On 30 June 2017, the Cyprus Tax Authorities (CTA) issued a Circular, guiding taxpayers on the implementation of new rules relating to intra-group financing activities in Cyprus from 1 July 2017.
The Circular applies to intra-group financing activities where loans are granted by a company to related parties, financed by financial means and instruments, such as private loans, cash advances, bank loans and debentures.
The Circular gives guidance in terms of substance and transfer pricing requirements to back-to-back financing transactions in line with the OECD Guidelines, as well as for guidance on the required content of a transfer pricing study substantiating the arm’s length level of the financing margin earned by a Cypriot company.
Two companies are considered as related parties if they fall under the scope of Article 33 of the Income Tax Legislation (which contains definitions of related or connected parties for the purpose of applying the arm’s length principle).
Transfer pricing requirements
Each Cyprus tax resident financing company is required to submit a transfer pricing study as proof that each financing transaction has been executed on an arm’s length basis.
This involves the company identifying each commercial and financial relationship with related parties and commercially substantiate that the transaction has been entered into based on market conditions.
An analysis will also be required of the functions performed, assets used and risks assumed by the Cyprus tax resident financing company.
The importance of a risk analysis is that a financing company bearing risks must have the financial capacity to manage those risks and bear the financial consequences if the risks assumed actually materialize. The company is expected to determine, using relevant methodology, the appropriate level of equity that would be needed to assume the risks
To prove that the arm’s length principle is met, it is necessary to prepare a comparability analysis testing the group transaction against similar transactions between unrelated entities/ independent parties.
The Circular specifies that Cyprus tax resident financing companies must have sufficient substance in Cyprus and have qualified employees to control the risks and transactions they are entering into.
A financing company which meets the substance requirement mentioned above and is engaged in purely intermediary financing activities, borrowing from related entities and on- lending to related entities, will be deemed for the sake of simplification to comply with the arm’s length principle if it receives in relation to its controlled transactions a minimum return of 2% after-tax on assets.
Entry into force
The Circular applies from the 1st July 2017, for all existing and future transactions. Any rulings issued prior to this date will no longer be valid for periods from the 1st July 2017 onwards.