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This is a general review of requirements introduced by the Cyprus Tax Department in the Interpretative circular of 30th of June (which came into effect from July 1st 2017 for all existing and future transactions, irrespective of the date of entering into the relevant transactions and irrespective of any tax rulings effective prior to the above date) setting out the revised tax treatment of intra-group back-to-back financing arrangements. This Circular sets out the requirements for companies that are either Cyprus tax resident (namely companies whose management and control are exercised in Cyprus), or are tax resident outside Cyprus but have a permanent establishment in Cyprus, and carry out group financing transactions.
Let’s take a look at the Circular and outline the basic new developments in general terms.
1. The “arm’s length” principle to intra-group financing transactions will be applied
The above principle was implemented with the aim of guaranteeing that the state obtains taxes. The “arm’s length” principle is the international standard adopted by OECD member states, and was introduced by Cypriot tax legislation in 2003. However, the specific rules of transfer pricing, or any requirements of transfer pricing documentation, were not set out until now.
From July 1st 2017 a determination will be made with respect to each intra-group financing transaction as to whether the remuneration proposed complies with the above-mentioned principle. In other words, whether such remuneration corresponds to the price that would have been exchanged between independent parties in comparable circumstances, taking into account the economic nature of the transaction.
2. Another requirement of new Circular is the necessity to conduct comparability analysis
A comparability analysis shall be carried out in order to determine whether the transaction between related entities can be compared to transactions between independent entities,. The comparability analysis will involve:
- Identifying the commercial or financial relationship between related entities and determining the conditions and economically relevant circumstances in order to accurately delineate the controlled transaction;
- Comparing as accurately as possible delineated conditions and economically relevant circumstances of the controlled transaction with those of comparable transactions between independent entities.
It is advisable:
- to ascertain the role of each entity taking part in controlled transactions;
- to review the structure and organization of the group;
- to understand the interdependencies between the functions performed by the entities and the contribution made by related entities to the creation of value within the group, and the impact of this contribution on the ‘arm’s length’ remuneration of each of the entities participating in the controlled transactions;
- to determine the characteristics of a controlled financing transaction, such as its terms and functions, the assets used and the risks assumed by related entities, etc.
3. Requirements of actual presence in Cyprus shall be taken into account
In order to justify risk control and to further validate that the management and control are exercised in Cyprus, a group financing company must have an actual presence in Cyprus.
The Circular provides several criteria of an actual presence in Cyprus, such as:
- Meetings of the Board of Directors and Shareholders will be held in Cyprus;
- Basic management and commercial decisions will be made in Cyprus;
- A number of Directors will be Cyprus tax residents.
In addition, the group financing company must have qualified personnel able to control the transactions performed.
4. Simplification of procedure applies with regard to a purely intermediary activity
When a group financing company pursues a purely intermediary activity, the simplified procedure applies, and for sake of simplification the transactions are regarded as complying with the ‘arm’s length’ principle if the company receives a minimum return of 2% after tax on assets. This percentage is subject to change by the Tax Department, depending on the results of relevant market analysis. It should be noted that in order to benefit from the above simplified procedure, entities must submit the necessary information to the Tax Department in the prescribed manner.
5. Minimum requirements for transfer pricing analysis will be taken into account
Such requirements are found in paragraph 29 of the Circular. The transfer pricing analysis should be prepared by a transfer pricing expert and include a number of points prescribed, including, but not limited to, the precise scope of the transactions analysed, a general description of market conditions, a complete list of searched potentially comparable transactions, a description of the computation of equity allocation required to assume the risks, etc.
We realize that the amendments mentioned above affect a number of taxpayers; therefore, we strongly recommend our clients and stakeholders to start reviewing their current group structure to contact professionals immediately in order to receive additional information. Our company will provide the appropriate services and assist you in complying with the long list of requirements introduced and in determining the impact of the relevant rules on your business. You may get in touch with out Tax Advisory Team.