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Cyprus Tax Authority issues guidance on back-to-back loan financing

On 30 June 2017, the Cyprus Tax Authorities (CTA) issued a Circular (the Circular) revising the transfer pricing framework for companies carrying out intra-group financing activities in Cyprus.

The Circular is effective from 1 July 2017 and replaces the Minimum Margin Scheme introduced back in 2011.

The Circular replaces Minimum Margin Scheme and provides for guidance in terms of substance and transfer pricing requirements to back-to-back financing transactions in line with the OECD Guidelines, as well as for guidance on the required content of a transfer pricing study substantiating the arm's length level of the financing margin earned by a Cypriot company.

Previous Scheme being replaced by the Circular

The Minimum Margin Scheme was introduced in an attempt to provide guidance as to the minimum margins (spreads) that the CTA accepted for intra-group financing arrangements (back-to-back loans). In accordance with the scheme, the CTA accepted that when a Cypriot tax resident company was engaged in group financing transactions, certain net financing margins (ranging from 0.125% to 0.35% per annum) were considered as an appropriate minimum contribution to the taxable profit of the Cypriot financing company for the purpose of applying the arm's length principle codified in the law.



The circular applies to any company that conducts intra-group financing transactions (hereinafter referred to as the Group's financing company). For the purposes of the preceding sentence, the activities associated with the holding of participating interests are not taken into account. Further, this Circular applies to companies which are Cyprus tax residents, i.e. companies whose control and management exercised in Cyprus, in accordance with article 2 of the income tax Act N.118 (I)/2002 (CITL), as ammended. 

Shall also apply on proportion basis (mutatis mutandis), to companies that are not Cyprus tax residents  and have a permanent establishment in Cyprus in accordance with article 2 of the CITL and in this case the Circular is applicable insofar as the taxation of the permanent establishment in Cyprus.

Meaning of the term “Intra-group financing transaction”:

The term “intra-group financing transaction” 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. Two companies are considered to be related if they fall within the scope of Section 33 of the Cypriot Income Tax Law.

A group financing company may grant loans and other credit facilities to related companies for various commercial reasons, such as (i) financing of fixed assets, (ii) financing of current assets, (iii) long term strategic financing and (iv) other types of financing.

General information

The principle of trade (arm's length principle), as set out in Article 9 of the OECD Model Tax Convention on Income and on Capital, is the international standard adopted by OECD Member States for price-fixing transfer between associated enterprises that conduct cross-border transactions. To ensure the application of this principle, the OECD developed regularly updated guidelines that must be adhered to by both multinational enterprises and tax administrations in relation to the transfer prices between associated entities that conduct cross-border transactions. 

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

This analysis will need to consist of two parts:

Part 1 - Identification of commercial/financial relationships between the related entities and determination of the conditions and economically relevant circumstances

It is necessary to determine characteristics of the controlled financial transaction, such as its contractual terms, to determine assets used, functions, risks assumed by the related entities, to perform risk analysis in order to determine the adequate level of equity and to establish if the financing company has an actual presence in Cyprus.

In order to assess the equity level required to assume the risks, special consideration should be given to a profile of the financing entity i.e. whether, subject the EU Regulation, the group financing company falls under the definition of a financial sector company or not.

Part 2 - Comparison of the controlled transaction with those of comparable transactions between independent entities and determination of arm's length remuneration

Comparable transactions must be identified in order to assess the arm's length remuneration. The identification process must be transparent, systematic and verifiable.

Simplified measures
For group companies exercising a purely intermediary financing activity, the transactions entered into by such group financing companies will be considered as compliant with the ALP if such group companies obtain a minimum return on the assets financed after tax of at least 2%. To be eligible to simplified measures Cypriot companies of the group must have sufficient level of actual presence in Cyprus.

Simplified measures are also available to certain regulated entities (financial institutions). A return on equity of 10% would be considered as compliant with the ALP for the eligible regulated entities.

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

A deviation with the above-described requirement of a 2% minimum return is acceptable when duly justified in a transfer pricing analysis.

The minimum requirements of such an analysis should include:

  1. A description of the computation of equity allocation required to assume risks
  2. A description of the group and the inter-linkages between the functions performed by the entities
  3. The precise scope of the transactions analyzed
  4. A complete list of the potentially comparable transactions searched
  5. A rejection matrix for the aforementioned transactions (with rejection justification)
  6. The final list of comparable transactions selected
  7. A general description of the market conditions
  8. A list of all previous transfer pricing agreements concluded with other countries in relation to the transactions
  9. A list of all previous agreements concluded and being still valid with the entity or entities under analysis
  10. Projected income statements for the years covered by the request

The transfer pricing analysis should be prepared by a Transfer Pricing Expert. It is expected that the transfer pricing analysis is submitted to the Cyprus Tax Department by a person who has a licence to act as an auditor of a company according to the Cyprus Company Law and is required to carry an assurance control confinning the quality of the transfer pricing analysis.

Advance tax rulings and advance pricing agreements (APAs)

Application for the issuance of tax rulings (including rulings relating to the simplification measures) or an APA are subject to the above minimum requirements for transfer pricing analysis.

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, whether applied following the issuance of a ruling or not, are subject to the exchange of information rules set under the Directive on Administrative Cooperation (Council Directive (EU) 2011/16 as amended by Council Directive Council Directive (EU) 2015/2376).

Entering into force of the circular
The new circular applies with effect as from 1 July 2017, for existing and future transactions, irrespective of the date of entering into the relevant transactions and irrespective any tax rulings issued prior to the said date.

Any tax rulings issued prior to 1 July 2017 on transactions within the scope of the relevant circular 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 post the reference date and they were supported by a transfer pricing study, the said transfer pricing study will need to comply with the provisions of the relevant circular, which will be verified by the Tax Commissioner.

All tax ruling requests, irrespectively of the date they have been submitted, must comply with the Circulars Nos. 2015/13 and 2016/13 issued by the Tax Department, which relate to the issuing of tax rulings by the Tax Department.



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