There are compelling reasons why the property sector in Cyprus should be subject to greater taxation and, moreover, should be a key part of the forthcoming tax reform.

Firstly, in view of mounting future demands for government spending Cyprus will need to have a sustained increase in its government revenues through a broadening of the tax base. And property taxes are the obvious candidate for broadening the tax base since they are at a very low level in Cyprus as well as being according to fiscal experts and the IMF the least “growth-unfriendly” of taxes.

Secondly, annual progressive taxes on property wealth and incomes would contribute importantly to reducing the rising wealth and intergenerational inequalities prevailing in Cyprus.

Thirdly, the low level of taxes on the property sector – compared with many other countries – is stimulating a strong foreign demand for Cyprus real estate, particularly for “luxury” apartments, that in turn is pricing and crowding out many domestic residents, particularly younger persons, from the housing market.

Fourthly, the very high and mounting demand for Cyprus properties together with very generous tax incentives for property developers is diverting resources away from investments in other, potentially more productive, sectors of the economy such as in expanding and renovating facilities for education and the care economy.

And, fifthly, excessive property development fuelled by a benevolent tax regime is ruining the natural environment of Cyprus.

Raising property taxes

What changes in property taxes should be part of the forthcoming tax reform? Notably, Cyprus receives less than 2 per cent of its tax revenue from property taxes compared with the average for EU countries of around 4.7 per cent. And the main component of property tax revenue in many EU countries is receipts from the annual tax on the value of immovable properties.

The annual central government tax on immovable properties for Cyprus was abolished in 2017. Property owners in Cyprus are required to pay a municipal property tax yearly, which is at the very low flat rate of 0.024 per cent of the property’s value. This compares with progressive tax rates ranging from 2.6 to 6.4 per cent for Denmark levied annually on property values, 1.5 to 2.3 per cent for Germany, 0.4 to 0.7 per cent for Italy, 0.3 to 0.8 per cent for Portugal, 0.3 to 0.4 per cent for Spain, and 0 to 2.0 per cent for Greece with properties over €500,000 subject to higher rates.

It is recommended that in view of the reasons listed above including the need to broaden the tax base that the Cyprus authorities reintroduce a recurrent progressive tax on immovable properties at up-dated market values, with rates ranging from zero for residential properties below €200,000, to 1.0 per cent for properties between €200,000 and €500,000, and 2 per cent for properties above €500,000.

The mounting purchases of Cyprus properties, especially by foreigners, has become overwhelming. The Cyprus authorities need, among other things, to use changes to the tax system to reduce significantly the demand for Cyprus real estate, particularly by foreigners. Both Spain and Portugal, which are experiencing housing crises, have announced their intention to raise taxes on the foreign purchases of properties in their countries.

Accordingly, Cyprus should raise taxes and fees on the purchase of properties by foreigners. In addition, institutional and classification procedures under the questionable “Golden Visa Programme” need to be overhauled to ensure that the programme is properly implemented so that correctly categorised foreign companies bear and are forced to pay the full cost for buying Cyprus real estate.

Reviewing tax incentives

But, the housing crisis problem in Cyprus is far from being entirely due to the purchases by foreigners. In truth, the under-taxing of developers and owners in the up-market property sector induces the preferential allocation of resources toward the construction of more “luxurious” properties as against investments in other projects, such as in social housing and building facilities for the care economy. 

Indeed, property developers can take advantage of appealing tax incentives offered by Cyprus, including of a Notional Interest Deduction (NID) scheme that allows a deduction of up to 80 per cent on taxable profits from new equity financing, that in turn enables the effective corporate tax rate to be reduced to as low as 2.5 per cent.

In addition, the government provides reduced VAT rates for new residential properties. While the standard VAT rate is 19 per cent, developers can sell new residential properties to buyers who intend to use them as their primary residence under a reduced 5 per cent VAT rate on the first 200 square metres of the property. And this incentive can be passed onto the buyer who must live in the property for at least 10 years.

Notably, the proposed tax reform focuses on giving additional tax breaks to existing companies, including big property developers, that appear to be more geared to propping up their financial viability rather than advancing the economy’s competitiveness. Whereas the corporate tax rate is to be increased from 12.5 to 15.0 per cent, the much-criticised deemed dividend distribution system for tax purposes is abolished, and the tax on actual dividend payments is to be reduced from 17 to 5 per cent.

And the tax reform keeps the special taxation treatment favouring foreign companies and professionals newly domiciled in Cyprus; the zero-withholding tax on dividends to non-residents is maintained, while high-income new resident professionals will continue to enjoy a 50 per cent personal income tax break and be exempt from the Special Defence Contribution tax on dividends received.

Accordingly, there is the issue of whether these tax incentives are too generous and are even being largely abused in promoting the excessive allocation of resources to the up-market property sector. There needs to be a serious and critical review of such incentives by the Cyprus authorities, so as to roll back and adjust tax incentives deemed inappropriate in order to get at least contractors and property developers to allocate their resources better in constructing essential infrastructure and in building social housing.

Thus, it can be concluded that in order to deal with key problems afflicting the Cyprus economy and society including the ongoing housing crisis, mounting wealth and intergenerational inequalities, deficient energy infrastructure, and the economy’s lack of competitiveness, the Cyprus authorities should give serious consideration to adjusting the tax rates and incentives impacting on the property sector. And the resultant agreed changes in property taxes should form a key part of the forthcoming tax reform, which obviously would have to be delayed because of the aforementioned need for a critical review of the property tax regime and the requirement to up-date property values.