Transfer pricing regulations govern intercompany pricing for goods, services, royalties and loans between companies, in a cross-border context. In light of OECD (Organisation for Economic Co-operation and Development’s) base erosion and profit shifting (BEPS) initiative, multinational companies may now need to establish a transfer pricing policy. Our Cyprus auditors at Yiallourides and Partners are here to help with all the information you need to know.
In June 2017, Cyprus Tax Authorities introduced the concept for Group Financing Companies and subsequently in 2022 for all other intra group transactions including royalties, trading, and services. All tax consultants in Cyprus are aware of these issues, but you should also know about them if you own/operate a business in Cyprus.
Why do I need a Transfer Pricing report?
The arm’s length principle (Article 33 of the Income Tax Law 2002) is the cornerstone of transfer pricing rules and regulations in Cyprus and is codified in. As per Article 33, any commercial or financial transactions between related parties are taxed on the profits that would have accrued if the transactions had been at arm’s length between independent parties.
Moreover, in line with the OECD BEPS Action 8-10 targeting the erosion of the taxable base and the shifting of profits to jurisdictions with low or even zero tax rates, you ensure that your group is navigated in safe waters and that no unpleasant disputes with the local and or foreign Tax Authorities arise. The necessity that arises is not just for complying with the Tax Law but also to optimise the tax planning of the group.
It is essential that a transfer pricing study is prepared (and it is recommended to use Cyprus auditors for that) preceding the actual transaction to do so. A Transfer pricing study is also a necessary tool for the directors and management of the group to ensure that all transactions are at arm’s length. In cases where the company provides loans, it is also an important tool for the directors to be able to monitor the probability of default of the loans.
The key developments of the Law in Transfer Pricing studies in Cyprus
June 2017 / Cyprus Tax Authorities have introduced the concept for intra-group financing activities, along with guidance in terms of substance and transfer pricing requirements (replacing the Minimum Margin Scheme regime applicable until 30 June 2017). Tax Authorities issued a circular, taking into account the guidance from the OECD BEPS Action 8-10, stating that a transfer pricing study should be prepared for intra-group back-to-back financing transactions. No minimum threshold was set.
It was stated that the following principles must be applicable by the Cyprus Financing Company:
- The company controls the financial risks associated with its funding and makes its own assessment of whether the party receiving the money is creditworthy.
- The company maintains an audit trail on critical functions and risks assumed in relation to the intercompany loan, including creditworthiness analysis of the borrower.
- The financing company must have an actual presence in Cyprus.
The term actual presence is not officially defined nor regulated, yet the following actual presence criteria are detailed in the Circular:
- The majority of board directors members should be Cyprus tax residents.
- The majority of the board of directors meetings must be held in Cyprus and the main management and commercial decisions must be made in Cyprus.
- The majority of the shareholders meetings must be held in Cyprus.
- The financing company must have qualified personnel controlling and managing the financing transactions, such as Cyprus auditors.
June 2022 / A new law is introduced, stating that all intra-group transactions including financing, royalties, services and trading that exceed the minimum threshold of EUR 750.000 must prepare a TP study.
January 2023 / The Commissioner of Taxation with Circular 1/2023 informs that the provisions of Interpretive Circulars No.3 and No.5 relating to “back-to-back” financing arrangements are retroactively terminated as of 31 December 2021. In that respect, as from 1/1/2022, companies can not apply the simplification measures on the intra-group “back-to-back” financing transactions (taxable profit margin of 2%). These numbers can be further explained to you by any company of tax consultants in Cyprus.
June 2023 / Circular 6 is issued by the Tax Authorities that clarifies the requirements for all transactions below the minimum threshold (see below).
June 2023 / Circular 7 is issued by the Tax Authorities that clarifies the preferred methodology to be used in TP studies.
February 2024 / Tax Authorities issue a memo that clarifies the new thresholds applicable retrospectively as from 1 January 2022, that governs all intra group financing transactions exceeding EUR5,000,00 and all other transactions exceeding EUR1,000,000.
This may seem a bit complex to understand, especially if you are not familiar with the material that Cyprus auditors or tax consultants in Cyprus handle, but we will try to make it clearer.
TP ADDITIONAL INFORMATION (it is recommended to consult Cyprus auditors on the matter, if anything is unclear)
Transactions covered
The Transfer Pricing Law and regulations cover all types of transactions between related parties in excess of €1,000,000 per category of transactions, except financial services.
