On 30 June 2017, the Cyprus Commissioner of Taxation issued the Interpretive Circular No. 3 relating to the new rules governing the tax treatment of intra-group back-to-back financing arrangements.

The Circular applies to any company carrying out group financing transactions (hereinafter referred to as a group financing company) meaning any entity that conducts intra-group financing transactions. For the purposes of the preceding sentence, the activities related to holding of participations are not taken into consideration. Further, this Circular applies to companies that are Cyprus tax resident, namely companies whose management and control are exercised in Cyprus, as per Section 2 of the Income Tax Law 118(l)/2002 as amended (ITL). It also applies, to companies that are tax resident outside Cyprus and have a permanent establishment in Cyprus as per Section 2 of the ITL and in such case the Circular applies to the extent that it is relevant to the taxation of the Cyprus permanent establishment.

For the purposes of the said Circular, the term intra-group financing transaction refers to any activity consisting in the granting of loans or cash advances remunerated by interest (or should be remunerated by interest) to related companies, financed by financial means and instruments, such as debentures, private loans, cash advances and bank loans. Two companies are considered to be related if they fall within the scope of Section 33 of the ITL.

A summary of the contents of the Circular can be viewed below:

Application of arm’s length principle to intra-group financing transactions

For the purposes of transactions falling within the contents of the Circular, it is necessary to determine for each intra-group financing transaction conducted, same as with all types of intra-group transactions, whether the agreed remuneration complies with the arm’s length principle, i.e. corresponds to the price which would have been accepted by independent entities in comparable circumstances in the open market, taking into account the economic nature of the transaction.

Transfer pricing requirements

From 1 July 2017, all Cyprus tax resident financing companies are required to prepare a transfer pricing study that will confirm that each of their financing transactions has been executed on an arm’s length basis. In order to accurately delineate the controlled transactions and to determine the arm’s length remuneration in a precise manner, it is necessary to describe the role of each of the entities participating in the controlled transactions, in the context of their commercial or financial relations within the group to which they belong, it might also prove appropriate to understand the structure and organization of the group and the extent to which these aspects affect the functioning of the said group. Likewise, it may be useful to understand the interdependencies between the functions performed by the entities participating in the controlled transactions and the rest of the group, the contribution of the related entities to the value creation within the group in the broad sense, and the impact of this contribution on the arm’s length remuneration of each of the entities participating in the controlled transactions. At this instance, the Cyprus tax resident financing company will identify each financial relationship with related parties and commercially substantiate that the transaction has been entered into based on market conditions. An analysis will also be required of the functions performed, assets used and risks assumed by the Cyprus tax resident financing company.

A fundamental rule of the risk analysis is that the Cyprus tax resident financing company which will bear the risks should have the monetary ability to manage those risks and suffer the financial costs if the risks assumed materialize. In this respect, the Cyprus tax resident financing company is expected to determine, using any relevant methodology, the appropriate level of equity that would be needed to assume the risks.

An appropriate comparability analysis must also be carried out in order to identify comparable transactions between unrelated parties in a transparent, systematic and verifiable manner using appropriate sources of information. At this instance, the Cyprus tax resident company will be able to determine whether the transactions executed with related parties are comparable to transactions between independent entities. Based on the comparability analysis, the Cyprus tax resident company can benchmark its remuneration against that generated by comparable transactions and circumstances between unrelated parties.

Substance requirements

The Circular specifies that a group financing company controls the risk if it has the decision-making power to enter into a risk-bearing commercial relationship, if it has the ability to address such risks, and if it actually performs such decision-making functions. A group financing company can outsource the daily activities of risk mitigation. It must however be able to determine the objectives of the outsourced activity, to decide to use the services of a risk mitigating provider, to assess whether the objectives are properly met and, if necessary, to decide to modify or terminate the contract with the service provider, as well as to actually perform these functions.

Therefore, in order to justify the risk control and to further validate that the management and control are exercised in Cyprus, it is imperative that a group financing company must have an actual presence in Cyprus. In this respect we note that the actual presence criteria take into account, the following:
• The number of board of Directors members of the company that 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.

Further, the group financing company must have the qualified personnel to control the transactions performed. The group financing company may nonetheless subcontract functions that do not have a significant impact on risk control.

Simplification measures

When a group financing company which meets the criteria of substance as set out above pursues a purely intermediary activity, grants loans or advances to related entities which are refinanced by loans or advances granted by related entities, it is considered that for sake of simplification, the transactions will be deemed to comply with the arm’s length principle, if the company receives a minimum after tax return of 2% on assets.
The 2% percentage will be regularly reviewed by the Tax Department based on relevant market analyses.

An entity which fits such a profile, and which does not intend to prepare transfer pricing documentation may choose to benchmark its remuneration based on this minimum return on assets approach.

It is noted that a deviation from this minimum return is only allowed in exceptional cases, where it is duly justified by an appropriate transfer pricing analysis.

Minimum requirements for a transfer pricing analysis

The minimum requirements for a transfer pricing analysis in compliance with the principles set out in the previous sections should include:
• a description of the computation of equity allocation required to assume the risks,
• a description of the group and the inter-linkages between the functions performed by the entities participating in the controlled transactions and the rest of the group, together with a description of the value creation in the broad sense within the group by the entities participating in the transactions,
• the precise scope of the transactions analysed,
• a complete list of the searched potentially comparable transactions,
• a rejection matrix for rejected potentially comparable transactions together with justifications of such rejections,
• the final list of comparable transactions which have been selected and used to determine the arm’s length price applied to the intra-group transaction(s) accurately delineated,
• a general description of market conditions,
• a list of all previous agreements on TP concluded with other countries in relation to the transactions in question,
• a list of all the previous agreements concluded with the entity/ies under analysis which are still in effect at the time of the submission of the request,
• a projection of the income statements for the years covered by the request.

The Transfer Pricing Analysis should be prepared by a Transfer Pricing Expert. It must be submitted to the Commissioner of Taxation by a person who is licensed to act as an auditor of a company in Cyprus, and who is required to carry an assurance control review of the transfer pricing analysis.

Entry into force

The Circular applies from the 1st of July 2017, for all existing and future transactions. Any rulings issued prior to this date will no longer be valid for periods from 1st of July 2017 onwards. For any further information or clarifications on the above information you may directly contact