The Minimum Margin Scheme (MMS) under which inter-company loans could bear, without any issues an interest rate of 0.35% has been withdrawn by the Cyprus Tax Office as of 1st July 2017.

This means that intra-group financing transactions (IGFTs) will now be examined on the basis of the arm's length principle of the OECD Transfer Pricing (TP) Guidelines.  Perhaps regrettably, this change has immediate effect as it applies to all existing as well as future IGFTs with no grandfathering provisions.  This means that any rulings issued previously on IGFTs are, unless challenged in Court1, to be considered as no longer binding.

As things are now, under section 33 of the Cyprus Income Tax Law, any income from IGFTs (interest or coupon payments on a financial instrument) needs to be in keeping with the Arm's Length Principle and take place on generally acceptable market terms for similar transactions under similar circumstances.

Cyprus has been applying the Arm's Length Principle to loans between companies belonging to the same group.  However, the OECD/G20 Base Erosion and Profit Shifting Base Erosion and Profit Shifting (BEPS) initiative which seeks to do away with "tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations" in which, the OECD informs us "over 100 countries and jurisdictions are collaborating to implement the BEPS measures and tackle BEPS,"2 has meant that the MMS as the manifestation of the Arms' Length Principle, is no longer with us.

The result of this change is that in an effort to avoid findings of state aid any intercompany loans or back to back financing within a group will need to be supported by a transfer pricing study which in turn needs to be based on the OECD transfer pricing guidelines.

The study will need to be a detailed form of analysis comparing the terms of the IGFT and confirming that the transactions are being carried out on an arm's length basis. Additionally the analysis will need to provide details of the adequacy of the equity levels and an explanation of the substance of the entities in Cyprus involved in the IGFT.

Substance is of major importance with the Cypriot entity having to show that an informed decision was made by its Cypriot based directors who have independently decided to become involved in this decision to borrow and lend onwards funds.

As we understand it the analysis has to look beyond contractual terms to fully justify the reasons why such a transaction is taking place under the terms and between the parties involved taking into consideration the financial capabilities of the parties and what might (in a somewhat old fashioned legalistic manner) be referred to as the business efficacy of any IGFT.  In any effect all parties need to justify their role in any such transaction.

Although it may be under specific circumstances possible for an entity taxable in Cyprus to opt for a Simplification Measure (giving a minimum 2% after-tax return on assets) where no extensive analysis will be required.  This process will still need to be justified.

Any IGFTs will need to be analysed and properly justified with adjustments to be made to comply with the revised rules.  An analysis of the type described above needs to be prepared on the basis of the guidelines set out in the relevant Cyprus Tax Authorities circular and on BEPS.

07 July 2017


1 It is basic principle of tax law in Cyprus that no law should retrospectively impose tax.  Depending on how this is interpreted, it may be arguable that a ruling or law which changes the tax status of any taxpayer is illegal and not binding on an IGTF which, when set up was taxed on a set of rules which have now been changed.  This is likely to be litigated upon so watch this space.


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