The Cyprus Tax Department (CTD) has informed the Institute of Certified Public Accountants in Cyprus (ICPAC) of their intention to abolish the practice of accepting pre-agreed minimum profit margins of 0,125% - 0,35% on intra-group and related party financing arrangements that were in the form of back-to-back loans.

It is being reminded that in accordance with Article 33 of the Cyprus Income Tax Law, all transactions between related parties must, for tax purposes, be made on an arm’s length basis. The CTD has the right to impose tax adjustments to make up for any deviation from the arm’s length principle (usually made in the form of a notional interest income). In the case of back-to-back loans between related parties, the CTD has, by way of practice, accepted such thin spreads / minimum profit margins without challenging the arm’s length applicability.

This current practice, which had been agreed between the CTD and ICPAC during July 2011, is expected to be abolished as from 1 July 2017. From then onwards, any tax rulings that have been issued in relation to such arrangements will become void and shall need to follow the new rules.

On the way forward, any intra-group financing arrangements and their profit spreads should be supported by a transfer pricing study, based on the relevant OECD guidelines. This will be required both for the purposes of issuing tax rulings as well as for corporate tax assessments.

The driving force behind this decision is the intention to align the Cyprus tax treatment of such arrangements with Action Points 8 – 10 (transfer pricing) of the OECD BEPS Action Plan.

Although the transfer pricing rules have not yet officially been concluded within the Cyprus tax laws, they are expected to follow the relevant OECD transfer pricing guidelines. It is further expected that the CTD will issue more specific guidance on the implementation of the above.

With the above in mind, it is strongly recommended that such existing intra-group financing arrangements are carefully reviewed in order to assess the potential impact of the upcoming changes and to take corrective action, if required.  For new transactions of this type, companies should consider having a transfer pricing study in place.