Cyprus implements revised tax treatment for intra-group back-to-back loans

The Cyprus Tax Department issued a circular with amendments relevant to the corporate tax treatment concerning intragroup back-to-back financing transactions.

As of the 1 July 2017, The Arm’s Length Principle, as defined in the OECD Model Tax Convention on Income and Capital (Article 9), it is now applicable in Cyprus to particular intra-group back-to-back financing transactions. It is now imperative that each group ensures that the associated consideration to each covered financial transaction complies with the Arm’s Length Principle.

Covered Financial Transactions

The circular concerns every Cyprus tax resident entity. A Cyprus tax resident entity is a company that is managed and controlled in Cyprus, as well as a non-Cyprus resident company that has set up a permanent establishment in Cyprus.

Intra-group financing transactions concern cash or loans remunerated with interest granted to related companies that are funded by financial instruments (i.e. private loans, bank loans, cash advances or debentures).

According to Cyprus tax law (section 33 of Income Tax Law), two companies are considered related when one of the companies directly or indirectly participates in the control, capital or management of the other company or when the same individuals directly participates in the management, control or capital of both companies.

New Regulations

A group is now obligated to determine the suitable remuneration or reward according to transfer pricing principles (instead of the minimum profit margin system which was applicable in Cyprus). Therefore, the group must conduct a comparability evaluation in order to ensure that the purported remuneration is equivalent to transactions made amongst independent parties that have been in similar transactions.

The evaluation includes two parts:

  • Identifying the commercial/financial relationship amongst related entities and determining the economic conditions linked to the entities relations so as to outline with accuracy the controlled transaction.
  • Compare the delineated conditions and economic circumstances of the particular transactions with similar transactions conducted amongst independent parties.

Simplification measures

The circular provides a simplified scheme to particular Cypriot tax resident group finance companies that only take part in intermediary financing activities, advances of loans to related companies that are then re-financed by other related companies.

In order to simplify matters, a Cyprus Company that collects at least 2% after tax return on assets, the Tax Office will deem that the relevant Cyprus Company has complied with the Arm’s Length principle. The Tax Department of Cyprus has specified that the particular rate will be revised according to market analysis. In order to benefit from this measure, a company must be considered as having substance and the use of the scheme should be clarified to the Tax Department of Cyprus.

Substance

The Tax Department of Cyprus outlines the substance regulations within the circular, which require a company to be present in Cyprus in order to benefit from the abovementioned-simplified scheme.

The circular outlines that a company’s presence in Cyprus is defined by the following:

  • The number of the board of director meetings that are held in Cyprus;
  • The number of the management & commercial decisions which are taken in Cyprus;
  • The amount of board of directors that are Cyprus tax residents;
  • The number of shareholder meetings that are held in Cyprus.

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