Cyprus: Tax Treatment Of Intra-Group Back-To-Back Financing Arrangements In Cyprus

Last Updated: 7 August 2017
Article by Philippos Aristotelous and Alexandra Spyrou

Introduction

Earlier this year the Cyprus Tax Department announced that the so-called minimum margin scheme, under which a deemed margin is imputed on "back to back" intra-group loans for the purposes of assessing taxable income, would be abolished and replaced with new detailed transfer pricing rules with effect from July 1, 2017. The new rules have now been published in the form of a circular.

The provisions of the circular cover all Cyprus-resident entities undertaking intra-group financing transactions. The circular makes clear that activities related to holding of participations are not intragroup financing transactions. They also apply, mutatis mutandis, to companies tax resident abroad which have a permanent establishment in Cyprus. The term intra-group financing transaction refers to any activity consisting in the 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. Companies are considered to be related if they meet the conditions set out in Article 33 of the Income Tax Law (ITL) of 2002.

Under the new rules, intra-group financing transactions will be evaluated to ensure that the agreed remuneration complies with the arm's length principle (that is to say, it 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 out in order to determine whether transactions between independent entities are comparable to transactions between related entities.

The arm's length principle is already incorporated in Article 33 of the ITL, which allows the tax authorities to adjust reported taxable profits in the event that transfer prices agreed between related parties differ from the prices that would have been agreed between independent entities.

Comparability Analysis

The comparability analysis should consist of two sections:

  • Identification of the commercial or financial relationship between the entities concerned and determination of the conditions and economically relevant circumstances attaching to those relations in order to accurately describe the transaction;
  • Comparison of the conditions and economically relevant circumstances of the transaction with those of comparable transactions between independent entities.

A group financing company may grant loans or advances to related entities for purposes such as financing of fixed assets, financing of current assets, long term strategic financing and other financing. The circular regards these as the economically significant characteristics of a financing transaction, and the first part of the comparability analysis should contain a full analysis of the terms and functions of the transaction, the assets used and the risks assumed by the related entities. The extent to which the comparability factors are economically significant for a particular transaction depends on the extent to which it would be taken into consideration by independent entities assessing the terms of the same transaction, if it were concluded between them.

For the purposes of the comparability analysis the conduct of the parties is more important than any written terms. Even when a contract is formalized in writing, if the actual conduct of the parties differs from what was contractually agreed, it is the actual conduct of the parties that must be taken into account. While the functions assumed by the lender in connection with granting loans or cash advances to related entities are comparable to those assumed by independent credit institutions subject to the supervision of the relevant regulatory authorities, there could be substantial differences in their application in practice. An effective functional analysis involves an understanding of the decision-making process regarding the origination and the subsequent management of the loan, in particular in terms of corporate strategy and risks and the respective legal rights and obligations of each party, and how this impacts upon the outcome in terms of pricing. In a free market, higher risk generally implies higher pricing. Economically significant risks related to financing transactions should be assessed based on the facts and circumstances of each individual case.

In order to confirm that the management and control of the lender company are exercised in Cyprus, it is imperative that a group financing company must have an actual presence in Cyprus, and that the main management and commercial decisions are taken in Cyprus based on the tax residence of board members, and that Cyprus is the location of board meetings and shareholders' meetings. The company must also have the qualified personnel to control the transactions it undertakes.

Once the transaction has been accurately characterized it is necessary to compare its terms with the terms of similar transactions on the open market. The circular requires the process of identifying such transactions to be transparent, systematic and verifiable. The search should be conducted using all sources of information available at the time of the undertaking of the transaction. The circular adopts a return on equity of 10 percent after-tax as a benchmark arm's length remuneration for the financing and treasury functions based on the current market practice of regulated companies. It makes clear that this is based on current market conditions, and that it will be regularly reviewed.

The circular also deals with the eventuality that no comparable open-market transactions can be identified or, indeed, that the transaction concerned is devoid of any commercial rationale, to the extent that independent parties would not have agreed to enter into such an arrangement. In this event the entire transaction and the associated tax consequences will be disregarded to ensure full compliance with the arm's length principle.

Simplified Basis

As a simplification measure the circular provides that transactions undertaken by a Cyprus tax-resident group financing company which pursues a purely intermediary activity, granting loans or advances to related entities which are financed by loans or advances granted by related entities, will be deemed to comply with the arm's length principle if the company earns a return of 2 percent after-tax on assets in relation to the transactions concerned. This percentage will be regularly reviewed by the Tax Department based on relevant market analyses. In order to benefit from this simplification measure, entities should indicate in their annual tax return that it has been used for the corresponding fiscal year.

This simplified basis is only acceptable for the limited types of transactions specified. Where the nature of the transactions is different, a full transfer pricing analysis must be performed in order to determine arm's length remuneration.

Contents Of Transfer Pricing Analyses For Advance Pricing Agreements

The circular requires all transfer pricing analyses to be prepared by what it describes as a "transfer pricing expert," but does not define what qualification is required. It also requires a licensed auditor to examine the analysis before it is submitted to the Tax Department and to confirm the quality of the transfer pricing analysis, which must cover all the following matters:

  • 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 analyzed;
  • A 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;
  • A general description of market conditions;
  • A list of all previous agreements on transfer pricing concluded with other countries in relation to the transactions in question;
  • A list of all the previous agreements concluded with the entities under analysis which are still in effect at the time of the submission of the request; and
  • A projection of the income statements for the years covered by the request.

The issuance of tax rulings or advanced pricing arrangements, and the use of the simplified basis described above are subject to the exchange of information rules contained in the EU Directive on Administrative Cooperation (Council Directive 2011/16/EU as amended by Council Directive Council Directive (EU) 2015/2376).

Effective Date

The new arrangements apply from July 1, 2017 for all existing and future transactions, irrespective of the date of entering into the relevant transactions and regardless of any earlier tax rulings. Any earlier tax rulings on transactions within the scope of the circular will no longer be valid for tax periods from July 1, 2017. Any transfer pricing studies undertaken before July 1, 2017 to support existing intra group financing transactions will continue to be accepted only if they comply with the new requirements.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Philippos Aristotelous
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.