On June 30, 2017 the Cyprus’ Tax Department has issued a circular updating the rules for intra-group back-to-back financing arrangements. Effective since July 1, 2017, the circular states that all these arrangements now must meet the arm’s-length principle. There are documentation requirements and simplification measurements. All tax rulings regarding this matter from before July 1, 2017 are no longer valid. The circular applies to all Cypriot tax resident companies, including all companies with a permanent establishment in Cyprus.
“Intra-group financing transactions” are broadly defined as loans or cash advances which
- are (or should be) remunerated by interest, and
- are between related companies, and
- are financed by private loans, advances or bank loans, among others.
“Arm’s-length principle” is the condition that the parties to a transaction are independent and on an equal footing. You can find a lengthy description here.
The Past and the Present
In the past Cyprus had pretty favorable rules about how to handle a back-to-back loan. The 2011 Minimum Margin Scheme allowed for a very low margin between 0.125% and 0.35%, depending of the size of the loan. This led to a low taxation from the use of these loans. The new rules apply the arm’s-length principle to these back-to-back instruments. That means that they have to correspond to the price (or interest) which independent entities would agree to in comparable situations. Of course the margin will be higher now.
In order to prove that the arm’s length principle is met in a transaction, a so-called “Comparability Analysis” is needed. The first part is the identification of the relationships between the related entities and determination of the conditions and economically relevant circumstances.These include characteristics like contractual terms, assets used, risks assumed and so on.
The next part is a comparison of the transaction with similar transactions between independent entities regarding the remuneration. This analysis should be produced by a professional and has to be transparent, systematic and verifiable. Only the actual conduct of the parties will be considered, not what was contractually agreed.
A “Functional Analysis” is also needed, identifying the economically significant activities, responsibilities and functions of the entities involved, the assets used and the risks assumed. The financial analysis focuses on on the actual activity of the parties, like decision-making, credit risk monitoring, and managing.
Last but not least, a “Risk Analysis” is necessary. The lending entity needs to be able to manage and assume the risk involved in the transaction. The circular explicitly states that a group financing company must have an actual presence in Cyprus. It mentions that the criteria to take into account are:
• the number of Board of Directors members of the company who are Cyprus tax residents.
• the number of Board of Directors meetings held in Cyprus and the main management and commercial decisions taken in Cyprus
• the number of shareholders’ meetings taking place in Cyprus
The question of substance is coming up here again. Having a real office in Cyprus and staff capable of controlling the transactions performed will help a long way. Offices and staff can be outsourced. Ask us how!
The Tax Department will accept a transaction as being compliant with the arm’s-length principle under the following circumstances:
- the company meets the criteria of having enough substance and local activity (see above)
- it pursues strictly intermediary activity, grants loans or advances to related entities which are loans or advances granted by related entities
- it receives a minimum return of 2% after-tax on assets.
Companies willing to use this simplification should fill in the relevant field in the tax return.
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