This is a tax update in reference to the new circulars issued by the Tax Authorities, 6/2023 and 7/2023 in reference to Transfer pricing studies.
Technical circular 6/2023
Simplification measures for persons exempted from the obligation to comply with the documentation in a Cyprus Local File based on paragraph (9)(a) of article 33 of the Income Tax Law.
1. This circular provides guidance on documenting the price of controlled transactions and introduces simplification measures in sub-categories of transactions in case of exemption of a person from the obligation to comply with the documentation in a Cyprus Local File based on paragraph 9(a) of article 33 of the Income Tax Law N.118(I) 2022 as amended (ref “Income Tax Law”) which was inserted into the basic law by the amending law N.101(I) 2022 effective from 01/01/2022.
A. Where is applicable;
2. The circular applies to any business carried on by a person resident in the republic or from a permanent establishment in the republic of a person who is not a resident of the republic (ref “the business”), regarding controlled transactions that cumulatively per category do not exceed or would not exceed, based on the principle of transfer pricing seven hundred fifty thousand euros (€750.000) per tax year, as a result of which they are exempt to comply with the documentation in a Cyprus Local File, based on the provisions of paragraph (9)(a) of article 33 of the Income Tax Law.
B. Arm’s length principle and minimum documentation required
3. According to the provisions of paragraph 1 of article 33 of the Income Tax Law, the satisfaction of the arms length principle, is achieved in the event that the terms are set or imposed between two businesses, regarding their commercial or financial relations which do not differ from the conditions that would be established between independent parties. However, in the event that the terms in question between two businesses differ from those set between independent businesses, any profits or benefits, which if these terms were not set would be carried out from one of the businesses but due to these terms did not take place, then they could be included in the profits or benefits of the business and taxed accordingly.
4. In the context above, the minimum documentation is required to comply with the principle of transfer pricing for persons exempted from the obligation to comply with the documentation in a Cyprus Local File and and conduct controlled transactions in any transaction category specify as follows:
a) Brief description of the functional analysis (functions, assets, risks)
b) Description of the characterization of the entity, based on the results of the functional analysis
c) Record the reasons that make the selected pricing method the most appropriate
d) Determining the equidistant value based on comparability search results of internal or external comparable depending on the case or any other relevant analysis were based on the guidelines of OECD, it is advisable to use valuation models as in the case of financial guarantees.
5. It is understood that in the event that the business that exempts you from the obligation to observe Cyprus Local File and at the same time chooses to use a simplification measure for one or more transaction subcategories, the minimum required documentation to comply with the principle of equal distances as described in paragraph 4 is limited to the points 4.a) and 4.b) of this circular for the subcategory for which the use of the simplification measure is chosen. Furthermore, it is pointed out that beyond points 4.a) and 4.b), additional documentation is required for each subcategory as specified below in section D.
C. Horizontal layout regarding the choice to use a simplification measure(s)
6. The subcategories for which any business exempt from the obligation to comply with the documentation in a Cyprus Local File has the possibility to choose the use of any simplification measure are the following:
a) “Financing transactions between related parties financed by financial instruments, Section D.1”
b) “Financing transactions to equity- financed related parties, Section D.2
c) “Financing transactions from related parties to the extent that they are used in the business, Section D.3”
d) “Low value- adding Services), Section D.4”
7. The horizontal arrangements regarding the use of simplification measures for the four subcategories are as follows:
a) The use of the distance measure should be accompanied by the required additional minimum documentation as specified for each sub-category of Section D of this circular
b) The minimum documentation as specified in paragraph 4 or and paragraph 5 and Section D, is available to the Tax Collector whenever requested by them within 60 days from the receipt of the relevant request, either from the business, or a person authorized by the business to act as a representative for that purpose
c) The minimum or maximum rates of return/ profit mark-up which are specified below in paragraphs 14, 18, 25 and 31 will be reviewed periodically by the Tax Department based on the facts and the circumstances of the relevant purchases of each category of transactions and the conditions of the global and domestic economy or/and any other factors or criteria that the tax commissioner deems relevant when re-examining and re- determining the said minimum or maximum rates of return/profit mark-up
d) Deviation is not allowed from the height of the minimum or maximum performance rates / profit mark-up, as specified below in paragraphs 14, 18, 25 and 31 unless the deviation is documented properly from the minimum documentation set out in paragraph 4 of this circular. It is highlighted that if the accounting profit from the controlled transactions is higher than what condemned from the result of the transfer pricing study as well as the percentage that is allowed from the simplification measure, the Tax Department will not make any downward adjustment of the taxable income (in accordance with the provisions of the article 33(5) of the Income Tax Law to the extent that is applied
e) The business should declare to the Tax Department the use of a simplification measure for one or more transaction subcategories in case of their choice, filling electronically the relevant part of the tax return/ in the controlled transaction information summary table, the latest by the obligation date to submit the income statement of the liable person for the tax year referred to.
