Cyprus Compliance: Uncovering Overlooked Transfer Pricing Transactions

Welcome to the latest edition of International Tax Insights, published every month, allowing your business to make informed tax decisions.

For this latest edition we analyse how MNE groups with a presence in Cyprus should review their existing or planned Transfer Pricing arrangements to ensure they are aligned with the new regulations to avoid penalties and additional taxes.

On May 27, 2024, the Cyprus Tax Authorities (CTA)?released?additional advancements and?guidance, exclusively in Greek, regarding the Cyprus Transfer Pricing (TP) regulations. These updates detail the procedures for filing and completing the summary information table (SIT). The SIT requires comprehensive information on related party transactions, including the identification of counterparties, their tax residency jurisdiction, and the transaction values for each of the five transaction categories: (1) sale/purchase of goods; (2) provision/receipt of services; (3) financial transactions; (4) receipt/payment of IP licenses/royalties; and (5) others. Consequently, the precise identification and documentation of controlled transactions are crucial. However, many transactions not prominently featured in a company’s financial statements are often overlooked, leading to their exclusion from the SIT and the local file. This can result in penalties and additional taxes.

This article outlines the critical controlled transactions we have encountered in practice, which taxpayers must consider when preparing their SIT and local files. Given that corporation tax encompasses the provision of labour and the use of assets, we categorize these transactions into income from assets and income from the provision of services.

Income from (In)tangible Assets

Consider a scenario where a Cyprus tax resident company or a Cyprus permanent establishment (PE) of a foreign entity holds a tangible asset (such as an aircraft or real estate), an intangible asset (such as a copyright, patent, or trademark), or a financial asset (such as a loan) on its balance sheet. If these assets are utilized by related companies within the group without any remuneration—for instance, a lease-free arrangement for tangible assets or a royalty-free agreement for intangible assets or an interest-free loan agreement for financial assets (whether written, oral, or implied)—the Cyprus tax resident company or PE may not recognize any income on their income statement. However, for transfer pricing purposes, these transactions must be evaluated and priced according to the?2022 OECD Transfer Pricing Guidelines?(Guidelines). This necessitates an upward transfer pricing adjustment to reflect the arm’s length value of the license or royalty-free arrangement. In other words, the absence of license, rent, interest or royalty income can raise concerns about the arm’s length nature of the transaction. The CTA would typically adjust the pricing to ensure alignment with the arm’s length principle, resulting in adjustments to taxable income and potential penalties for non-compliance.

A similar example involves “off-balance sheet” assets, recognized for transfer pricing purposes but not under IFRS (international financial reporting standards). For instance, the IP definition in paragraph 6.6 of the Guidelines is broader than that under IAS 38. A typical scenario involves costs associated with the internal development of intangibles, such as research and development and advertising expenditures, which are sometimes expensed rather than capitalized for accounting purposes. As a result, the intangibles generated from these expenditures may not be reflected on the balance sheet. Nevertheless, these intangibles can generate substantial economic value and must be considered for transfer pricing purposes. Therefore, an arm’s length remuneration should be calculated if such off-balance sheet intangible assets are transferred (e.g., during a business restructuring) or utilized by group companies.

Income from the Provision of Services

An illustrative scenario arises when a multinational enterprise (MNE) group aims to centralize its operations by setting up a regional service hub to offer intra-group services like accounting, HR, compliance, and marketing. These services are rendered to group affiliates under a no-service agreement or a service-free arrangement, whether written, oral, or implied. The lack of service income from the Cyprus tax resident company may raise questions about the arm’s length character of the transaction. Typically, the CTA would adjust the pricing to ensure alignment with the arm’s length principle, resulting in alterations to taxable income and potential penalties for non-compliance.

Regarding financial transactions, consider the example of financial guarantees, including downstream, upstream, or cross guarantees. For instance, a Cyprus tax resident company may serve as a guarantor, providing a financial explicit guarantee to its subsidiary to secure a third-party loan. If the subsidiary benefits from this arrangement, such as obtaining a lower interest rate or accessing a higher loan amount, transfer pricing principles dictate that the Cyprus tax resident company should charge its subsidiary for this benefit, typically in the form of a guarantee fee. Another example is cash pooling, whether notional or physical. If the Cyprus tax resident company functions as the cash pool leader, its compensation should reflect the functions performed, assets utilized, and risks assumed in facilitating the cash pooling arrangement. Conversely, if the company participates as a cash pool member, its compensation should align with the arm’s length interest rates applicable to debit and credit positions within the pool. In both cases, the absence of income from the Cyprus tax resident company may prompt inquiries regarding the arm’s length nature of the transaction. Typically, the CTA would adjust the pricing to ensure compliance with the arm’s length principle, potentially resulting in changes to taxable income and the imposition of penalties for non-compliance.

Conclusion and Planning Points

The above paragraphs have illustrated some of the common intra-group transactions that may fall under the scope of transfer pricing rules and should be documented under both the SIT and local file in Cyprus. Failure to do so may result in significant tax adjustments, interest, and penalties, as well as reputational damage and increased scrutiny from the CTA. Therefore, MNE groups with a presence in Cyprus need to review their existing or planned arrangements and ensure that they are aligned with the transfer pricing requirements and best practices as follows:

• Perform a functional and risk analysis to identify and evaluate the intra-group transactions that are subject to transfer pricing rules and documentation requirements in Cyprus;
• Prepare and maintain a SIT and a local file for each tax year, in line with the CTA’s guidance and OECD standards; and
• Seek professional advice from transfer pricing experts to ensure compliance and avoid potential disputes and penalties.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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For a comprehensive understanding of the issues discussed in this article, please refer to my previous presentation given at the 7th Cyprus International Tax Conference organised by IMH Business.

For a deeper discussion regarding Cyprus Compliance: Uncovering Overlooked Transfer Pricing Transactions get in touch with me at [email protected]

The article was published in Bloomberg BNA at International Tax News

Best Regards

Christos Theophilou