Simplification measures that exempt the obligation to maintain a Cyprus local file for controlled transactions for transfer pricing purposes

July 22, 2023 Uncategorized

The Tax Department of Cyprus has issued a circular that exempts persons from the obligation to prepare a Cyprus local file for transfer pricing documentation purposes of Controlled Transactions with minimal documentation. The exemption applies to Controlled Transactions cumulatively by taking into account separately the four Controlled Transactions sub-categories as defined by the law and OECD and applies to Controlled Transactions that do not exceed, or will not exceed based on the arm’s length principle, of €5,000,000 for controlled transactions falling under the category of “Financial Transactions and €1,000,000 for all other categories of controlled transactions per tax year. 

The circular is valid from January 1, 2022.

According to the applicable law, if the transactions between related parties are not carried out on a commercial basis, the Cyprus tax department has the right to adjust the taxable income of the relevant person.

Minimum documentation should include:

  1. Brief functional analysis (functions, assets, risks)
  2. Description of the operational profile of the entity, based on the results of the operational analysis
  3. The rationale for choosing the most appropriate method
  4. Determination of prices on an arm’s length basis supported by relevant benchmarking results using internal or external comparables (as applicable) or any other relevant economic analysis per OECD guidelines (eg using valuation models for financial guarantees).

Upon request by the Cyprus tax department, the minimum documentation should be submitted within 60 days.

The exemption applies to the following controlled transactions

a) “Financing transactions between related parties

Loans or cash advances to related parties that bear (or should bear) interest, which are financed by financial instruments such as bonds, loans from related companies or related persons, including interest-free loans from shareholders, cash advances, and loans from credit institutions.

Minimum pre-tax net return (margin) of 2.5% per annum on the average outstanding balance (Includes the principal amount of financing plus unpaid accrued interest)

b) “Financing transactions in related parties financed by equity

Loans or cash advances to related parties, bearing (or should bear) interest, financed by equity (proceeds from the issue of share capital and premium, non-remunerative capital contributions, or retained earnings)

The interest rate applied (on each transaction) by the eligible lender is at least equal to the ten-year government bond yield of the jurisdiction in which each borrower operates, increased by 3.5%. (Includes principal plus unpaid accrued interest).

c) “Financing transactions from related parties to the extent that they are used in the business

Borrowings such as interest-bearing loans, bonds or cash advances received from related parties to the extent that they are used in the business and the interest is deductible per the relevant provisions of Cyprus tax legislation.

The interest rate applied is the interest rate that does not exceed the yield rate of the ten-year government bond of the Republic of Cyprus plus 1.5%. (Includes principal plus unpaid accrued interest).

The persons who choose to apply the above measures for transactions a) b) and c) above should keep the following supporting documents:

  1. Brief functional analysis and description of the functional profile of the parties involved.
  2. Description of the transactions for which the simplification measure is applied such as contract dates where applicable, amount and currency, balances at the end of the tax year, repayment dates where applicable, collateral, interest rate where applicable, details of any modifications, etc.)
  3. Description of the reasons justifying that the financing was financed by these means
  4. Reconciliations document how the interest rate or related yield was applied to the relevant person’s income tax calculation.

d) “Low value-adding Services”

As per the OECD guidelines are those services within the group that:

  1. They have a supportive character.
  2. They are not part of the core business of the group (ie, they do not generate profit-making activities or contribute to economically significant activities of the group).
  3. It does not require the use of or lead to the creation of unique and valuable intangibles.
  4. Do not involve the assumption or control of significant risk by the service provider and do not cause the creation of significant risk for the service provider.

Examples of such services

  1. Bookkeeping services and similar
  2. Processing and managing accounts receivable and payable
  3. HR activities such as staffing and recruiting, employee training, compensation services, developing and monitoring staff health procedures, and similar
  4. IT services (related to the IT infrastructure and the operation of the group’s internal IT systems)
  5. Internal and external communications and public relations support
  6. Internal legal services
  7. Activities related to tax compliance obligations of group entities
  8. General administrative or clerical services.

Eligible Controlled Transactions are generally priced on a cost + markup basis (per OECD guidelines).

In the case of receiving such service from related parties, the acceptable surcharge applied to the related costs shall not exceed 5%.

The persons who choose to apply this measure must keep the following supporting documents:

  1. Brief functional analysis and description of the functional profile of the parties involved.
  2. Description of the categories of service provided/received and identity of beneficiaries.
  3. A description of the reasons why each category of service qualifies under the definition described above.
  4. Tasks supporting the determination of the relevant cost pool and the application of the mark-up (where applicable)
  5. Description of selected assignment and operation methods showing their application.
  6. Assignments and agreements to document how the measure was applied to the income tax calculation of the relevant person.

Important notes

  1. Persons who choose to apply these measures should notify the Cyprus tax department of this choice by completing electronically the relevant part of the Income Tax Declaration / Summary Table of Information for Controlled Transactions.
  2. Deviation from the prescribed minimum or maximum returns/rates/increments should be supported by the preparation of the relevant work as determined above.
  3. If a company in one of the four sub-categories carries out controlled transactions and at the same time possesses internal comparables as determined by the Law and the OECD which are indicated to be used to determine that controlled transactions are carried out on a commercial basis, then the use of the simplification measure is not allowed in the said sub-category.
  4. The tax department of Cyprus will only make upward and not downward tax adjustments.
  5. Cross-border controlled transactions subject to simplification measures should be treated as reportable transactions under the Taxation Administrative Cooperation Act 2012 (DAC 6)

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