Cyprus: Saying Goodbye To Back To Back Loans And Welcoming Transfer Pricing Regulations
A. Introduction
In February 2017 Cyprus Tax Department has announced that the current practice regarding profit margins between related Company loans will be abolished by the 30th June 2017.
The announcement indicates that the minimum acceptable margins will apply up to 30th June 2017, and as from 1st July 2017 all related Company transactions (e.g. financing arrangements) where Cyprus Tax Resident Companies are involved, should follow the arm’s length principle. In addition, the announcement indicates that independent Transfer Pricing Study (TPS) should be provided as supporting document evidencing that the interest rate used in the particular transaction will be considered as correct having based on the market’s conditions existed at the time the transaction took place.
B. Definitions
Arm’s Length Principle (ALP) is defined as the condition or the fact that the parties to a transaction are independent and on an equal footing. This principle is commonly used to commercial and financial transactions between related companies. Article 33 of the Cyprus Income Tax Law introduces the ALP.
Arm’s Length Transactions (ALT) is defined as the transactions should be valued as if they had been carried out between unrelated parties, each acting in his own best interest.
Back to Back Loan (BTBL) is defined as the arrangement for lending/ borrowing between related parties.
TPS is defined as the document to be provided to the Cyprus Tax Authorities as supporting document evidencing that the transaction took place, was based on ALP.
C. Current Legislation
Based on Article 33 of the Cyprus Income Tax Law, transactions between related parties should have been carried out at arm’s length terms. This includes also loan agreements.
The Cyprus Tax Authorities could have imposed tax adjustments in case related party transactions did not follow ALP (in most cases as notional interest income).
However, Cyprus Tax Authorities treated TBTLs in a different way. In 2011 BTBL regime, between related companies, was agreed with the Tax Commissioner, which allowed low profit margins for funding between related parties. The acceptable margins ranged between 0.125% and 0.35% depending on the amount of the loan. Cyprus Companies enjoyed low taxation from the use of back to back arrangements.
D. New Developments
The Cyprus Tax Authorities having thorough studied the current legislation and considering EU and OECD framework, international standards and code of conduct for the taxation of businesses, and with the intention to fully comply with the OECD BEPS framework, decided to change the current tax regime in relation to the BTBLs.
In February 2017 Cyprus Tax Department has announced that the current practice regarding profit margins between related Company loans will be abolished by the 30th June 2017, as mentioned above.
As from 1 July 2017 all related Company transactions (e.g. financing arrangements) where Cyprus Tax Resident Companies are involved, should follow the arm’s length principle. In addition, the announcement indicates that TPS should be provided as supporting document evidencing that the interest rate used in the particular transaction will be considered as correct having based on the market conditions existed at the time the transaction took place.
As the current legislation does not contain any transfer pricing rules and regulations and also does not require TPS to be submitted, the Cyprus Tax Authorities announced that detailed transfer pricing rules and regulations for intercompany financing transactions (based on OECD guidelines) will be circulated shortly. These new rules and regulations will apply to tax assessment, issuing of tax rulings as well as TPS requirements.
E. TPS
TPS is the first effort by Cyprus to document transfer pricing framework and needs to fulfil the following requirements based on OECD guidance:
- Appropriate thought is given to transfer pricing requirements when prices and other conditions are established;
- Tax Authorities are given all required/ necessary information to prepare a transfer pricing risk assessment; and
- Tax Authorities are given all required/ necessary information to conduct a thorough audit of the transfer pricing practices of the entities (subject to tax in their countries of tax residency).
A TPS will provide a concrete indication that the specific client has studied its tax situation, considered available data and concluded to a consistent transfer pricing position.
The TPS should be in a position to steadily prove that the transactions between related parties are determined, for tax purposes, in accordance with ALP. Information such as accounting records and taxable profits should be satisfactorily provided.
Therefore, the TPS will be an essential part of the client’s strategic tax risk management.
F. Conclusion
As the circular of the Cyprus Tax Authorities is still to be issued, there is no clear guidance as to specific requirements. It is expected to be based on other countries rules and regulations (for example Luxembourg). It is anticipated that TPSs might not be required for intergroup loans below certain market values.
It has also been announced that any tax rulings issued before 1 July 2017 in relation to the profit margins for BTBLs will be considered as void and therefore be cancelled.
Any transactions that will exist after the 30th of June 2017 will require to be evidenced by TPSs.
As a large number of clients will be affected by the said changes, we suggest that all affected parties to commence a review of their current arrangements and financing structures, recognize and evaluate possible influence of the new forthcoming regulations, re-assess and proceed with necessary steps to correct the current arrangements (such as restructuring of intragroup loans through Notional Interest Deductions – NID – as per our article of January. This re-evaluation and corrective actions will ensure that the new transfer pricing rules and regulations will be properly followed.
