Cyprus tax news on Cyprus Companies' intra-group financing transactions (New Cyprus transfer pricing rules on Cyprus Companies' intra-group financing transactions)
The Cyprus Tax Department has issued a circular for the tax treatment of intra-group financing transactions (Cyprus transfer pricing rules on intra-group financing transactions). The term intra-group financing transaction (transfer pricing rules on intra-group financing transactions) refers to any activity consisting in the granting of loans, debentures, or cash advances remunerated by interest to related companies (Related companies are defined as the relationship between two companies for instance that of holding company and subsidiary company or the relationship between associated companies where there is control on the composition of board of directors, holding the majority of the voting rights etc).
Scope of the Cyprus Companies' intra-group financing transactions circular (New Cyprus transfer pricing rules on intra-group financing transactions)
The Cyprus Companies' intra-group financing transactions circular follows the OECD Transfer Pricing (TP) Guidelines which require Cyprus companies to make sure that Cyprus intra-group financing transactions have adequate interest rate profit margins and apply the arm's length principle. Thus if financing transactions between related parties differ from similar transactions between independent parties the tax base may be adjusted.
The Cyprus Companies' intra-group financing transactions circular methods in calculating interest rate profit margins
The Cyprus Companies' intra-group financing transactions circular gives two approaches in determining adequacy of interest rate profit margins on Cyprus Companies' intra-group financing transactions.
1. Simplified approach
Provided Cyprus substance requirements are met, a Cyprus financing company may now be assumed to comply with the Cyprus Intra-group financing transactions circular if it receives a minimum percentage of return of 2% after tax (pre-tax 2.29%). Cyprus financing companies adopting this approach should notify the Cyprus tax department by completing relevant section in their annual tax return.
2. Cyprus Companies' intra-group financing (Cyprus Companies' transfer pricing on intra-group financing) documentation approach
Transfer pricing analysis on intra-group financing should be prepared by a transfer pricing expert (e.g. a licensed auditor) in order to justify that transactions between independent parties are comparable to transactions with related parties.
Some of the most important considerations to be included in the analysis are:
- 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 within the group by the entities participating in the transactions;
- the precise purpose of the transactions analysed;
- a list of the searched potentially comparable transactions;
- a rejection matrix for rejected potentially comparable transactions with justifications;
- the final list of comparable transactions which have been selected and used to determine the arm's length price applied to the Cyprus intra-group transactions accurately delineated;
- 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 entities under analysis which are still in effect at the time of the submission of the request;
- projections of the income statements for the years covered by the request.
Important considerations in applying the arm's length principle to Cyprus Companies' intra-group financing transactions
Some of the most important considerations in determining and applying the arm's length principles to Cyprus Companies' intra-group financing transactions are:
- The role of each of the entities within the group to which they belong;
- The contribution of the related entities to the value creation within the group;
- Τhe economic circumstances in which the Cyprus intra-group financing transaction has been conducted;
- The economic strategies of the parties and of the group in general;
- Εvaluation of the ability of the Cypriot financing company to lend and its sources of income;
- The behavior of the parties in relation to the intra-group financing transaction irrespective if written or oral. The actual behavior of the parties should be similar to what was contractually agreed;
- Managing the financing for the transaction.It is important to demonstrate that the intra-group financing transaction is controlled and managed by the Cypriot financing company and that the Cyprus financing company has the decision-making power to enter into commercial financing transactions;
- The assets used in the intra-group financing transaction;
- The credit and financial risks incurred by related entities;
- Use of funds emanated from the intra-group financing transaction;
- If intra-group financing transactions (debentures, bonds) are quoted in a regulated market;
- Τhe terms and conditions of the
intra-group financing transaction:
- examining the relevant financial statements,
- if guarantees, charges exist;
- If additional interest penalties exist on any unpaid amounts;
- If clauses exist which require the Company to immediately pay back any amounts;
- If there are any commitments, undertakings and representations in respect of the borrower;
- the purpose of the credit;
- the duration of credit;
- If intra-group financing transactions are related or unrelated to back to back financing;
- Examining risk vs remuneration i.e. the higher the risk the higher the remuneration;
- If the intra-group company to which the financing will be granted, has the financial capacity to manage the risk and to bear its financial consequences in case of a non repayment;
- If the company to which the financing will be granted is sufficiently capitalized or has adequate resources to be able to cope with financing;
- If the Cyprus finance company of the group controls the risk and if it has the power to make financial transaction decisions even if it outsources the transactions to third parties;
- If there are comparable intra-group financing transactions in the market (Intra-group financing transactions must be transparent, systematic and verifiable);
- The practice applicable in similar sectors;
- If the intra-group financing transactions were carried out without a commercial purpose (economic reason) and probably carried out in order to reduce tax;
- Other alternative form of investments currently available in respect of the financing company;
- The borrower's accessibility to financial institutions and the possibility of achieving a lower interest rate than that offered through intra-group financing;
- If there is a proof for maximising the wealth of a group for instance in cases where a lower interest rate can be offered through inta-group financing;
Cyprus management and control and Cyprus economic substance
The Cyprus Companies' intra-group financing transactions circular also states that Cyprus financing companies need now demonstrate Cyprus substance and that the management and control are exercised in Cyprus. In this respect a Cyprus finance company should demonstrate:
- The number of board of Directors members of the Cyprus financing 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;
- Further the group Cyprus financing company must have the qualified personnel to control the transactions performed. The Cyprus group financing company may nonetheless subcontract functions that do not have a significant impact on risk control;
The effective date of the circular for intra-group financing transactions for Cypriot companies is July 1, 2017 therefore all intra-group financing transactions of Cypriot financing companies and all existing Cyprus financing structures which relate to Cyprus intra-group financing transactions should now be urgently revised.
How we can help
We can review the existing structure of your Cyprus financing company so that it complies with the principles of the circular. We can also sign an NDA agreement with regard to the work we will carry out.
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.