A Guidance on Taxation of Intra-Group Financing Transactions
The Cyprus Tax Authorities (the “CTA”) issued on 30 June 2017 a tax circular (the “Circular”) regulating the Transfer Pricing rules in relation to the companies which carry out back-to-back intra-group financing transactions in Cyprus. The Circular has been in effect since 1 July 2017. With this new tax framework, all the related companies which are tax resident in Cyprus and carry out transactions between them, are required to apply the arm’s length principle, as described in the OECD Transfer Pricing guidelines.
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.
In order to indicate that an intra group financing transaction was completed pursuant to the arm’s length principle, a transfer pricing report must be provided to the CTA as a supporting document. The minimum requirements that must be embodied in the transfer pricing report are laid down in the Circular where it is also provided that the transfer pricing report should be prepared by a transfer pricing expert and submitted to the CTA by a licensed person who has authorisation to act as an auditor of the company in accordance with the Cyprus Companies Law Cap. 113. The auditor of the company is also required to perform an assurance control of the transfer pricing report and confirm its accuracy and quality.
Another important aspect of the Circular, is the requirement for the remuneration arising from the intra group financing transaction to comply with the arm’s length principle. Put simply, the arm’s length principle, provides that the remuneration arising from an intra group transaction must correspond to the price that would have been agreed in comparable transactions completed by companies and/or independent parties which are not related between them.
In this regard, a comparability analysis must be carried out in order to:
- Identify the commercial and financial relationship between the related parties and determine the conditions and the economically significant circumstances of the transaction. As stipulated in the Circular, in order to exactly describe an intra group financing transaction, it is requisite to determine the characteristics such as its terms and functions, the assets used and the risks assumed by the related parties of the transaction. The comparable analysis shall also include conclusions resulting upon the review of the contractual terms, the functional analysis and the risk analysis. The Circular also provides that the capability of assuming and managing risk demonstrates the substantial economically characteristics that must be identified in order to be able to describe the transaction precisely. In furtherance of the above and in order to suffice in providing a precise description of the transaction, a company shall be considered to be able to assume risk if, in case the risk crystallises, it has the financial capacity to manage such risk and eventually bear the financial consequences arising out of it. In addition, a company shall be considered to be able to manage the risk if it exercises the power of decision making to enter into a transaction which reserves risks and has the ability to address and overcome such risks. On this point, the Circular adds that a company must have actual physical presence in Cyprus, something that is determined while considering other factors some of them being the number of directors that are tax residents in Cyprus, the number of the board of directors’ meetings which are actually held in Cyprus and whether the management and control of the board of directors of the company is made from Cyprus etc. It is also specified through the Circular that the company must have qualified personnel to control the transactions performed on behalf of the company.
- Compare the conditions and economically significant circumstances of the transaction with comparable transactions between independent parties. Once the transaction is precisely described as mentioned in (i) above, then it must be confirmed whether the arm’s length principle has been followed with regard to the remuneration of the transaction.
There are though some simplified measures that could be applied in relation to the aforesaid. In particular, if the requirement of actual physical presence of a company is met and the company merely conducts intermediary transactions such as borrowing from related parties and on-lending to related parties, then it is at the company’s own discretion to follow the simplification measures laid out in the Circular. If this is the scenario, the intra group transactions will be considered compliant with the arm’s length principle if from such transactions, the company receives at least a 2% return after-tax on assets. The percentage of 2% will be reviewed by the CTA frequently and pursuant to the relevant market analyses. In some exceptional cases, deviation from the 2% minimum return may be allowed subject to the condition that an appropriate transfer pricing analysis will be provided. One practical note for the companies wishing to benefit from the simplification measures, is that they must disclose such intention to the CTA through their annual tax return report in the corresponding fiscal year.
