Cyprus Tax Authorities introduce guidance for taxation of Intra-Group Financing Transactions
On 30 June 2017, the Cyprus Tax Authorities (the “CTA
”) issued a tax circular (the “Circular
”) with respect to the new rules for the taxation of back-to-back intra-group financing transactions. The Circular is effective as from 1 July 2017 and follows the application of the arm’s length principle set out in the OECD Transfer Pricing Guidelines.
Earlier this year, the CTA announced that, with effect from 1 July 2017, the application of the specified minimum profit spreads (0.125% - 0.35%) on qualified back-to-back related-party financing transactions will be terminated and the treatment of such transactions is now subject to the Circular.
We briefly outline below the main provisions of the Circular:
1. Scope of the Circular
The Circular applies to Cyprus tax resident entities and permanent establishments which are involved in back-to-back intra-group financing transactions. The Circular defines intra-group financing transactions as the granting of loans or cash advances to related companies (within the scope of Section 33 of the Cyprus Income Tax Law) that are (or should be) subject to interest and are financed by financial means, such as debentures, private loans, cash advances and bank loans.
The new guidelines apply to all existing and future transactions, irrespective of the date of entry into the relevant transactions and any tax rulings obtained prior to 1 July 2017. In this respect, tax rulings issued prior to 1 July 2017 on transactions within the scope of the Circular are no longer valid.
2. Application of the Arm’s Length Principle and the Comparability Analysis
The Circular provides that the remuneration arising from back-to-back intra-group financing transactions should comply with the arm’s length principle i.e. correspond to the price that would have been agreed by independent parties in comparable transactions, taking into account the economic nature of the transaction.
In this respect, a comparability analysis must be carried out for the purpose of:
(a) Identifying the commercial and financial relationship between the related parties and determining the conditions and the economically significant circumstances of the transaction
The Circular specifies that in order to precisely describe the intra-group financing transaction, it is necessary to determine the characteristics, such as its terms and functions, the assets used and the risks assumed by the related parties.
The following matters should be considered and taken into account as part of the analysis:
The actual conduct of the parties should be taken into consideration when determining the terms of the transaction even though this may differ from what was contractually agreed.
A functional analysis should be carried out for the purpose of identifying the economically substantial activities, responsibilities and functions, the assets used and the risks assumed by the parties in the context of the transaction, and is necessary for the determination of the risks related to the transaction. The Circular includes a non-exhaustive list of functions that may be performed by entities involved in intra-group financing transactions.
The Circular provides that the ability to assume and manage risk constitutes the economically significant characteristics which must be identified in order to describe precisely the transaction.
An entity is considered to be able to assume
risk if it has the financial capability to manage the risk and bear the financial consequences in the event that the risk materialises. The Circular, sets out the methodology to be used as part of the risk analysis, including using comparables to credit institutions and investment firms pursuant to EU Regulation, in order to determine the entity’s equity levels and whether these are sufficient to enable it to assume the relevant risk.
An entity is considered to be able to manage
the risk if it has, and actually exercises, the decision making power to enter into risk bearing transactions and if it has the ability to address such risks. In this respect, the Circular provides that entities:
(b) Comparing the conditions and economically significant circumstances of the transaction with comparable transactions between independent parties
(1) Must have actual presence in Cyprus, which is determined by taking into account the following criteria: the number of Cyprus tax resident directors, the number of the board of directors’ meetings held in Cyprus and whether the main management and commercial decisions of the board of directors are taken in Cyprus, the number of shareholders’ meetings held in Cyprus.
(2) Must have qualified personnel to control the transactions performed. It is noted that the Circular allows for the outsourcing to third parties of any functions that do not have a significant impact on risk control, including daily activities of risk mitigation, provided that the entity maintains control and supervision of the risk and function outsourced.
Once the transaction has been precisely described, then the arm’s length remuneration is determined by comparing the transaction with comparable transactions observed between independent parties in the open market.
The comparability analysis must be transparent, systematic and verifiable, using all sources available at the time of the transaction.
3. Transactions without commercial rationale
Intra-group financing transactions that cannot be observed in the open market as part of the comparability analysis and which lack any commercial rationale, must be disregarded to ensure full compliance with the arm’s length principle.
4. Simplification measures
Where an entity satisfies the actual presence provisions mentioned above and conducts purely intermediary activities (borrowing from related parties and on-lending to related parties) it may, at its option, follow the simplification measures set out in the Circular. In this respect, transactions will be deemed to comply with the arm’s length principle if the entity receives in connection with a transaction at least a 2% return after-tax on assets. This percentage will be regularly reviewed by the CTA based on relevant market analyses.
Deviation from the 2% minimum return will only be allowed in exceptional cases provided it is justified by an appropriate transfer pricing analysis.
In order to benefit from the simplification measures, the relevant entities should disclose the use of such measures to the CTA through their tax return in the corresponding fiscal year.
5. Transfer Pricing report requirements
The Circular prescribes the minimum requirements that need to be included in a transfer pricing report. In addition, it provides that the transfer pricing report should be (i) prepared by a transfer pricing expert, and (ii) submitted to the CTA by a person who has a license to act as an auditor of a company according to the Cyprus Companies Law Cap. 113 and is required to carry out an assurance control confirming the quality of the transfer pricing report.
For further advice please contact our tax lawyers, Stelios Triantafyllides and Olga Adamidou who can assist with your tax queries.