8. A necessary condition for the use of a simplification measure for one of the four subcategories of this circular is that the sum of the transactions both for the subcategory the simplification measure is being used for as well as the controlled transactions that belong to the same category in which the subcategory falls to not exceed or has not exceeded based on the transfer pricing principle the seven hundred fifty thousand euros (€750.000) per tax year.
9. Under no circumstances can a business benefit from a simplification measure in any of the four subcategories as described in section D, provided the business has a compliance to maintain a Local file for the category in which the subcategory falls, i.e., the total number of controlled transactions exceeded or would exceed, based on the transfer pricing principles, the seven hundred fifty thousand euros (€750.000) per tax year.
10. It is understood that in the event that the business carries out controlled transactions in one of the four sub-categories and at the same time possesses internal comparable (paragraphs 3.27 and 3.28 OECD) which should be used to determine the transfer pricing with regards to the controlled transactions then the simplification measure is not allowed to be used in that subcategory.
11. The use of unilateral safe harbour rules as defined in paragraphs 14,18,25 and 31, from a business which conducts cross border transactions makes the transactions in question declares cross border regulations according to the article 2(1)5 and the appendix IV, Part II,OECD as amended. In accordance with the provision of the regulation 42(2) 438/2021, the use of unilateral safe harbor rules should always take place in the context of intra-border cross-border transactions as prerequisite.
D. Simplification measures
D.1 Financing transactions between related parties financed by financial instruments
12. For the purposes of this particular circular, the term “financing transactions between related parties financed by financial instruments” refers to any activity related to granting loans or cash advances of affiliated entities or to related parties bearing interest ( or should be bearing interest), financed by financial instruments such as bonds, loans from affiliated entities or related parties including interest – free loans by the shareholders of the business, cash advances and loans from credit institutions.
13. The functions of a business that conducts financing transactions, as described in paragraph 12, are related to the process of creating a loan and the subsequent negotiation of a loan, including functions related to risk control. These functions are included in Section B of part II of the 2010 OECD report ON THE ATTRIBUTION OF PROFITS TO PERMANENT ESTABLISHMENTS. Clarifying that even though the subject of the said report, concerns the sharing of profits in permanent installations, however, the section under reference B of II of the report is the best representation of the operations of a business that conducts financing transactions and its use in these cases is prohibited. It is understood that characterizing such activity as described in paragraph 12 is not affected by the number, the nature, maturity or other characteristics of the loan or cash advance.
14. Any business that carries out financing transactions as described in paragraph 12, that is, granting loans or cash advances to affiliated entities or to related parties which are financed by bonds or loans or cash advances received from affiliated entities or related persons or from credit institutions, regardless of whether the business has the financial capacity to undertake equity risks it is considered for simplification reasons that the transactions comply to the transfer pricing principle if the business under consideration receives in relation to the controlled transactions the minimum yield of two and a half (2.5) percentage points before tax deduction. Understanding that the said output is after the expenses deduction which represent amounts that were allocated or spent entirely and exclusively for the purpose of acquiring the income in question.
15. The minimum output applies to the value of loans receivable which are financed from financial instruments. It is specified that the minimum output percentage of paragraph 14, applies to the average term of the principal of the receivable loan during the tax year in question including interest charged and not collected.
16. The business that chooses the application of the above simplification measure for loans that fall under the subcategory “financing transactions between related parties financed by financial instruments” will have to prepare the following additional minimum information and documentation:
a) Detailed description of the loans for which the simplification measure is used (dates of conclusion of the loan agreements, loan amounts, loan balances at the end of the tax year, repayment dates, collateral, interest rates, details of any amendments to loan agreements etc.)
b) Listing the reasons justifying that the loans meet the definition “financing transactions between related parties financed by financial instruments” as specified in paragraph 12 of Section D.1
c) Numerical analysis, reconciliations and explanation regarding the use of the simplification measure on controlled transactions for the purposes of determining the taxable income of the liable person.
D.2 Equity-financed related party financing transactions
17. For the purposes of this circular, the term related party financing transaction to the extent that it is financed by equity, refers to any activity related to the granting of loans or cash advances to affiliated entities or to related persons that bear interest (or should bear interest), financed by the company’s own funds i.e. funds that have been brought into the business through the insurance of share capital or from the issue of shareholders at a premium, to the extend that these have been paid, non-reciprocal capital contribution or and funds from own resources which came from profits from the conduct of business activities.
