you should annually sign and submit to the bank a declaration for exemption (forms IR.18 and IR.18Q). Then the bank will subsequently stop making the deduction.
As briefly mentioned at the outset, individuals whose income (including interest) does not exceed €12,000 are subject to a reduced rate of special defence contribution. In practice, Cyprus banks will continue to withhold 10% tax but the individual is entitled to 7% refund after making an application to the Cyprus Inland Revenue Department (form IR.27).
Finally, if a bank deposit account is held by a husband and a wife, with the husband being non-resident and the wife resident of Cyprus, only half of the interest will be subject to special defence contribution.