Cyprus transfer pricing and Cyprus taxation on intra-group transactions

As of 1 January 2022 regulations apply for transfer pricing in Cyprus, “transactions between related companies – intra-group transactions”, which are defined as transactions between persons whose direct or indirect connection amounts to a percentage equal to or greater than 25%. The provisions are in line with the Organization for Economic Co-operation and Development – OECD Guidelines and apply to both businesses and tax authorities.

Transfer pricing Documentation Files and Quality Assurance Review

Cyprus transfer pricing Documentation File

Obliged to maintain a transfer pricing Cyprus Documentation File are Cyprus companies or Cyprus permanent establishments, whose intercompany transactions with related companies in total per category of transactions exceed or should exceed if carried out on an arm’s-length principle basis 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. Transaction categories relate to goods, services, rights, and other intangible assets and financial transactions. The content of the Cyprus Documentation File should be similar to the OECD recommendations. That is, it focuses on the analysis of the financial and operational profile of the Cyprus company or Cyprus permanent establishment, the market conditions where it operates, the analysis of the documentation methodology of its relevant transactions, and the comparison or reference data.

As a general rule and subject to certain conditions, a person or enterprise is considered to be related if it holds, directly or indirectly, 25% or more of the voting rights or capital of another enterprise, or if a person or enterprise directly or indirectly holds 25% or more of the voting rights or capital of two other undertakings which carry out transactions between them.

Transfer pricing Basic Documentation File or Master File

A transfer pricing Basic Documentation File or a Master File is drawn up by Cyprus companies that are the ultimate parent entities of a multinational group or have been designated as surrogate parent entities by the group to which they belong, which for the year preceding the year under review has a consolidated revenue of more than 750 million euros. General information about the group is included in the Master Documentation File.

Documentation Files are subject to quality control review

The Documentation Files that are drawn up are subject to quality control review by approved persons who hold a practicing certificate of ICPAC or any other recognized institute of certified accountants in Cyprus no later than the date of the obligation to submit the tax return of the taxpayer. Transfer pricing Documentation Files are made available to the Cyprus Tax Department within 60 days after they have been requested. The Files are updated every tax year.

Obligation to prepare a Summary Table of Information

Obligation to prepare a Summary Table of Information, which presents a summary of entity’s-intercompany transactions, and the tax jurisdictions and tax identities of the entities with which the transactions took place. The Summary Table of Information is submitted electronically to the Tax Department of Cyprus together with the tax return of each Cyprus company or Cyprus permanent establishment.

Possibility of applying for pre-approval of the transfer pricing methodology (Advance Pricing Agreement).

It is possible to apply for pre-approval of the transfer pricing methodology for specific future or existing transactions of Cyprus companies or Cyprus permanent establishments with related persons to the tax department of Cyprus.

The tax department of Cyprus decides within 10 months (the decision time can be extended up to 24 months) from the application submission and the decision is communicated to the applicants. The duration of validity of the pre-approval decision may not exceed four years and its temporal validity may not refer to a tax year that has passed at the time of the submission of the pre-approval application.

The pre-approval decision is considered binding but can be revised during its validity, either upon application or ex officio by the tax department in cases of incorrect or materially changed assumptions and data, as well as in case of an application for a mutual settlement procedure.

Format and language

The Transfer Pricing Documentation File should be maintained by the taxpayer in electronic or paper format and may be prepared in a generally acceptable language, preferably in English; however, the Tax Authorities may request its translation in Greek if necessary.

Charges and fines

In non-compliance with the relevant documentation obligations of intercompany transactions, a fine of between €5,000 and €20,000 will be imposed depending on the days of delay in compliance. In case of delay in submitting the Summary Table of Information, the fine amounts to €500.

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

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)

 

Frequently asked questions as clarified by the Cyprus Taxation Department:

1. If the controlled transactions in Category “A” cumulatively exceed or shall exceed the relevant threshold based on the arm’s length principle as described in article 33(9)(a) of the ITL and at the same time the controlled transactions in Category “B” cumulatively do not exceed the relevant threshold in a tax year, is there an obligation to include the controlled transactions of Category “B” in the Cyprus Local File?

No, there is no obligation to include Category’s “B” controlled transactions in the Cyprus Local File.

Only, the controlled transactions of a category that cumulatively exceed the threshold based on the arm’s length principle during a tax year must be documented and analyzed in the Cyprus Local File.

In this specific example, it will be Category’s “A” controlled transactions only.

2. How is the threshold being determined in the context of rental income activities during each tax year?

The threshold is determined by reference to the total rental income based on the arm’s length principle in a tax year.

