VAT on Financial Services in Cyprus

Why financial services are exempt from VAT

Financial services are exempt from VAT across the EU under the VAT Directive. The exemption covers the core activities of financial intermediation — lending and borrowing of money, foreign exchange, transactions in securities and management of special investment funds. The rationale is partly administrative — calculating VAT on the margin of a financial transaction is extremely difficult — and partly policy — adding VAT to the cost of financial intermediation would harm the broader economy. The exemption is mandatory across all EU member states including Cyprus.

Financial services exempt from VAT in Cyprus

• Granting and management of loans and credit
• Acceptance of deposits and other repayable funds
• Foreign exchange transactions
• Transactions in bonds, shares and other securities
• Management of special investment funds
• Insurance and reinsurance premiums
• Financial guarantees and sureties
• Payment processing and money transfer services
• Operation of current and savings accounts

What financial businesses do that IS taxable

Not everything a financial institution does is exempt. Financial advisory services — investment advice, M&A advisory, corporate finance — are separate from the exempt financial transactions themselves and are generally taxable at 19%. Asset management performance fees above a threshold may be taxable. Safe custody services charged as a fee may be taxable. Financial information and data services sold to third parties are taxable. Software and technology services provided to other financial institutions are taxable.

The input VAT recovery problem

The financial services VAT exemption creates a significant cost for banks and financial institutions. Because their core activities are exempt they cannot recover input VAT on the costs that support those activities — IT systems, premises, staff, professional fees, compliance costs. For a major bank with hundreds of millions in annual operating costs the irrecoverable input VAT is a substantial number. The partial exemption calculation determines how much input VAT can be recovered against any taxable activities the institution conducts.

Special partial exemption methods for financial institutions

Large financial institutions in many EU jurisdictions negotiate special partial exemption methods with the tax authorities that more accurately reflect the extent to which costs relate to taxable activities. The standard turnover-based method often produces a recovery percentage that does not reflect the true position of a financial institution. A transaction-based or floor-space based method may be more appropriate. In Cyprus the Tax Department can agree special methods — financial institutions with significant taxable activities should consider whether a bespoke method improves their recovery position.