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2017.07.07 - Cyprus – changes of taxation rules in relation to the operations of financing and loans.

 

Historically, Cyprus companies are the optimal tool for financing operations within a group of companies (Intra-group financing agreements) – e.g., a Cyprus company receives funds from a third company and thereafter transfers those funds to affiliated or other companies within the group, for trading or other operations.

As is known, previously the taxation of such transactions were governed by the Circular of the Tax Department of Cyprus issued in 2011. This defined a minimum acceptable difference between the interest rates of received and transferred funds, specifically the taxable income of a Cyprus company had to be not less than 0.35% of the amount of the received/transferred funds.

On the 30.06.2017. the Tax Department of Cyprus issued Circular 3, Ref No. 05.13.001 which cancels the previous principle of a minimum allowed difference of the rates and, as of 01.07.2017, defines the conditions for measuring the interest rates for taxation purposes on the basis of the comparison of the interest rates with general market conditions.

The financial operations for related companies (the criteria of related companies are defined by Article 33 of Cyprus Income Tax Law) are now considered from the viewpoint of the ‘Arm’s Length Principle’ – specifically based on interpretation of this term in Section IX of OECD Model Convention on Income and Capital, as this international standard is now adopted in Cyprus.

The methods of assessment whether the interest rates applied by a Cyprus company correspond to the above principle will be based on the following:

  1. The nature of the transactions as such are now considered, rather than the form of a contract (“Substance Over Form”).
  2. Risk analysis. In other words, whether the funding Cyprus company undertakes its own commercial risk (i.e. - makes its own financing decisions), or only acts as a formal intermediary.
  3. The comparison of the financial transactions performed by a Cyprus company with the transactions of other entities performed in the market under similar conditions.
  4. An assessment of the commercial logic of the transactions – whether the financing operations are profitable for the company, or are they just formal transfers.

The Circular also provides for a simplified methodology, i.e. – if the income of the company gained from such transactions after taxation is at least 2% of the amount of the transactions, then the company is considered as having met the above criteria. In all other cases, the analysis of the financing operations must demonstrate compliance with the above criteria. The obligation to carry out the above analysis is imposed on an auditor – that is, the auditor shall not accept the company’s financial statement if the interest rates on its transactions do not meet either the above criteria or the simplified approach conditions.

Comments by INTERNATIONAL OVERSEAS SERVICES:

In practice, taking the Arm’s Length Principle as the basis for the assessment of the interest rates means that the conditions of the rates must correspond to the conditions that would be applied by two independent parties acting in the same circumstances and considering the specific details of a certain transaction.

Based on this criterion, the Tax Department of Cyprus may adjust the amount of taxable income of a company as result of additional analysis of such transactions.

It is important to note that the above conditions apply not only to straightforward loan and credit transactions, but also to other operations that may be interpreted as funding - for example, deferred payment for goods with a deferral time different from the period generally used on the market under similar conditions.

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