Abolishment of minimum margins on back-to-back loans
Posted: 8 March 2017
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 set 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, intra-group financing arrangements and their interest rates / 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, at which time we will inform you accordingly.
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.
Loan restructuring opportunity:
The relatively recently introduced provision for allowing a tax benefit through a
Notional Interest Deduction
(NID) on new equity continues to attract great interest by international tax advisors. This provision, apart from reducing the effective tax of the Cyprus company by up to 80%, can also tackle the topical tax issue of being the ‘beneficial owner of income’, especially in the cases of loans granted by the Cyprus company. Note that in the case of loans eligible for NID, the resulting Cyprus tax charge can be as low or even lower than in the case of using thin spreads.
For example, instead of engaging the Cyprus company through a back-to-back loan arrangement, one can take advantage of the NID provisions and grant out a loan through own funds that were introduced in the share capital of the Cyprus company. New financing arrangements are prompted to consider using this method. Existing back-to-back loan arrangements are prompted to consider restructuring these by capitalizing the loans, which would entitle them to receive NID and at the same time help them achieve the beneficial owner of income test on interest received by the borrower.
You can read more about NID by
clicking here.