On July 6, 2023, the Cyprus Tax Department (CTD) issued a Circular regarding transactions falling below the Local File threshold.
This Circular is applicable to all taxpayers engaged in related party transactions (referred to as “Controlled Transactions”), which are exempt from mandatory documentation in a Cyprus Local File. To reiterate, according to Article 33 of the Income Tax Law (the “arm’s length principle”), this exemption applies when the total value of Controlled Transactions within a specific category (such as goods, services, IP related income, financial transactions) does not exceed €750,000 per tax year, assuming these transactions were conducted based on the arm’s length principle.
The new Circular introduces simplified documentation requirements for Controlled Transactions falling below this threshold, regardless of the transaction category. Additionally, the Circular outlines the use of safe harbours for specific types of financing activities and low value-adding services, provided that these transactions remain below the Local File threshold.
The key provisions of the Circular are detailed as follows:
Simplified Transfer Pricing documentation requirements
Taxpayers falling within the scope of the Circular, eligible for simplified Transfer Pricing (“TP”) documentation based on the criteria mentioned above, must maintain specific documentation to validate their compliance with the arm’s length principle for Controlled Transactions. This documentation should include the following essential components, which need to be retained as evidence:
- Brief description of the functional analysis (functions undertaken, assets used and risks assumed);
- A description of the characterisation of the entity, based on the results of the functional analysis;
- The reasons for the chosen TP method being considered the most appropriate one;
- Determination of the arm’s length price/remuneration based on the benchmarking analysis undertaken, using either external or internal comparables. The benchmarking approach may also include any other appropriate method whose use is warranted under the circumstances described in the OECD TP Guidelines for Tax Administrations and Multinational Enterprises (the “OECD TP Guidelines”).
Safe harbours for certain types of transaction
The Circular also introduces safe harbours for specific sub-categories of Controlled Transactions, which are as follows:
- Financing Transactions: This includes loans or cash advances provided to related parties, funded from financial sources like bonds, loans from related entities, interest-free loans from shareholders, cash advances, and bank loans. The safe harbor applies regardless of whether the taxpayer assumes the risks of the financing activity.
- Receivable Loans or Cash Advances: These are loans or cash advances received from related parties funded from the entity’s own capital, such as issued share capital, share premium, non-return capital contributions, and retained earnings.
- Funding Received from Related Parties: This covers funds borrowed from related parties through interest-bearing loans, bond issuance, or cash advances, specifically used in the business.
- Low-Value Adding Services.
For taxpayers to utilize a safe harbour, the total aggregate value of Controlled Transactions within the specific sub-category, combined with other Controlled Transactions in the same main category, must not exceed, or should not have exceeded if executed based on the arm’s length principle, the €750,000 threshold for the tax year. Compliance with the arm’s length principle is assumed if Controlled Transactions fall within these safe harbours, outlined as follows:
The safe harbour amounts stated above are before the deduction of taxes.
In cases where the yield rate of the ten-year government bond turns negative, safe harbour rates for transactions described under II and III will be 3.5% and 1.5% respectively. For scenarios I, II, and III, the relevant safe harbour should apply not just to the principal amount but also to any interest charged but not paid. These rates are subject to periodic review and potential adjustments based on prevailing market conditions or other influencing factors.
Additional Conditions and Documentation Requirements:
Utilizing the safe harbours for the mentioned transaction sub-categories requires supporting documentation.
This documentation includes the functional analysis overview (describing functions, assets, and assumed risks) and entity characterization based on the analysis results.
Moreover, the minimum documentation supporting the use of the safe harbor requires additional information. For instance, in the case of financing transactions mentioned earlier, this entails providing a detailed list of pertinent loans and specific loan-related details. It also necessitates outlining the reasons they align with the necessary criteria for safe harbor usage, alongside numerical analyses and reconciliations aimed at determining the taxable income.
The requirements for applying the 5% mark-up on relevant costs, referred to as the “simplified approach” in the OECD TP Guidelines, for low value-adding services are in line with Chapter VII of the OECD TP Guidelines, albeit with minor differences. Generally, services categorized as low value-adding are supportive in nature, not integral to the group’s core activities, lack unique and valuable intangibles, and do not involve significant risks for the service provider. Specific examples of services falling within or outside the low value-adding category are outlined in Section D of Chapter VII of the OECD TP Guidelines. Under the simplified approach for such services, comprehensive documentation and information are necessary, providing justifications for the services’ eligibility under the simplified methodology of a 5% mark-up on relevant costs. This documentation should also includes specific analyses and calculations.
Taxpayers opting for a safe harbour must electronically declare its usage to the CTD via the relevant section in the annual income tax return/summary information table. If reliable internal comparables are available, the safe harbour option is not allowed. Moreover, if accounting profit from Controlled Transactions surpasses that determined by a TP Study or the safe harbour amount, the CTD will not adjust taxable profits downward.
Reporting and Mandatory Disclosure Rules:
Simplified TP documentation for Controlled Transactions under the Circular must be furnished within 60 days of receiving a request from the CTD, either by the taxpayer or an authorized representative. Furthermore, the employment of the safe harbours falls under the DAC6 provisions of the Administrative Cooperation in The Field of Taxation Law, specifically under the automatic hallmark (E1) concerning unilateral safe harbours.
However, the Circular states that the simplified methodology of a 5% mark-up on relevant costs for low value-adding services might be exempt from DAC6 reporting if the taxpayer fully adheres to the guidelines outlined in Chapter VII of the OECD TP Guidelines. This exemption applies if the taxpayer’s information and documentation strictly follow to the contents specified in the OECD Guidelines.
We remain at your disposal for any further clarifications may be needed.