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Cyprus – Tax Treatment of intra-group back-to-back loans

The Cyprus Tax Department has issued on 30 June 2017 a Circular in relation to the Tax Treatment of intra-group back-to-back financing arrangements, which becomes effective from 1 July 2017.

This Circular applies to any Cyprus tax resident company (or to a company that is tax resident outside Cyprus and has a permanent establishment in Cyprus) carrying out intra-group financing transactions to related parties.

The term intra-group financing transaction refers to any activity consisting in the granting of loans or cash advances remunerated by interest to related parties and includes debentures, private loans, cash advances and bank loans. According to the Circular, two companies are related if they fall within the scope of Section 33 of the Income Tax Law (ITL).

The arm’s length principle

Reference to the arm’s length principle is made in section 33 of the ITL and allows for adjustment of the reported profits in cases where the transfer prices differ from the prices that would have been agreed between independent entities. It is also set out in Article 9 of the OECD Model Tax Convention on Income and on Capital and used in determining the transfer prices between related undertakings conducting cross-border transactions.

Application of the arm’s length principle to intra-group financing transactions

For each intra-group financing transaction conducted, it is necessary to determine whether the remuneration agreed is in line with the arm’s length principle. An appropriate comparability analysis must be carried out to determine whether the transactions between independent entities are comparable to transactions between the 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 in order to accurately delineate the controlled transaction;

-Comparison of the as accurately delineated conditions and economically relevant circumstances of the controlled transaction with those of comparable transactions between independent entities.

Actual presence in Cyprus (Substance)

The Circular emphasises the substance criteria, by clarifying that, in order to justify the risk control and to further validate that the management and control are exercised in Cyprus, it is imperative that a group financing company must have an actual presence in Cyprus. The presence criteria taken into account include the following:

-The number of board of Directors members of the company that are Cyprus tax residents.

-The number of board of Directors meetings held in Cyprus and the main management and commercial decisions taken in Cyprus.

-The number of shareholders’ meetings taking place in Cyprus.

Furthermore, the group financing company must have the qualified personnel to control the transactions performed. The group financing company may nonetheless subcontract functions that do not have a significant impact on risk control.

Transactions with commercial rationale

In case where particular transactions cannot be observed in the open market or are devoid of any commercial rationale, such transactions must be disregarded to ensure full compliance with the arm’s length principle.

Simplification measures

When a group financing company which meets the criteria and pursues a purely intermediary activity grants loans or advances to related entities which are refinanced by loans or advances granted by related entities, it is considered that, for sake of simplification, the transactions are deemed to comply with the arm’s length principle if the analysed entity receives a minimum return of 2% after-tax on assets. This percentage will be regularly reviewed by the Tax Department based on relevant market analysis.

In order to benefit from this simplification measure, entities should communicate the use of said measure to the Tax Department by filling in the relevant field in the tax return of the corresponding fiscal year.

The minimum requirements for transfer pricing analysis

The Circular provides a list of the minimum requirements for a transfer pricing analysis, which include:

– a description of the computation of equity allocation required to assume the risks

– a description of the group and the inter-linkages between the functions performed by the entities participating in the controlled transactions and the rest of the group, together with a description of the value creation in the broad sense within the group by the entities participating in the transactions

– the precise scope of the transactions analysed

– complete list of the searched potentially comparable transactions

– a rejection matrix for rejected potentially comparable transactions together with justifications of such rejections

– the final list of comparable transactions which have been selected and used to determine the arm’s length price applied to the intra-group transaction(s) accurately delineated

– a general description of market conditions

– a list of all previous agreements on TP concluded with other countries in relation to the transactions in question

– a list of all the previous agreements concluded with the entity/ies under analysis which are still in effect at the time of the submission of the request,

– a projection of the income statements for the years covered by the request

Tax rulings

The issuance of tax rulings including rulings related to simplification measures or Advanced Pricing Arrangements, are subject to the exchange of information rules set under the Directive on Administrative Cooperation (Council Directive 2011/16/EU as amended by Council Directive Council Directive (EU) 2015/2376).

Entry into force

The Circular applies from 1 July 2017 for all existing and future transactions. It is further noted that any tax rulings issued prior to this date will no longer be valid for tax periods as from 1 July 2017.

If the intra-group financing transactions effected prior to 1 July 2017 are still ongoing and they were supported by transfer pricing study, the said transfer pricing study will need to comply with the provisions of the Circular.