Cyprus has become one of the EU’s stronger performers on VAT compliance, but it still lacks basic tools to measure how much revenue it loses through personal and corporate income tax non-compliance — a blind spot the European Commission links to the country’s sizeable shadow economy. These are among the key takeaways of the Commission’s “Mind the Gap” Cyprus country fiche, which reviews tax compliance gaps and tax expenditures, and maps where member states are improving — and where vulnerabilities remain.

The report puts Cyprus’ VAT compliance gap in 2023 at around €100 million, or 3% of the VAT total tax liability — well below the EU average of 9.5% and the third-lowest in the Union. It also notes a steady decline over the past five years, from 11% in 2019, including a three-percentage-point drop between 2022 and 2023. At the same time, it estimates losses linked to missing trader intra-community (MTIC) fraud at around €50 million in 2023.

But while VAT performance is presented as a relative success story, the Commission underlines that Cyprus does not officially estimate or publish national tax gaps beyond the EU VAT gap exercise — and that it is “not aware of any” personal income tax or corporate income tax gap estimation activities by the Cypriot authorities. That matters, the fiche argues, because measuring these gaps can reveal where enforcement is failing and what drives informal activity, helping tax policy target the right pressure points.

One likely driver, the report suggests, is undeclared work. It cites estimates placing Cyprus’ shadow economy at 23.9% of GDP in 2022 — well above the EU average — and points to common patterns such as envelope wages, under-reporting by the self-employed, and undeclared side work, especially in sectors such as construction, accommodation and food services, agriculture, and retail.

The fiche also draws attention to Cyprus’ tax structure and what it implies for fairness. Total tax revenues were below the EU average in 2023 (37.4% of GDP versus 39.0%), even though Cyprus recorded one of the largest increases in tax revenues since 2010 (around five percentage points). VAT plays an unusually prominent role in the tax mix: VAT revenue represented 25.4% of total tax revenues, compared with an EU average of 18.3%. The Commission adds that while labour taxes are relatively progressive, the tax-and-benefit system’s ability to reduce inequality is among the lowest in the EU, partly because Cyprus has no wealth, inheritance or gift tax, and capital gains are “in principle” untaxed.

Digitalisation is framed as a major area of progress — and a potential lever for closing compliance gaps. The report highlights the launch in 2023 of the integrated “Tax For All” (TFA) system, designed to replace fragmented legacy platforms and provide tax authorities with a unified taxpayer view for monitoring and inspections. Cyprus plans to add more artificial intelligence elements by the end of 2025. The fiche also records very high e-filing rates, including 100% for VAT filings in 2023 and 99.9% for personal income tax, both above the EU average.

However, the Commission argues that several “next-step” tools are still missing or underdeveloped. It says Cyprus could benefit from stronger upfront checks before VAT registration, more systematic follow-up on VIES numbers, and continued work on improving on-time filing using risk-based criteria. It also notes that debt-management functions in the new system are still under development — and flags that Cyprus’ tax administration does not have a formal tax recovery strategy, does not publish a recovery report, and reported no national recovery-rate data for claims relating to VAT, personal income tax, and corporate income tax in a 2025 survey.

Another major weak spot, according to the fiche, is how Cyprus processes cross-border data under the Directive on Administrative Cooperation (DAC). It reports data-matching rates for individuals well below the EU average: about 45% for DAC1 and 14% for DAC2, compared with EU averages of 84% and 87%. The Commission attributes the limited results to transliteration issues and limited resources dedicated to processing incoming data, while also noting very limited use of DAC3 and DAC4 and only selective use of DAC6.

On tax policy “gaps,” the report highlights the scale of foregone revenue from VAT exemptions and reduced rates. It estimates the VAT policy gap at 41% of notional ideal revenue in 2023 — around €2 billion — with an exemption gap of 26% (around €1 billion) and a rate gap of roughly €800 million (15%). It adds that the introduction of reduced VAT rates for primary residences and selected products is reflected in these figures.

The fiche also points to transparency issues in Cyprus’ reporting on tax expenditures. While Cyprus includes tax expenditure reporting in a budget annex, the Commission says coverage is limited, comparability is weak, and there is little visibility on whether relief measures are evaluated for effectiveness. It cites a global tax expenditures database estimate putting the fiscal cost of tax expenditures at around €930 million, or 3.2% of GDP in 2022. The report also notes a striking discrepancy between Cyprus’ own tax expenditure figures and the much larger VAT policy-gap estimates, suggesting substantial methodological differences.

Finally, the Commission flags recent steps to tighten corporate tax rules — particularly on outbound payments — as progress in closing policy gaps. It notes that from 1 January 2026 Cyprus plans to apply non-deductibility of interest and royalty payments to zero- and low-tax jurisdictions, as well as a withholding tax on dividend payments, while a withholding tax on interest, dividends and royalties paid to jurisdictions on the EU list of non-cooperative jurisdictions has been in place since 2023.