On 6 July 2023, the Commissioner of Tax issued circular 6/2023 (attached) providing clarifications and guidance on the applicability of the Transfer Pricing (TP) Legislation effective as of 1 January 2022, on categories of related party transactions (Controlled Transactions) which do not exceed the threshold of €750.000, and thus do not create the obligation for the preparation of a Cyprus Local File.
The new circular provides guidance on the minimum requirements and the approach to be applied for documenting these transactions, along with the pricing methods to be applied. In short, the taxpayer will have the option to proceed with a “simplified” transfer pricing study for such transactions/ categories of transactions or in specific cases, apply simplification measures.
The main provisions of the Circular are outlined below:
A. The simplified TP study should include the following sections:
Taxpayers falling under the provisions of the Circular, who are eligible to maintain simplified TP documentation based on the above, will be required to include the following minimum contents in such documentation, which should be kept on file to support their compliance with the arm’s length principle for their Controlled Transactions:
- Short functional and risk analysis.
- Entity characterization.
- Method of documentation selected and basis of selection.
- Economic analysis with comparability search results based on OECD guidelines.
B. With regards to the simplification measures these are applicable in the following cases:
- Financing arrangements with related parties involving borrowings (e.g., back-to-back loans).
- Financing arrangements to related parties financed out of equity.
- Financing obligations/ arrangements of which the funds are used in the business.
- Low value-added services.
The Circular emphasises that in order to be able to use a safe harbour, the total aggregate value of Controlled Transactions within the particular sub-category for which the safe harbour will be used, together with the value of the remaining Controlled Transactions which belong to the same main category to which the sub-category belongs, should not exceed or should not have exceeded had the Controlled Transactions been executed based on arm’s length principle, the threshold of €750.000 for the tax year.
C. The application of the simplification measures will require the following:
- Preparation of documentation as per A1 and A2 above.
- For back-to-back loans the required net return (before tax) has been set at 2,5% on the average principal of the loan receivable during the year, including any accrued interest.
- For loans/ arrangements financed out of equity/ own funds, the minimum return has been set as being equal to the 10-year government bond yield of the country of residence of the borrower plus 3,5% (before taxes). The return is calculated based on the average principal of the loan receivable during the year, including any accrued interest.
- For financing arrangements in which the Cypriot entity is the borrower, and the funds have been used for business purposes, the maximum allowable borrowing cost will be calculated based on the 10-year government bond yield of Cyprus of the tax year under consideration, plus 1,5% (before taxes). The calculation will be based on the average principal of the loans during the year (plus any accrued interest).
- For low value-added services, as these are defined in the circular and the TP guidelines as issued by OECD, a minimum return of Cost-Plus 5% will be accepted in the cases where the Cypriot entity is the provider of the services. In the cases where the Cypriot entity is the receiver of the services, then the Cost-Plus 5% will be the maximum expense to be allowed.
For transactions falling under C2, C3, C4 and C5 there are also minimum requirements with regards to the documentation/ analysis that needs to be prepared to support the application of the relevant simplification provisions.
D. Reporting and Mandatory Disclosures
The simplified TP documentation for Controlled Transactions covered by the Circular should be made available within 60 days of the receipt of the Tax Department’s request by the tax payer or an authorised person to act as a representative of the tax payer.
The use of the above safe harbours 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.
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Our team will be at your disposal to assist you in understanding the potential impact of the above circular and support with the compliance obligations that may arise.