The relevant transactions include:
– Goods
– Services
– Intellectual properties (licensing, disposals etc.)
– Any other types of transactions
The threshold for Financial Services is €5,000,000
New definition of a related party
Two or more persons are considered related if they act together (or take directions) to directly or indirectly:
- hold 25% of the voting rights or share capital, or
- have the right to at least 25% of the profit of a company.
TP methods examined amongst others
The Capital Asset Pricing Model approach (“the CAPM” as it is known by tax consultants in Cyprus) was used to determine whether a company engaging in financing activities earns an adequate spread or return on equity on the loans given to related parties that are financed through the use of related party loans. The average spread earned was calculated with reference to the average interest that the company pays for its financing (from related parties). The method uses the Arm’s Length Return on Equity.
The Comparable Uncontrolled Price (“CUP”) method basically compares the terms and conditions (including the price) of the loans received and the loans given, to those offered to a third-party transaction, and evaluates whether the amount charged in the controlled transaction complies with the arm’s length principle.
The Transactional Net Margin Method (“TNMM”) is a method that examines the net profit margin relative to an appropriate base (e.g. costs, sales or assets) that a taxpayer realises from a controlled transaction.
What will the TP Report from Cyprus auditors include?
The TP Report can be prepared by tax consultants in Cyprus and it will include in summary the following:
- Executive summary
- Description of the intra group activity
- Documentation and sources used
- Risk analysis
- Functional analysis
- Arm’s length remuneration summary and conclusions
- Tax residency
- Independence and competence of the Board
- Credit rating of borrowers
- Methodology
Local file contents
- General description of group activities
- Group structure, showing tax residency and jurisdiction of establishment for each entity
- Annual audited financial statements by Cyprus auditors (management accounts if audited are not available)
- Summary of financial information used
- Summary schedules of relevant financial data for comparable used
- Management structure of the local entity
- Business strategy of the local entity
- Key competitors of the local entity
- Description of intercompany transactions
- Detailed functional analysis, with respect to each documented category of controlled transactions, and any changes compared to the prior year
Master File contents
Note – this is an obligation only for an Ultimate Parent Entity (UPE) or Surrogate Parent Entity (SPE) of an MNE Group, which is subject to CbCR (i.e. Group has consolidated revenues exceeding EUR750M). Also, this can all be created with the help of Cyprus auditors and/or tax consultants in Cyprus.
- Legal and ownership structure
- Jurisdiction of tax residency and establishment of entities
- Description of the MNE’s business activities
- Drivers of business profit
- Supply chain for the group’s largest products/services
- Important service arrangements between members of MNE Group and corresponding TP policies
- Main geographic markets for the group’s products and services
- Brief functional analysis contribution analysis to value creation by individual entities within the group
- Important facts acquisitions and divestitures
- Overall strategy concerning the intangibles development, ownership, exploitation, management, location of principal R&D facilities and R&D decision making
- General description of group TP policy for R&D and intangibles
- Details of any important transfers of IP
- List of important intangibles and which entities legally own them, as well as the relevant intercompany agreements
- Description of how the group is financed, both from related and unrelated lenders
- Description of the general transfer pricing policies related to intercompany financing arrangements
- Identification of any members of the group that provide a central financing function for the group, including the country under
- Annual consolidated financial statements
Once again, we emphasise the benefits of involving a firm of Cyprus auditors in the process.
Advance Pricing Arrangement (APA)
Cyprus tax resident persons and non-Cyprus tax resident persons that have a permanent establishment situated in Cyprus, may submit to the CTD an APA Request with respect to current or future domestic or cross border Controlled Transactions. Do you fall into this category? You should check with tax consultants in Cyprus just to be on the safe side.
The APA request may cover the various conditions and assumptions relevant for determining the arm’s length pricing of the Controlled Transactions for a specified period, including:
- the critical assumptions on the functional and risk profile of the parties involved,
- the relevant market conditions,
- the applicable TP method to be followed,
- the identified uncontrolled comparable transactions and any necessary adjustments made to determine,
- the arm’s length price range,
- any other specialised matter relating to the pricing of the Controlled Transactions.
Once again, this can all be done with the help of Cyprus auditors. The CTD examines the APA request and approves or rejects it.
