Profit margins on back to back loans

Profit margins on back to back loans

On February 2017, the Cyprus tax department (CTD) notified the Institute of Chartered Accountants (ICPAC) regarding the minimum margins on back to back loans transactions that CTD used to accept. As per the said notification, the existing regime (with the minimum margin requirements) will be abolished from 01/07/2017 onwards. This decision was taken due to the international tax developments (OECD/G20 initiative – BEPS) and as well the review of the regime under Business Code of Conduct and under a state aid perspective. From 2017 onwards these transactions need to be supported by Transfer Pricing Studies, to be prepared by independent professionals based on OECD guidelines. From 01/07/2017 any tax rulings issued based on previous regime will cease to be applicable. Any back to back loans remaining in place after 01/07/2017 need to be supported by Transfer Pricing Studies.
Intra – group financing transactions. Circular issued from Cyprus Tax authorities

Intra – group financing transactions. Circular issued from Cyprus Tax authorities

On the 30th of June 2017 the Cyprus Tax Authorities issued a circular (“the Circular”) providing guidance regarding the tax treatment of the intra – group financing transactions (“IGFTs”) following the abolishment of the minimum margin scheme from 01/07/2017.

The Circular is relevant to for determining taxable profits on IGFTs and applies to both existing and future financing transactions.

The Circular follows the guidelines of OECD regarding Transfer Pricing (“TP”) and requires the application of the arm’s length principle.

The main terms of the Circular are described below.

  1. Type of companies affected by the Circular

The Circular applies for the Cyprus Tax resident companies and permanent establishments situated in Cyprus that are granting loans/cash/advances to related parties that carry (or should carry) interest and these are financed by loans/advances/bank borrowings.

  1. How the intra group financing transactions will be taxed

The tax authorities require that these transactions should comply, for tax purposes, with the arm’s length principle. In order to substantiate the arm’s length principle, the affected companies need to carry out a transfer pricing study for each financial transaction that will contain a comparability analysis with similar transactions in the open market. The circular describes the elements and characteristics of the comparability analysis and the minimum contents/requirements of a transfer pricing study.

In case that a company has similar characteristics with regulated financing institutions an after tax return on equity of 10% is considered as an arm’s length remuneration (return) for the purposes of the comparability analysis.

  1. Simplification measures

The pure financing companies have option to opt for simplification measures where under these measures the transactions are deemed to comply with the arm’s length principle if at least 2% after tax return is received on the total assets of the Company.

This means that the effective tax of the Company will be 0,286% on total assets (2%/ (1-12,5%). This percentage will be regularly reviewed by the Cyprus Tax Authorities.

If a Company opts for the simplification measure no Transfer Pricing Study needs to be prepared. The mechanism for the simplification measure is that it will be declared through annual tax form (expecting 2017 tax form).

Finally, it is important to note that any deviation from the minimum margin is allowed only in exceptional cases and only if supported by an appropriate Transfer Pricing Study.

  1. Others

a)  The use of the simplification measures, tax rulings and advance pricing arrangements will be subject to exchange of information rules.

b)  The Transfer Pricing Study need to be prepared by a TP expert. The TP study will be submitted to the Tax Authorities by a licensed company auditor who is required to perform an assurance engagement on the TP study.

The present article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Our tax specialists are at your disposal should you require any further information or clarifications.