While many EU countries have already adopted and apply in their national legislation the OECD Transfer Pricing Guidelines, Cyprus is the last country to introduce transfer pricing (TP) legislation in its income tax law.
To date, Cyprus has had no detailed TP legislation included in its income tax law. In 2002, Cyprus legislation was amended and a specific arm’s-length provision was incorporated therein, despite there being no guidance on how to apply it.
In 2017, a detailed TP circular, was issued by the Cypriot tax authorities based on the OECD Transfer Pricing Guidelines, governing (only) financial arrangements, such as loan facilities.
In particular, Article 33 of the Income Tax Law (ITL) (Law 31(I)/2021, as in force), provides a detailed definition of associated enterprises. Two companies are deemed as associated if:
- One company participates directly or indirectly in management or control or share capital of another company; or
- The same persons (individuals) or legal entities participate directly or indirectly in management or control or share capital of another company.
Please note that two companies can also considered as associated if they are both controlled by spouses or close relatives. Therefore, the ITL of Cyprus provides a broad definition of associated entities that may fall under the TP regulations.
Moreover, the ITL incorporates and elaborates on the OECD Transfer Pricing Guidelines regarding the arm’s-length principle, allowing taxable profits to be adjusted if the controlled prices differ from those agreed in comparable uncontrolled transactions.
Article 33 adopts the arm’s-length principle statement of Article 9 of the OECD Model Tax Convention on Income and Capital.
The ITL authorises the tax auditor for an upward adjustment of the profits generated by a CY company or permanent establishment of a foreign company in Cyprus, in case of non-compliance with the arm’s-length principle. In the same context, the other party involved in the transaction is eligible for recognition of an equal deduction affecting its taxable profits accordingly.
Obviously, if both CY companies are profitable, such adjustments do not usually affect the tax burden of a group. However, in case of at least one loss-making company, such an adjustment may result in higher taxable income and change in group’s tax due.
The tax treatment is more complicated if cross-border intra-group transactions are carried out. Consider that a Cypriot company is a subsidiary of a UK company. The controlled transactions are also governed by the double tax treaty between Cyprus and the UK, which sets forth TP provisions and regulates this exact framework.
In this case, the difference between the corporate tax rates (UK: 19%, Cyprus: 12.5%) could lead to profit shifting to the Cypriot subsidiary to achieve a lower tax burden on a group level. However, the tax auditor would not proceed to a profit adjustment since pretty much all tax is payable in the Republic of Cyprus. However, if a Cypriot company is associated with an enterprise registered in a zero-tax jurisdiction, the implementation of an aggressive tax planning would shift profits outside Cyprus.
In a tax audit, the Cyprus tax authority will affect an upward adjustment to the taxable profit of the Cypriot resident company. In fact, there will be a relevant tax burden on a group level since there will be no tax to be offset by the company incorporated in that zero-tax jurisdiction.
In addition, Article 33A was introduced in 2019, defining the TP adjustments. It disallows any deduction of Cyprus tax resulting from any arrangement or series of arrangements, put in place for the purpose of eliminating the tax base and which have as a purpose the acquisition of a tax advantage.
Article 33A can be useful in practice for an intra-group transaction, which seems to be arm’s-length but in fact it is deprived of business and commercial status.
In 2017, the Cypriot Tax Authority issued a TP circular for intragroup financial arrangements and back-to-back loans. This circular is almost compliant with OECD Transfer Pricing Guidelines requiring a detailed comparability analysis and providing for safe harbours.
However, there is no sufficient analysis of the TP methods or directives for the selection of the more appropriate method. This circular is of limited scope and not extended to intra-group commercial and economic transactions. Therefore, additional rulings may ensure the application of the TP framework to every controlled transaction in accordance with Article 33 of the ITL.