Timeline: The CTD should issue the APA decision within 10 months (the CTD may notify extension of this deadline up to 24 months) from the date of submission of the APA request by the taxpayer. The APA decision may be applicable for a maximum term of four years. It is recommended to keep track of the request, with the help of tax consultants in Cyprus.
However, it cannot apply for any tax year prior to the tax year in which the request is submitted.
Bilateral and Multilateral APAs: The APA request for cross border Controlled Transactions may be bilateral or multilateral, involving the tax authorities in other jurisdiction(s) with which Cyprus has concluded a Double Tax Treaty. In such cases, a corresponding request needs to be filed by the taxpayer with the authorities in the other jurisdiction(s), and the CTD may consult in writing with such authorities under the relevant mutual agreement and exchange of information procedures and applicable EU legal framework, for the purpose of issuing the APA decision. For more information regarding that, you can consult a firm of Cyprus auditors.
Validity of APA decision: The prices of the Controlled Transactions covered by an APA decision will be considered as arm’s length, provided that any conditions included in the APA decision are met, and that the critical assumptions on which the APA was based continue to be valid and applicable. If you feel unsure about this, do not hesitate to approach any firm of tax consultants in Cyprus, including us here at Yiallourides and Partners.
An approved APA decision is considered binding, but it can be revised during its agreed term upon request of the taxpayer or at the discretion of the CTA, only if:
- the critical assumptions on which the APA decision was based are proven incorrect; or
- the conditions or critical assumptions on which the APA decision was based have substantially changed so that it is impossible to apply the APA decision; or
- if an arbitration process is followed for transactions covered by the APA decision, under an effective Double Tax Treaty or under the EU Arbitration Convention on the elimination of double taxation in connection with the adjustment of profits of associated enterprises.
If you need to know more about double tax treaties, you can talk to us at Yiallourides and Partners, or consult another well-recognised firm of Cyprus auditors of your choice.
Revised APA decisions issued by the CTD shall apply for the remainder of the term of the original APA decision. The CTD may revoke an APA during its term (in which case the APA is considered as not issued) if it is established that:
- the critical assumptions on which the APA was based were incorrect due to misinterpretation of fault attributed to the taxpayer; or
- the taxpayer has failed to comply with one or more of the key terms and conditions included in the APA.
An APA may be cancelled by the CTD at any time during its term, if it is established that:
- there is a significant change to the critical assumptions and conditions on which the APA was based; or
- the taxpayer has failed to comply with key terms of or obligations described in the APA; or
- there is a substantial change in the applicable tax provisions which significantly affect the APA.
An APA cannot be cancelled if it may be revised. Nevertheless, when cancelled, the APA ceases to be in effect from the relevant date specified in the cancellation decision issued by the CTD. Cancellation of an APA is also something that Cyprus auditors can provide more data about. Also, if this has happened to you, please do not wait, and consult the help of tax consultants in Cyprus, in order to prevent unnecessary damages to your business.
Administrative Penalties, in case of Failure to provide Local File or Master File upon request
If notice from CTD to provide TPD (within 60 days) is received but the taxpayer fails to do so, these are the possible fines:
- EUR 5,000 if submitted from 61 days to 90 days after request date
- EUR 10,000 if submitted from 91 days to 120 days after request date
- EUR 20,000 if submitted 120 days after request date
In the case of non-submission of the TP Documentation File following the notification by the CTD of a request for submission, a penalty of EUR 20,000 will apply. That’s why it is important to consult your Cyprus auditors and avoid the hefty penalty. Also, tax consultants in Cyprus can give you more information on these numbers and dates.
Circular 6/2023 – Transactions that fall below the Local File threshold
On 6 July 2023, the Cyprus Tax Department (“CTD”) issued a circular with respect to transactions that fall below the Local File threshold. The Circular applies to all taxpayers with related party transactions (“Controlled Transactions”), which are exempted from the obligation to be documented in a Cyprus Local File.
