Transfer Pricing Developments
On 1 February 2024, the Cyprus Tax Department (“CTD”) issued a Circular with retrospective effect as of 1 January 2022 and onwards, announcing the increase of the materiality threshold for the preparation of a
Cyprus Local File.
The Local File focuses on information relevant to the Transfer Pricing (“TP”) Study, covering transactions between related parties, including relevant financial information, a comparability analysis and the selection and application of the most appropriate TP method.
History of Regulation
On 8 July 2022, Cyprus introduced TP rules and reporting obligations in accordance with the OECD legislation that went into effect as of 1 January 2022.
According to the TP regulations, a Local File must be prepared by taxpayers if their transactions with connected persons either exceed (or should have exceeded based on the Arm’s Length Principle) the amount of €750,000 per annum in aggregate per category of transactions.
In addition, the CTD issued a Circular on 6 July 2023 (the “Circular”), with retrospective effect as of 1 January 2022, introducing
Minimum TP Documentation requirements and Optional Simplification measures (safe harbour rules) regarding intra-group transactions which are below the threshold of €750,000 in aggregate per category of transaction per tax year. It worth noting that 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.
New thresholds in the Regulation
According to the announcement from the CTD on 1 February 2024, the materiality threshold for the tax year 2022 onwards for the preparation of the
Cyprus Local File has been increased from €750,000 to the below mentioned thresholds:
-
€5,000,000 for related party transactions in the category of financing transactions and
-
€1,000,000 for the rest categories of related party transactions, e.g goods, services, intellectual property and other.
It is worth mentioning that according to the provisions of Article 33 of the Cyprus Income Tax Law (the “ITL”), N.118(I)/2022 (as amended), only the controlled transactions of a category which cumulatively exceed or shall have exceeded the thresholds stated above during a tax year must be documented and analyzed in the Cyprus Local File.
Conversely the provisions of
Circular 6/2023 must be applied for the controlled transactions of a category which cumulatively
do not exceed the revised thresholds for that category.
Circular 6/2023 – Main Provisions
The main provisions of the circular are briefly analyzed below:
A. Simplified Transfer Pricing documentation requirements
According to the provisions of Article 33 of the Cyprus income tax legislation, controlled transactions shall be at arm's length, otherwise the company undertakes a tax assessment risk (Transfer Pricing upwards adjustment) upon an inspection by the Tax Authorities.
Therefore, taxpayers that are not obliged to maintain “Local File” because they are having receivable loans previously below the threshold of €750,000 for the tax year and now below the threshold of €5,000,000, will be required to keep the following Minimum TP Documentation, to support the arm’s length nature of their Controlled Transactions:
a. Brief description of the functional analysis (functions undertaken, assets used and risks assumed).
b. A description of the characterisation of the entity, based on the results of the functional analysis.
c. The reasons for the chosen TP method being considered the most appropriate one.
d. Determination of the arm’s length price/remuneration based on the benchmarking analysis undertaken, using either external or internal comparables.
The Minimum TP Documentation should be available for submission to the CTD upon request (within 60 days).
B. Optional Simplification Measures (safe harbour rules) for certain types of Controlled Transactions
The Circular also introduces safe harbour rules for financing transactions such as loans or cash advances granted to related parties which are funded out of debt instruments/borrowings (such as bonds, loans from related parties, interest free loans from the shareholders, cash advances and bank loans).
The circular highlighted that the safe harbour rules cannot be applied, if the
value (decided in an arm’s length basis) of all the financial transactions
exceeds €750,000 per annum in aggregate.
According to the 1 February 2024 circular the Safe harbour rules cannot be applied, if the
value (decided in an arm’s length basis) of all the financial transactions of the taxable person
exceeds €5,000,000 per annum in aggregate for the financing transactions and
€1,000,000 per annum in aggregate for the rest categories of related party transactions, e.g goods, services, intellectual property and other.
The Simplification Measures
cannot be applied if reliable internal comparables (i.e. comparable transactions with unrelated parties) can be used to determine the arm’s length price.
The table below summarizes the
Simplification Measures (Safe Harbour Rules):
|
No |
Eligible Transactions |
Safe Harbour rule |
|
1 |
Provision of financing to connected persons funded by debt instruments |
Minimum pre-tax return of 2.5% on the average outstanding receivable balances |
|
2 |
Provision of financing to connected persons funded by equity (own funds) |
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% |
|
3 |
Receipt of financing from connected persons used for business purposes |
Allowable cost of borrowing (interest expense) 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% |
|
4 |
Low value-adding services |
5% mark-up on the relevant costs |
Persons that
opt to apply for the above simplified measures need to maintain the following
supporting documentation:
-
Brief description of the functional analysis (functions undertaken, assets used and risks assumed);
-
A description of the characterisation of the entity, based on the results of the functional analysis and description of the reasons justifying that the financing granted to related parties has been financed by debt instruments/borrowings;
-
Description of the loans for which the simplification measure is applied (dates of conclusion of the loan agreements, loan amount and currency, loan balance at the end of the tax year, repayment date, collaterals, interest rate, details of any amendments to the loan agreements, etc.); and
-
Numerical calculations and reconciliations to document how the simplified minimum pre-tax net return (margin) has been applied in the income tax computation of the relevant Cyprus lending company.
The persons that opt to apply for any of the Simplification Measures described above, should disclose such election to the CTD, by completing electronically the relevant part in their Income Tax Return/Summary Information Table for Controlled Transactions, by the relevant applicable deadline.
The required documentation supporting the application of any of the Simplification Measures should be submitted to the CTD upon request (within 60 days).
The use of the above safe harbour rules will be
subject to the DAC6 provisions of the Administrative Cooperation in The Field of Taxation Law and accompanying Regulations, under the automatic hallmark (E1) on the use of unilateral safe harbours.
“This publication can be used purely as general informational guide and should not be considered as a professional advice. It is essential to seek independent advice tailored to the specific circumstances of your situation. Oneworld cannot be held responsible for any losses resulting from decisions made or actions taken based on the content of this publication.”