Mode of taxation of financing operations within a group of companies — 19 July 2017
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On June 30, 2017, Cyprus changed the tax treatment of intra-group financing operations. The new directive takes into account the “extended hand” principle, as foreseen by the OECD Guidelines on Transfer pricing for multinational companies and tax authorities.
Earlier, the Cypriot government announced that the use of pre-agreed minimum return rates (from 0.125% to 0.35%) to back-to-back loans would be discontinued on June 30, 2017. Such compensatory loans and some other financing operations that will continue after this date will be subject to the new terms and conditions set out in the directive.
The main provisions of the directive dated June 30, 2017 are analyzed below:
Scope of application
The Directive addresses the issue of the taxation regime for business entities – residents of Cyprus and permanent establishments located in Cyprus who carry out financing operations within a group of companies – that is, the provision of loans or cash loans to related companies, with such entities receiving (Or should receive) remuneration in the form of interest and financed by cash and financial instruments such as unsecured bonds, private loans, cash loans and kivski loans.
In accordance with this directive, the two companies are considered to be related if they fall under Section 33 of the Cyprus Tax Law “On Income Tax”.
Transfer pricing requirements
The investor company will have to determine the amount of its remuneration based on the principles of transfer pricing. This implies that such a company should provide information on all commercial and financial relations with related parties (“controlled operations”) and determine the economically significant conditions and circumstances relevant to such transactions.
It is necessary to take into account the actual actions of the parties, if they differ from the contractual conditions. An analysis of the performed functions, assets used and risks taken by the investor financing company is required.
The basic principle of risk analysis is that the company that carries out the financing and the risks should be financially able to cope with such risks and financial consequences that may result from such risks. In this respect, it is expected from the company that it will determine, with appropriate methodology, the appropriate amount of capital that will be required to take such risks.
It is also necessary to perform a proper comparative analysis to determine whether the remuneration derived from transactions between related parties is comparable to the remuneration of transactions between independent parties under similar circumstances in the open market. Thus, the company can determine the criteria for a comparative analysis of its remuneration with remuneration from comparable transactions under comparable circumstances between unrelated parties
Requirements for content
The Directive stipulates that financing companies must have an actual presence in Cyprus and skilled personnel for the control of risks and operations carried out. It is believed that the financing company controls the risk if it is able to make a decision on the conclusion of a risk-bearing business relationship that is able to overcome such risks and actually perform such decision-making functions.
The actual presence criterion shall take into account the number of members of the Board of Directors who are tax residents of Cyprus and the number of meetings held by the Board of Directors and the shareholders’ meeting held in Cyprus.
Daily risk mitigation activities can be outsourced if the company is able to accept and make key outsourcing decisions.
Operations without commercial justification
To ensure full compliance with the principle of an extended hand, operations that are not observed in the open market and do not have any commercial justification should not be taken into account.
To obtain a simplification regime, it is necessary for the financing company to comply with the abovementioned requirement for content and exclusively engage in mediation activities (obtain loans from related entities and continue to issue loans to related entities, adheres to the principle An outstretched hand, if such a company receives a minimum return on assets of 2% in relation to its controlled operations.
An entity that meets such characteristics that does not intend to prepare transfer pricing documentation may choose a comparative assessment of its remuneration based on the return on assets. The above 2% will be reviewed regularly by the Tax Department on the basis of appropriate market analysis.
The tax returns will be changed by adding an appropriate field to be filled in by such entities to use such simplification.
It should be noted that deviations from such minimum returns are allowed only in exceptional cases, provided that they are properly substantiated by means of a transfer pricing analysis.
In addition to the above principles, the directive provides some minimum requirements for the analysis of transfer pricing:
· Description of the calculation of the amount of capital allocated for risk taking;
· Description of the group of companies and the relationship between the functions performed by the entities participating in the controlled operations and the rest of the group companies, along with a description of the way in which the entities created in the value added group are involved in the operations;
· The exact volume of the analyzed transactions;
· List of potentially comparable operations found;
· Deviation scheme for rejected potentially comparable operations with justification;
· The final list of comparable transactions that have been selected and used to determine the price on the basis of the extended arm, applied to precisely defined operations within the group;
· General description of market conditions;
· List of previous transfer pricing agreements concluded with other countries regarding this type of operations;
· A list of all previous contracts concluded with the business entities analyzed, valid at the time of the request;
· Forecast of earnings reports for the years covered by the request.
The directive also states that the transfer pricing analysis will be submitted to the Tax Department by auditors, which will be required to exercise control to assure the quality assurance of the transfer pricing analysis.
Clarification of tax authorities and exchange of information
Issuing tax authority clarifications on intra-group financing or Advanced Pricing Arrangements and the use of taxpayer simplification will depend on the rules for the exchange of information established under the Administrative Cooperation Directive.
Entry into force
The Directive comes into force on 1 July 2017 for all existing and future operations. Any clarifications of the tax authorities issued before this date are no longer valid for periods beginning after July 1, 2017.
If the intra-group financing operations are accompanied by a prepared transfer pricing documentation and continue beyond the aforementioned date, such transfer pricing documentation must comply with the provisions of the directive.
In case of questions regarding this topic, our company is ready to provide advice and contacts of Hip Hip Hopkins.
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