The new Circular provides for simplified documentation to be prepared for Controlled Transactions that do not exceed the threshold (regardless of category) and is applicable as from 2022. Your Cyprus auditors should know all about it, but here are some important pointers. The main provisions of the Circular are outlined below:
- Simplified Transfer Pricing documentation requirements
Taxpayers falling under the provisions of the Circular, who are eligible to maintain simplified Transfer Pricing (“TP”) documentation based on the above, will be required to include minimum contents in such documentation, which should be kept on file to support their compliance with the arm’s length principle for their Controlled Transactions:
- Brief description of the functional analysis
- A description of the of the entity
- The reasons for the chosen TP method being considered the most appropriate one
- Determination of the arm’s length price/remuneration based on the benchmarking analysis undertaken
2. Safe harbours for certain types of transaction – The Circular also introduces safe harbours for the following four types of sub-categories of Controlled Transactions:
I. Financing transactions such as loans or cash advances granted to related parties, which are funded out of financial means (such as bonds, loans from related parties, interest free loans from the shareholders, cash advances and bank loans). The safe harbour applies regardless of whether the taxpayer assumes the risks of the financing activity.
II. Loans or cash advances receivable from related parties which have been funded out of own capital (e.g. issued share capital and share premium, non-return capital contributions, and retained earnings).
III. Funding received from related parties (through interest bearing loans, bond issuance, or cash advances) to the extent that the funds borrowed are used in the business.
IV. Low value-adding services.
The Circular emphasises that in order to be able to use a safe harbour, the total aggregate value of Controlled Transactions should not be higher than €5,000,000 for financing arrangements and €1,000,000 the other transactions for the tax year. The safe harbours covered by the Circular relate to certain sub-categories of financing activity as well as to low value adding services, and they are as follows:
- The safe harbour amounts stated above are before the deduction of taxes.
- In the case where the yield rate of the ten-year government bond is negative, the safe harbour rates for transactions described under II and III should amount to 3.5% and 1.5%, respectively. Also for I, II, and III, in addition to the principal amount, the relevant safe harbour should also be applied to any interest charged but not paid
Transactions eligible for safe harbours | Safe harbour provision | |
I. | Loans or cash advances to related parties which are funded out of financial means. | Minimum return of 2.5% (after the deduction of allowable expenses). |
II. | Loans or cash advances receivable from related parties which are funded out of own capital. | Minimum return should be equal to the yield rate (as at 31 December of the prior tax year) of the 10-year government bond of the country in which the borrower operates, increased by 3.5%. |
III. | Loans payable to related parties to the extent that the funds obtained are used in the business. | Cost of borrowing must not exceed the yield rate (as at 31 December of the prior tax year) of the ten-year government bond of the Republic of Cyprus, increased by 1.5%. |
IV. | Low value-adding services | 5% mark-up on the relevant costs. |
The safe harbour amounts stated above are before the deduction of taxes (ask your tax consultants in Cyprus about this matter).
In the case where the yield rate of the ten-year government bond is negative, the safe harbour rates for transactions described under II and III should amount to 3.5% and 1.5%, respectively. Also for I, II, and III, in addition to the principal amount, the relevant safe harbour should also be applied to any interest charged but not paid. More information regarding safe harbours can be obtained from all licensed Cyprus auditors.
*Important note – Dac6 obligation for the use of safe harbours rules ifthere are two countries involved and you are using any of the below:
Transactions eligible for safe harbours | Safe harbour provision | |
I. | Loans or cash advances to related parties which are funded out of financial means. | Minimum return of 2.5% (after the deduction of allowable expenses). |
II. | Loans or cash advances receivable from related parties which are funded out of own capital. | Minimum return should be equal to the yield rate (as at 31 December of the prior tax year) of the 10-year government bond of the country in which the borrower operates, increased by 3.5%. |
III. | Loans payable to related parties to the extent that the funds obtained are used in the business. | Cost of borrowing must not exceed the yield rate (as at 31 December of the prior tax year) of the ten-year government bond of the Republic of Cyprus, increased by 1.5%. |
IV. | Low value-adding services | 5% mark-up on the relevant costs. |
We can help!
Yiallourides & Partners Consultants Ltd employs Cyprus auditors, tax consultants in Cyprus and transfer pricing professionals, with over 7 years of experience and a large number of studies in their portfolio, supported by our global alliance tax experts. This allows us to carefully consider all sides of virtually any transfer pricing situation by enlisting local country transfer pricing expertise, whenever and wherever the need arises.
We use the most advanced software for our Transfer Pricing reports that provides the data and process driven tax analysis tools that are used by tax authorities globally and all major advisory firms in high scrutiny countries.
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