18. Based on paragraph 1.64 of OECD guidelines, if the financing comes from equity, as described above, the lender, that is the business, is deemed to have the financial capacity to assume the risks associated with granting loans or cash advance to related parties or related persons. In view of the assumption of risks associated with the transactions in question, for simplification measures, the transactions comply with the transfer pricing principle, if the business receives in relation to the controlled transactions under consideration, the minimum output, which is equal to the yield rate of a ten year government bond of the state in which the borrower activity is increased by three and a half (3.5) percentage units before tax deduction.
19. The minimum output applies on the value of the loan receivable to the extent the equity finances. The percentage of minimum output applies to the average of the receivable loan capital (to the extent financed by equity) during the tax year period in question including interest charged and not collected.
20. If the business finances persons who operate in different states, then the output of each loan will be calculated and applied separately, based on the yield rate on the state’s ten-year government bond, in which the borrower activity is increased by three and a half (3.5) percentage units before tax deduction.
21. The reference interest rate of the ten-year government bond, of the state in which the borrower activity is equal to the interest rate on 31st December of the previous year of the tax year in question. It is clarified that in the cases where the said reference rate is negative, then it will not be considered in its calculations and the minimum output in these cases will be equal to three and a half (3.5) percentage units before tax deduction.
22. Meaning that the output interest rate of the state’s ten-year government bond in which the borrowers activity varies from year to year, then the minimum output as described above will be adjusted each tax year in question.
23. The business that chooses the application of the above simplification measure for loans that fall under the subcategory “equity financed related party financing transactions” will have to prepare the following additional minimum information and documentation:
a) Detailed description of the loans for which the simplification measure is used (dates of conclusion of the loan agreements, loan amounts, loan balances at the end of the tax year, repayment dates, collateral, interest rates, details of any amendments to loan agreements etc.)
b) Listing the reasons justifying that the loans meet the definition “equity financed related party financing transactions” as specified in paragraph 17 of Section D.2
c) Numerical analysis, reconciliations, and explanation regarding the use of the simplification measure on controlled transactions for the purposes of determining the taxable income of the liable person.
D.3 Related party financing transactions to the extent they are used in the business
24. For the purposes of this circular the term “Related party financing transactions to the extent they are used in the business” refers to receiving loans, bonds or cash advances from affiliate parties or related persons bearing interest to the extent that the said granting of loans or financial facilities used to invoke the basis of the articles 5(1) and 5(2) of the Income Tax Law.
25. For simplification reasons, the transactions described above in paragraph 24 comply to the transfer pricing principle, if the borrowing cost of the considered business in relation to the controlled transactions does not exceed the yield rate on the ten-year government bond of the Republic of Cyprus, increased by one and a half (1,5) percentage units before tax deduction.
26. The benchmark interest rate of the ten-year government bond of the Republic of Cyprus equals the interest rate as of the 31st of December of the tax year preceding the tax year under consideration and applies on the value of the loan payable to the extent used by the business based on article 5(1) and 5(2) of the Income Tax Law. The minimum output percentage applies to the average of the principle of the loan payable (to the extent used by the business based on article 5(1) and 5(2) of the Income Tax Law during the tax year under consideration including interest charged and unpaid.
27. It is specified that if the reference rate in question is negative then it will not be considered for the calculation of the maximum efficiency and the maximum output in such cases is equal to one and a half (1,5) percentage units before tax return.
28. Meaning that the rate of return of the ten year government bond of the Republic of Cyprus equals the interest rate as of the 31st of December varies from year to year, then the maximum output as described above will readjust each tax year under consideration.
29. It is understood that the simplification measure of the subcategory “related party financing transactions to the extent they are used in the business”.
30. The business which chooses to apply the above simplification measure for the loans falling under the subcategory “related party financing transactions to the extent they are used in the business” will have to prepare the following additional minimum information and documentation:
a) Detailed description of the loans for which the simplification measure is used (dates of conclusion of the loan agreements, loan amounts, loan balances at the end of the tax year, repayment dates, collateral, interest rates, details of any amendments to loan agreements etc.
b) Listing the reasons justifying that the loans payable satisfies the definition “related party financing transactions to the extent they are used in the business” as specified in paragraph 24 of Section D.3
c) Numerical analysis, reconciliations, and explanation regarding the use of the simplification measure on controlled transactions for the purposes of determining the taxable income of the liable person.
D.4 Low value-adding services
31. Any business conducting controlled transactions, which are low added value services, as analysed below in paragraph 32 are considered, to comply with the transfer pricing principle if the business in question receives in plan with the under consideration controlled transactions, the minimum profit mark-up of five (5) percentage units on the related costs, as defined in Part D.2.2 (paragraphs 7.56-7.62) of the 7th chapter of the OECD guidelines.
