But that need cannot be rushed and it’s impossible that the January 1 deadline can be met

Members of the House of Representatives should not rush to approve the questionable ‘tax reform’ proposed by the government. This is because its contents are largely not compatible with achieving the objectives of the reform, namely, to produce a fairer distribution of income and wealth, a more competitive economy, and a broadening of the tax base through raising tax compliance

Furthermore, the proposed tax reform is directed to improving the present financial situation of households and businesses with tax rates and incentives fixed for many years (last tax reform took place some 20 years ago), rather than addressing future fiscal challenges such as demographic change, mounting income and wealth inequalities, and the need to upgrade and expand basic infrastructure facilities, let alone finance the promise of higher defence and security expenditures.

And it is the view here that the proposed tax reform would benefit large public companies much more than smaller enterprises and that the bulk of lower and middle-income households will eventually be impacted adversely by the reform.

Fairer distribution of income

Low-income people, comprising around 36 per cent of employees, which already have annual personal incomes below the tax-free threshold of €19,500 are most unlikely to benefit from the 5.1 per cent increase in this threshold to €20,500. And since many of these persons are in families where no members pay personal income taxes, they can’t benefit from the proposed, new tax deductions.

While those earning yearly personal incomes between €19,500 and €20,500 will initially gain from the increase in the tax-free threshold, the impact of inflation on their incomes will probably drag them into the higher income tax bracket of 20 per cent over the next two to three years.

Similarly, many lower middle-income earners, that comprise around 40 per cent of employees earning from €1,500 to €3,000 monthly, would with the inflation of their incomes be dragged from the 20 per cent income tax bracket into the higher 25 per cent tax bracket over the medium-term. And those middle-income employees earning between €3,000 and €5,000 monthly could in the next few years be dragged into the higher 30 per cent tax rate bracket.

In marked contrast, it is people with annual incomes between €60,000 and €80,000 that will benefit most disproportionately from the tax reform as the tax rate for these taxpayers will be reduced from 35 per cent to 30 per cent. Interestingly this group comprises a considerable number of highly paid public sector and bank employees as well as academics, some of which were responsible for designing the proposed tax reform. Any conflict of interest here?

And given the propensity to not make the personal income tax system more progressive, the top marginal tax rate was kept at 35 per cent, which contrasts with the EU average of 42.5 per cent and that of Greece at 44.0 per cent.

Hence, although some lower-income and many middle-income households will benefit from the tax reform in the short-term, they will most likely suffer from inflation and higher taxes eroding their real disposable incomes over the medium to longer-term. In addition, the failure to tax higher income persons at new elevated rates will contribute to making the distribution of incomes increasingly unfair.

In response, while a number of MPs argue that the tax-free threshold on personal incomes should be raised substantially, it would be preferable to index or adjust every two years tax-free thresholds and brackets to inflation as is the case in EU countries such as Belgium, Denmark, Finland, France, Germany, the Netherlands, Slovakia and Sweden.

Unfair distribution of wealth

Cyprus has recorded one of Europe’s steepest increases in wealth concentration, with the top 10 per cent of income earners seeing their share of national wealth rising by 16 percentage points from 50.7 per cent in 2000 to 66.7 per cent in 2023 according to the “World Inequality Report, 2024” of “Credit Suisse” (now UBS).

And it is the very low taxation of wealth, especially on property, compared with most other European countries, that has contributed most importantly to great wealth inequality in Cyprus. In fact, the central government progressive tax on immovable property was completely abolished in 2017 and an inheritance tax does not exist.

Yet despite President Nikos Christodoulides stating that tax reform will bring about a “fairer distribution of wealth” there in the nothing in its contents on levying significant taxes on wealth. This is a glaring omission, and the Cyprus authorities at least should reintroduce a significant annual progressive tax on immovable properties at up-dated market values to not only mitigate wealth inequalities, but also to broaden the tax base as called for by Finance Minister Makis Keravnos.

Improving competitiveness?

Whether the contents of the proposed tax reform can improve the economy’s competitiveness is debatable.

While professional bodies including Keve, the Cyprus Stock Exchange Council, and Ciba are somewhat critical of the proposed tax reform arguing in particular that it does not promote tax competitiveness, these organisations should realise that large companies in particular have much to gain from the tax reform.

Indeed, the reform appears to focus on changing tax rates and extending generous tax incentives to bolster the profitability of existing public companies. More specifically, even though the corporate tax rate has been raised from 12.5 to 15.0 per cent, the tax reform favours larger companies in that the much-maligned deemed dividend distribution system is to be abolished, and the tax on actual dividend payments is to be reduced from 17 to 5 per cent.

Furthermore, in keeping the special tax treatment favouring foreign companies and professionals newly domiciled in Cyprus, bigger companies benefit disproportionately. In fact, the zero-withholding tax on dividends paid to non-residents is retained. Furthermore, high-income new residents will continue to enjoy a 50 per cent personal income tax break and be exempt from being taxed on dividends received. 

However, new tax incentives for promoting productivity and boosting competitiveness are a welcome part of the tax reform. These include extending to 2030 the 120 per cent super tax deduction for R&D expenditure related to intangible assets (patents, copyrights, brand names etc.) that is intended to reinforce Cyprus innovation and align with the Intellectual Property (IP) Box incentives. Furthermore, generous tax breaks for promoting innovative technologies and entrepreneurship in green and digital transition activities are proposed.

In addition, initial costs for a company listing on a recognised stock exchange are now tax deductible up to €300,000 and are geared to resuscitating the dormant capital market with listings of new companies on the Cyprus Stock Exchange. 

While there is the question of the extent to which these incentives to foster innovation and entrepreneurship will be effectively used or abused, the bigger question is whether the concentration of tax breaks to largely support existing companies will just allow many inefficient businesses to remain financially viable without raising their productivity and competitiveness. Such a development could in turn crowd out resources, including equity investments, required for the government-promised modernisation of the economy with more efficient firms and a flourishing capital market.

Broadening the tax base

The tax reform proposes measures to combat tax evasion and avoidance so as to enhance tax compliance and contribute to broadening the tax base. However, there are questions about the seriousness of the Cyprus authorities in effectively implementing and enforcing such administrative measures. Indeed, in this respect the government budget estimates for 2026 to 2028 show that income tax collections from the tax-evading self-employed people rise by a mere 1.9 per cent over these three years, whereas income tax collections from employees increase by a much higher 18.4 per cent.

While successfully tackling tax evasion and avoidance would contribute to broadening the tax base, it would help also to narrow the take-home pay inequalities between the richer self-employed persons and the less wealthy employees. And similarly, the reintroduction of a progressive tax on immovable properties would widen the tax base and contribute to reducing wealth inequalities.

The proposed tax reform should be substantially overhauled in order that its proposed measures are compatible with the officially stated objectives of producing a fairer distribution of income and wealth, a more competitive economy, and a broadening of the tax base needed to finance important fiscal challenges over the medium to longer-term. However, in effecting the above recommended fundamental amendments, such as changing tax brackets and reintroducing an annual tax on immovable property tax on updated market values, much time and analysis would be required, making it impossible for MPs to approve the tax reform by January 1, 2026.