Tax Alert - Restructuring of back to back loan arrangements
On 30 June 2017 the Cyprus tax office issued a tax circular to govern the treatment of back to back loan arrangements. The main provisions are as follows:
Application of the new law
The new law applies for companies that undertake intra group financing transactions. Any other operations (ie balances from investment holding operations) do not fall under the provisions of this new tax circular.
Definition of intra group financing transactions
Such term includes the provision of back to back loans to related companies either via monetary form or through non-monetary means (ie debentures/bonds/advances etc). Related parties are defined in accordance with the provisions of Section 33 of the Cyprus tax legislation.
Arm’s length principle defined
In accordance with the provisions of the Cyprus tax legislation the arm’s length principle is defined in Section 33 of the Cyprus income tax law, which states that where conditions are made or imposed between two businesses in their commercial or financial relations which differ from those which would be made between independent businesses, any profits which would but for those conditions have accrued to one of the businesses, but by reason of those conditions have not so accrued, may be included in the profits of that business and taxed accordingly.
Analysis to be prepared
In accordance with the provisions of the circular the following analysis needs to be prepared:
- Comparability analysis – The aim is to justify that transactions between independent parties are comparable to transactions with related parties. Thus such analysis should comprise of:
- Identification of the relationship between the parties and determination of conditions and economic justification as to those conditions;
- Comparison of conditions and economic circumstances between the transactions of the related parties as compared to similar transactions concluded between unrelated parties;
- Functional analysis – The aim is to be able to justify the responsibilities and functions, assets used and risks undertaken by each related party as compared to similar transactions concluded between unrelated parties. The following should be analysed:
- Origination of the transaction covering the commercial basis, negotiation, refinancing options etc;
- Monitoring of the transaction covering the refinancing schedule and terms being fulfilled;
As you may understand the above analysis will be time consuming and costly. In this respect, such analysis can be avoided if a Cyprus tax resident group financing entity undertakes a purely intermediary activity, granting loans to related companies stemming from similar refinancing received from related companies. In this respect, for such transactions if the Cyprus company receives a minimum return of 2% after tax on its assets it will be considered that it will comply with the arm’s length principles thus avoiding the burden of preparing a detailed analysis.
To utilize the above advantage the Cyprus tax resident financing company should meet the criteria of substance as mentioned in the circular, being:
- Actual presence in Cyprus;
- Majority of members of the board of directors being Cyprus tax resident;
- Number of board meetings being held in Cyprus;
- Availability of qualified personnel to control the financing transactions;
The company can subcontract functions which are not considered significant as to the risk control. The use of such a simplified procedure is communicated to the tax office through the completion of a relevant section in the tax return. The 2% return must be maintained unless a different return is justified via the preparation of a transfer pricing study as illustrated above.
The above mentioned rules are applicable as from 1 July 2017 onwards, for any already existing or new transactions.
How we can assist
It is evident from the above that existing back to back loan arrangement need to be revisited and restructured. In addition, it is very important to ensure that the simplicity option will be applied to avoid the necessity for the preparation of transfer pricing studies, the increase of substance being one of the major steps to be introduced towards this.