3. Do purchases and sales need to be aggregated to assess whether the threshold has been exceeded?

Yes, the threshold is based on reference to the absolute values of the controlled transactions for each category occurring in a tax year.

For example, if total purchases and sales amount to €400.000 and €700.000 respectively, the cumulative amount in this category is € 1,100.000. Thus the threshold in this category has been exceeded.

4. Is the Cyprus Local File and Summary Information Table prepared using the tax year or the accounting year of the company?

The Cyprus Local File and Summary Information Table are prepared concerning the tax year.

5. Under which category of the Summary Information Table should Financial Guarantees be reported?

Financial Guarantees should be reported under the category “Financial Transactions”.

6. Should a Benchmarking study be prepared every tax year or only if something changes about the intra-group loans?

A Benchmarking study should be prepared when a group loan is initiated and updated when:

(i) New loans are provided or received by the company, or

(ii) significant terms of the existing loans change or amended, or

(iii) the functional profile of the company changes, or

(iv) the market and economic conditions change significantly (if applicable).

The above list is indicative and not exhaustive. Further guidance is provided in the OECD TP Guidelines.

Plenote that per article 33(10) of the ITL, the master file (where applicable) and the local file shall be updated every tax year.

7. Who is responsible for completing and submitting the Summary Information Table?

It is the responsibility of the taxpayer to complete the Summary Information Table. The Summary Information Table shall be submitted by the Statutory Auditor or Tax Consultant.

8. Is the circular dated 30/06/2017 with the title “Tax treatment of intra-group back-to-back financing transactions” still applicable after the new TP Legislation and Regulations enactment?

The Back to Back circular was abolished as of 01/01/2022.

9. How is the threshold in the context of loan financing activities being determined in a tax year?

The threshold in the category of loan financing transactions is determined only by reference to the loan principal including interest charged but not paid.

10. Continuing from question 9 above, which balance is relevant in the case of loan financing activities (e.g. year-end, average balance for the year, facility amount)?

The maximum loan balance (i.e. only the loan principal including interest charged but not paid) during the tax year should be used to determine the threshold in the respective tax year and be reported in the Summary Information Table.

11. Should the loans or any other monetary facilities including cash withdrawals (but excluding any balances arising from commercial transactions) granted by companies to the persons described in article 5(1)(z) & 5(2)(z) of the Income Tax Law L. 118 (I)/ 2002 be taken into account to assess whether the threshold has been exceeded in the category of financing activities?

No, provided the company which is granting the loans or any other monetary facilities including cash withdrawals to its directors or to its shareholders who are individuals or their spouses or to their relatives up to and including the second degree of kinship does not have as a taxable activity the provision of financing.

In this specific case only, such balances should not be taken into account to assess whether the threshold has been exceeded in the category of financing activities and as such should not be reported in the Summary Information Table. No documentation concerning these specific transactions in the local file is required

12. Company A borrows from a related Company B or a related individual B, the amount of €6.000.000 to buy shares of the same amount.

The shares with an acquisition cost of the amount of €6.000.000 fall under the definition of “titles” as per article 2 of the Income Tax Law L. 118 (I)/ 2002 and circular 2008/13.

Should the transaction be as described above:

12.1 be documented in the Cyprus local file?

12.2 be excluded from the Summary Information Table?

In the case of Company A only (i.e. the Borrower), the transaction shall not be documented in the Cyprus local file and it shall be excluded from the Summary Information Table to the extent that the interest incurred does not constitute a tax-deductible expense in accordance to the provisions of articles 11(15) and 11(16) of the Income Tax Law L. 118 (I)/ 2002 and any other related Tax Circular that is in force.

13. A taxpayer has controlled transactions in Category “A” which cumulatively exceed €5.000.000 in a tax year or should exceed €5.000.000 based on the arm’s length principle as stipulated in article 33(9)(a) of the Income Tax Law L. 118(I)/2002, as amended, such that the said transactions in Category “A” need to be documented in a local file and at the same time the taxpayer in that tax year has controlled transactions in category “B” which cumulatively do not exceed or should not exceed the €5.000.000 threshold based on the arm’s length principle.
Does Circular 06/2023 apply to the Transactions in Category “B” in that tax year?

Yes, Circular 06/2023 applies to the transactions in Category “B” in that tax year, and thus the taxpayer should either:
a) prepare simplified transfer pricing documentation with the contents as described in the Circular 06/2023 or
b) opt for a safe harbor and maintain the prescribed supporting documentation in respect of the use of the safe harbor provided that the controlled transactions in Category “B” belong to one of the subcategories of transactions for which a safe harbor is available under the circumstances permitted in the Circular 06/2023.
Please refer to Circular 06/2023 which was published on 6th July 2023 for further details