Proposal to increase Cyprus' tax-free threshold: Balancing tax relief and fiscal implications

The proposal to increase the Cyprus's tax-free threshold has garnered significant attention and debate.

This article aims to delve into the intricacies of individual taxation and analyze the potential effects of the suggested changes. Tax residents in Cyprus are subject to income tax on income earned both within and outside Cyprus, while non-residents are only taxed on income sourced within Cyprus. By examining the background of Cyprus's tax system, exploring the proposed increase in the tax-free threshold, discussing the pros and cons, and considering the fiscal implications, we can gain a comprehensive understanding of the potential impact on taxpayers and the economy.

To determine tax residency, an individual must spend more than 183 days in Cyprus. However, there are conditions where an individual can be considered a tax resident even if they spend less than 183 days in the country, provided they meet specific criteria within the same tax year.

Currently, the personal income tax rates in Cyprus are as follows:

Understanding the existing tax system is essential to contextualize the effects of the proposal to increase the tax-free threshold and its potential implications. Certain types of income, such as dividend income, interest income (excluding interest arising in the ordinary course of business), and remuneration from employment exercised in Cyprus by non-residents, may be exempt from income tax.

The proposal to increase the tax-free threshold aims to raise it from €19,500 to €24,500. This adjustment would exempt a larger portion of income from taxation, potentially reducing the tax liability for individuals within the affected income range.

Potential Advantages of Raising the Tax-Free Threshold may be as follows:

• Tax Relief for Low and Middle-Income Individuals: By increasing the threshold provides more disposable income for individuals with lower incomes. This improves their financial well-being and reduces the tax burden on their budgets.
• Boost to Consumer Spending and Economic Growth: Increased consumer spending can have a ripple effect, generating additional business opportunities and supporting economic growth.
• Incentive for employment: A higher tax-free threshold may serve as an incentive for individuals to seek employment or increase their working hours.
• Enhanced Equity and Social Welfare: Low-income earners can contribute to greater income equality and improved social welfare. It can help alleviate financial stress and improve the quality of life for those in lower income brackets.

Potential Disadvantages of Raising the Tax-Free Threshold may include:

• Impact on government budget and services: A decrease in tax revenue could have implications for the government's ability to fund public services and infrastructure. It may require adjustments to the budget allocation and could potentially impact the quality and availability of public services such as healthcare, education, and infrastructure development.
• Impact on Progressivity and Income Distribution: Increasing the threshold may affect the progressivity of the tax system. It could lead to a smaller tax base and potentially shift a greater proportion of the tax burden onto higher-income individuals. Careful consideration should be given to maintain a balanced and equitable tax structure.
• Potential Unintended Consequences: Any significant change to the tax system carries the risk of unintended consequences. For example, raising the tax-free threshold might reduce incentives for individuals to increase their income or engage in productive economic activities. It is crucial to evaluate and mitigate such risks before implementing the proposed change.

Fiscal Implications that need to be considered under the proposal to increase the tax-free threshold are as follows:

• Revenue Impact: Estimating the potential revenue loss resulting from the increase in the tax-free threshold requires a comprehensive assessment. Based on current income distribution data, it is possible to approximate the reduction in tax revenue for the government and evaluate its impact on public finances.
• Compensatory Measures: To address the potential revenue loss, the government might consider implementing compensatory measures. These could include adjusting tax rates in higher income brackets, exploring alternative revenue sources, or implementing targeted measures to ensure fiscal sustainability while still providing tax relief.

Raising the tax-free threshold offers several advantages where predominately it provides tax relief for low and middle-income individuals, allowing them to keep a larger portion of their earnings. This increase in disposable income can stimulate consumer spending, bolster economic growth, and improve the overall well-being of taxpayers. Additionally, the proposed change may have positive social implications by reducing the tax burden on vulnerable groups and promoting income equality.

However, there are also concerns associated with raising the tax-free threshold. One of the key considerations is the potential revenue loss for the government, which could affect public finances and the provision of essential services. Additionally, the increase in the threshold may impact the progressivity of the tax system, as higher-income individuals may benefit more from the change compared to lower-income individuals.

In conclusion, the proposal to increase the Cyprus's tax-free threshold requires careful deliberation and analysis. While raising the threshold can offer tax relief and stimulate economic activity, it is essential to consider the potential fiscal implications and societal impact. Striking a balance between tax relief for individuals and maintaining a sustainable fiscal framework is crucial. Further research and deliberation, data-driven estimations, and thorough assessment of its impact are essential, as well as consultation with relevant stakeholders it is crucial, before implementing any changes to the tax-free threshold.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Demetris Philippides (BSc, MSc, FCCA), Manager, Tax Services, KPMG Limited