In June 2017, the Cyprus Tax Office issued detailed transfer pricing guidelines with an aim to replace the Minimum Margin Scheme regime that was applicable up to that date.
Cyprus is a country that highly complies with the Organisation for Economic Co-operation and Development (OECD) standards. OECD announced transfer pricing policies in an effort to increase integration of national economies, ensure that countries are using their rights to tax profits where the income arises and to support the evolution of Multinational Enterprises. Without any transfer pricing policies, entities may be in the position to manipulate transfer prices between their related companies and build a tax advantage by shifting income from a high jurisdiction to a lower one.
A few definitions are explained below to assist in understanding the concepts:
Transfer prices are defined as the prices at which entities transfer their services provided and their goods to other related companies;
Intercompany financing transactions are defined as the lending of funds to related companies that are subject to interest and are financed by similar resources (e.g. bank loans, debentures, private loans);
Arms' length transaction is defined by the OECD as a transaction that is carried out as if the two parties are not related and both parties are acting in favour of their own interest;
A Cyprus parent company receiving income must ensure that it is in line with international standards of inter-group billing and with the definitions provided by the OECD. The circular applies for all existing and new intra-group financing transactions.
A company should consider performing a transfer pricing study if it has intercompany loans (intra-group back-to-back financing) and/or has received funds from a third party either interest free or interest bearing.
When commencing a transfer pricing study, two important steps need to be taken:
- The first step is to identify the commercial and financial relationship between the two related companies. The study should review the economic terms and conditions of the transaction, perform a functional analysis and a risk analysis. The main purpose of the risk analysis is to ensure that the financing company bearing the risk has the financial ability to manage the risk and their consequences if the risk materialises. Along with the above, economic conditions must be taken into account as well. For example, the size of the market, other competition and the parties geographical locations. Lastly, the study should analyse the related parties' current and future business strategies.
- The second step is to perform a comparability test. A comparability test is performed to ensure that related party transactions carried out by the entity are comparable with non-related party transactions. A group company must be able to prove that charges made towards their related company are identical to those that would apply to a non-related company in an open market and under comparable circumstances. In order to perform such a test, the financial relationship between the two parties must be analysed, the economic substance of the transactions must be identified, along with any assets used and any risk associated with the transaction.
A transfer pricing report can only be prepared and performed by a transfer pricing expert and submitted to the Cyprus tax authorities by a licenced auditor once they have carried out an assurance control confirming its quality. The transfer pricing report is submitted to the Cyprus tax authorities as a form of supporting document signifying that the transactions between related parties are performed under arm's length principle. The transfer pricing report must meet the minimum requirements specified in the Circular.
Simplification measure for purely intermediary companies:
A simplification regime can be an option for entities to avoid the burden of preparing a transfer pricing analyses assuming certain criteria are met. Criteria are listed below:
- The simplification method is only acceptable if the group company is acting as an intermediary financing company (borrowing from one related party and lending to another related party);
- The company must have proper substance in Cyprus. This is determined by the number of Cyprus tax residents on the board, the number of board of directors'/shareholders' meetings that are held in Cyprus and also whether the main management and commercial decisions are taken in Cyprus;
- The company must be equipped with qualified personnel that have control of the risks and transactions performed;
- In addition to the above, the company must have a minimum return on the assets financed of 2% after tax. The 2% mentioned above will regularly be reviewed by the Cyprus tax department based on market analysis.
If all the above criteria are met, then the transaction will be considered to comply with arm's length principle. Companies opting for the simplification measure are required to disclose this in their annual tax returns.
Deviation from the 2% minimum return will only be acceptable in the cases where it is justified by an appropriate transfer pricing analysis.
In the event that a related party transaction is not in line with the arm's length transaction definition, profits that should have been accrued may be added to the profits of the company and taxed accordingly.
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.