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Transfer Pricing under Cyprus Law

Circular Issued by the Cyprus Tax Authorities
The basis of the Transfer Pricing and application of the Principal of Arm’s Length under Cyprus law, is the Circular issued by the Cyprus tax authorities on the 30 June 2017, (the Circular).

The Circular applies to all relevant existing and future intra group financing transactions, (“IGFT”). No grandfathering provisions have been provided for existing transactions, and therefore rulings previously issued on transactions within the scope of the Circular are no longer valid for tax periods as from 1 July 2017.

The Circular provides that the remuneration arising from back-to-back intra-group financing transactions should comply with the arm’s length principle i.e. correspond to the price that would have been agreed by independent parties in comparable transactions, taking into account the economic nature of the transaction.

Substance requirement
The Circular stipulates that financing companies must have an actual presence in Cyprus and have the qualified personnel to control the risks and transactions entered into. A financing company is considered to control 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 it actually performs such decision-making functions.

The actual presence criteria take into account the number of the members of the board of Directors that are Cyprus tax residents and the number of board of Directors’ meetings as well as shareholders’ meetings held in Cyprus.

The daily activities of risk mitigation may be outsourced as long as the company has the capability to take, and actually makes, the key decisions with respect to the outsourcing.

Option 1 - Simplification Regime
A financing company which meets the substance requirement mentioned above and is engaged in purely intermediary financing activities, borrowing from related entities and on-lending to related entities, will be deemed for the sake of simplification to comply with the arm’s length principle if it receives in relation to its controlled transactions a minimum return of 2% after-tax (2.286% gross) on assets.

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. The 2% mentioned above will be regularly reviewed by the Tax Department based on relevant market analyses.

Tax returns will be amended to include a relevant field to be filled in by such entities in order to benefit from this simplification measure.

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.

Option 2 - Transfer pricing requirements
A financing company will be required to determine its remuneration on the basis of transfer pricing principles. This would involve the company identifying each commercial and financial relationship with related parties (“controlled transactions”) and determining the economically significant conditions and circumstances relating to such transactions. The actual conduct of the parties should be taken into account if this differs from what was contractually agreed. An analysis is required of the functions performed, assets used and risks assumed by the financing company.

An underlying principle of the risk analysis is that a financing company bearing risks must have the financial capacity to manage those risks and bear the financial consequences if the risks assumed actually materialize. In this respect, the company is expected to determine, using relevant methodology, the appropriate level of equity that would be needed to assume the risks.

Furthermore, an appropriate comparability analysis must be carried out in order to determine whether the remuneration resulting from the transactions between the related parties are comparable to transactions between independent parties under similar circumstances on the open market. In this way, the company can benchmark its remuneration against that generated by comparable transactions and circumstances between unrelated parties.

The comparability analysis should involve a process of identifying comparable transactions in a transparent, systematic and verifiable manner using appropriate sources of information.

A transfer pricing analysis should be:
(i) Prepared by a Transfer Pricing expert;

(ii) Submitted to the CTD by a person who has a license to act as an auditor of a company according to the Cyprus Company Law and is required to carry an assurance control confirming the quality of the transfer pricing analysis;

(iii) Include the minimum requirements as specified in the Circular.