On 30 June 2017, the Cyprus Tax Department (“CTD”) issued a Circular with respect to the new rules for the taxation of intra-group financing arrangements which apply from 1 July 2017. The new Circular provides for the application of transfer pricing methodology to such activities based on the arm’s length principle as advocated by the OECD.
The new tax treatment is applicable for companies which meet the following criteria:
- The Circular applies to intra-group financing activities (Financing activities) refers to any activity of granting of loans or cash advances remunerated by interest (or which should be remunerated by interest) to related companies, financed by financial means and instruments, such as debentures, private loans, cash advances and bank loans. The activities related to investment holdings are not taken into consideration.
- Are Cypriot tax resident companies (i.e. their management and control is exercised in Cyprus), or are non-Cypriot tax resident companies which have a permanent establishment in Cyprus and the financing activities are attributable to the permanent establishment.
- Application of arm’s length principle to intra group financing transactions
For the purposes of transactions falling within this Circular, it is necessary to determine for each intra-group financing transaction conducted, same as with all types of intra-group transactions, whether the agreed remuneration complies with the arm’s length principle, (as set out in Article 9 of the OECD Model Tax Convention on Income and on Capital).i.e. corresponds to the price which would have been accepted by independent entities in comparable circumstances, taking into account the economic nature of the transaction. An appropriate comparability analysis must be carried cut in order to determine whether transactions between independent entities are comparable to transactions between related entities.
In the Cypriot tax legislation, the arm’s length principle is included in Section 33 of the Income Tax Law, which allows adjusting the reported profits as described therein in case the transfer prices differ from prices that would have been agreed between independent entities.
- Comparability Analysis
- An appropriate comparability analysis (transfer pricing report) must be carried out in order to determine whether transactions between independent entities are comparable to transactions between related entities.
- The comparability analysis should consist of two parts:
- Identification of commercial or financial relationship between related entities and determination of the conditions and economically relevant circumstances attaching to those relations.
- Comparison of the as accurately delineated conditions and economically relevant circumstances of the controlled transaction with those of comparable transactions between independent entities.
- Substance requirements
The Circular stipulates that financing companies must have an actual presence in Cyprus and have the qualified personnel to control the risks and transactions entered into. A financing company is considered to control the risk if it has the decision making power to enter into a risk-bearing commercial relationship, if it has the ability to address such risks, and it actually performs such decision-making functions.
The actual presence criteria take into account the number of the members of the board of Directors that are Cyprus tax residents and the number of board of Directors’ meetings as well as shareholders’ meetings held in Cyprus.
The daily activities of risk mitigation may be outsourced as long as the company has the capability to take, and actually makes, the key decisions with respect to the outsourcing.
- Simplification measures
When a Cypriot tax resident group financing company, which pursues a purely intermediary activity, grants loans or advances to related companies, which are refinanced by loans or advances obtained from related companies, it is considered that, in view of the risks associated with the transactions analyzed, for sake of simplification, the transactions are deemed to comply with the arm’s length principle, if the company receives in relation to its controlled transactions under analysis, a minimum after tax return 2% on the assets.
An entity which fits such a profile and which does not intend to prepare transfer pricing documentation may choose to benchmark its remuneration based on this minimum return on assets approach. The 2% percentage mentioned above will be regularly reviewed by the Tax Department based on relevant market analyses.
Tax returns will be amended to include a relevant field to be filled in by such entities in order to benefit from this simplification measure.
It is noted that a deviation from this minimum return is only allowed in exceptional cases, where it is duly justified by an appropriate transfer pricing analysis.
- Minimum requirements for transfer pricing analysis
The minimum requirements for the transfer pricing analysis are those that are set out in paragraph 29 of the relevant circular.
The Transfer Pricing Analysis should be prepared by a Transfer Pricing Expert.
It must be submitted to the Cyprus Tax Department by a person who has license to act as auditor of a company in Cyprus, who is required to carry an assurance control of the transfer pricing analysis.
- Rulings and exchange of information
The issuance of tax rulings (including rulings related to simplification measures) or Advanced Pricing Arrangements, as well as the use by a taxpayer of the simplification measures, will be subject to the exchange of information rules set under the Directive on Administrative Cooperation.
- Entering into force of the circular
The new circular applies with effect as from 1 July 2017, for existing and future transactions. Any rulings issued prior to this date will no longer be valid for periods from 1st of July 2017 onwards.
If the intra-group financing transactions had been supported by a Transfer Pricing study and are still ongoing after the above date, the study will need to comply with the provisions of the relevant circular, which will be verified by the Tax Commissioner.