New Tax Practice on Intra-Group Loan Facilities

INTRODUCTION

In February 2017, the tax department in Cyprus announced its plan to end the existing tax practice in regards to minimum acceptable margins on loans given to related parties.

The reason the tax department has decided to terminate the specific tax practice is that the tax system of Cyprus has to comply with the present international developments, known as OECD/G20 initiative – BEPS and the EU STATE AID.

In accordance to the recent announcement, the tax practice will remain in place till 30/6/17. Starting from the 1/7/17, all loan transactions and dealings amongst related parties must comply with the arm’s length rule. All transactions must also be based on the conditions of the market at the given time.

EXISTING TAX PRACTICE

In 2011, the Tax Department issued a letter in order to clarify what it viewed as the minimum acceptable interest margin on intra group back-to-back loans. The letter also included an outline of the criteria that financial agreements had to meet to be credited as an intra group back-to-back loan.

The minimum acceptable net margin for tax purposes concerning back-to-back loans was set as follows:

 

 

 

The letter issued by the tax department was comforting to investors because they financed their groups by using Cyprus structures.

NEW TAX PRACTICE

As aforementioned, the existing tax practice will remain effective up until the 30/6/17. Starting from 1/7/17, any related group loan must abide to the arm’s length rule and the interest rate that must be applied should be in accordance to the market conditions.

The tax department also announced that a Transfer Pricing Study prepared by external experts based on the relevant OECD standards should support any such loan transaction. The study must also state the explanations concerning the precision of the interest rate applied in the particular financing transaction.

Furthermore, any tax related rules related to the minimum acceptable margins concerning intra group loans formerly introduced, or those that may be introduced up until the 30/6/17, will no longer apply as on the 1/7/17.

Conclusion

The new tax practice is expected to influence the majority of companies that are operating within Cyprus since Cyprus companies were extensively used as financing means. However, the new tax reform and the implementation of the Notional Interest Deduction legislation on capital, it is believed that the negative effect will be controllable.

Thus, it is important for companies that will be influenced by the change in tax practice to carefully reevaluate their current financing structures, assess how their taxable profits will be influenced and introduce measures that will help them comply with the new regulations in accordance to the law.