It is understood that if the business in question is the recipient of the low value-added services and not the service provider, then the profit mark-up of five (5) percentage units of the relevant costs defines as the maximum acceptable profit margin. For more details on the method that should be applied regarding the allocation of the relevant costs for the audited entities and the application of the profit margin on the said expenditure please refer to parts D.2.2, D.2.3 and D.2.5 of the seventh chapter of the OECD guidelines.
32. According to paragraph 7.45 of the OECD guidelines, services of low added value for the purposes of the simplification measures are the services provided by one or more members of the group on behalf of one or more members of the group, which:
a) Are supportive in nature
b) They are not part of the main activities of the group (that is, they do not create profit-making activities or do not contribute to financially important activities of the group)
c) They do not require the use of unique and asset yards and do not result in the creation of unique and asset yards
d) They do not presuppose the assumption or control of a large or significant risk by the service provider and neither raise a significant risk to the service provider.
For examples of services that likely meet the definition of a low value-added service, see paragraph 7.49 of the OECD guidelines.
33. It is specified that the following activities do not meet the conditions for the use of simplification measures and therefore are not considered services of low added value:
a) Services that constitute the core activity of the group
b) Research and development services (including software development unless they fall within the scope of the technology or information services of paragraph 7.49 of the OECD guidelines)
c) Manufacturing and production services
d) Purchasing activities related to raw materials or other materials used in the manufacturing or production process
e) Activities related to sales, marketing, and distribution
f) Financial transactions
g) Mining, exploration, and processing of natural resources
h) Insurance and reinsurance
i) Services of the supreme etheric administration (extracting the supervision of the management of the services which are characterized as intra-group services of low added value as defined in paragraph 7.45 of the OECD guidelines)
34. The business which chooses to apply the above simplification measure will have to prepare the following additional minimum information and documentation:
a) Description of the categories of low added value intra-group services provided
b) Identity of the holder
c) Reasons justifying that, each service category is an intra-group service of low added value, within the definition set out in paragraph 32 of this circular
d) Description of the selected distribution keys
e) Documentation and calculations showing cost group determination, as described in section D.2.2 of the seventh chapter of the OECD guidelines and of the applicable profit margin thereon, a list of all the categories and the amount of the related expenses, including the cost of any services provided exclusively to a member of the group
f) Calculations showing the application of specified allocation keys
g) Numerical analysis reconciliations and explanation regarding the use of the simplification measure on controlled transactions for purposes of determining the taxable income of the liable person.
Technical circular 7/2023
Pricing based on the transfer pricing principle for cases of businesses carrying out back-to-back type financing transactions.
With this circular it is pointed out that for the tax year 2023 onwards, the tax collector considers the most appropriate method for transfer pricing is the comparable uncontrolled price method as clearly indicated by the OECD guidelines, which state that “the widespread existence of loan markets and the frequency of such transactions between independent borrowers and lenders, combined with the wide availability of information and market analysis related to loans facilitate implementation of the uncontrolled pricing comparison method”.
1. The comparable Uncontrolled Price method requires as comparatives the arm’s length interest rates and please note that this method also applies to any claim which:
a) Conducts back-to-back financing transactions type and said transactions are considered as loans against accurate delineation as described in chapter I of the OECD guidelines.
b) Based on the results of the functional analysis operations, assets and risks, qualifying as a financing claim with operational and financial ability to undertake assumption of risk, i.e., Executes the control risk and has sufficient equity capital to be able to absorb the loss if the risks in connection with the financing transactions take place.
See section C.1.2.1 of chapter 10 of the OECD guidelines for more complete relevant information.
2. a) Emphasize that only in exceptional cases will you allow the use of any method other than the of comparable uncontrolled pricing for the businesses that meet the assumptions of the above paragraphs 1a and 1b. In these cases you should secure prior approval from the tax authority through the general procedure for submitting tax opinions.
b) In these exceptional cases the business should additionally provide the following information:
i) The reasons for which the comparable uncontrolled pricing method is considered less appropriate or not applicable under specific circumstances. in support of such claim the interest rate comparability search results should be submitted
ii) Detailed analysis to support the claim that the chosen alternative method results in satisfactory pricing of the transfer pricing principle based on the the OECD guidelines
iii) The reasons for which the other method provides a better solution than the comparable uncontrolled pricing method.
In summary of the two above mentioned circulars in cases you have intra group transactions below the 750k threshold you should refer to the Technical circular 6/2023 and or seek for guidance and that CUP method should be also included in a transfer pricing report in cases of back to financing loans.
For any further clarifications please contact:
George Yiallourides
Managing Director
T: +357 25443132
E: yiallourides@ayca.com.cy
Yiannis Charalampous
Tax Manager
T: +357 25443132
E: ioannis@ayca.com.cy
