The Transfer Pricing rule is the method whereby tax law allocates income to related companies and permanent establishments.
The OECD Transfer Pricing Guidelines provide guidance on the application of the ‘’arm’s length principle’’, which is the international consensus on the valuation of cross-border transactions between associated enterprises.
In a global economy where multinational enterprises (MNEs) play a prominent role, governments need to ensure that the taxable profits of MNEs are not artificially shifted out of their jurisdiction and that the tax base reported by MNEs in their country reflects the economic activity undertaken therein.
As an internationally recognized business centre, even though it is not a member of OECD, Cyprus is a jurisdiction largely compliant with Organization for Economic Co-operation and Development (OECD) standards.
On 30th June 2022, the House of Representatives of Cyprus voted on and approved amendments to the Income Tax Law and the Assessment and Collection of Taxes Law in relation to Transfer Pricing (collectively ‘’TP legislation’’).
The above legislative developments aim to introduce transfer pricing rules and documentation requirements in accordance with recommendations of the Organization for Economic Co-operation and Development on Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD TP Guidelines).
The TP legislation is effective retroactively as from 1 January 2022.
Before the enactment of this law, the legal basis to address transfer pricing issues rested on the arm’s length principle (ALP), as found in section 33 of the of the Cyprus Income Tax Law (L118(I)2002) which is identical to Article 9 of the OECD Model Tax Convention.
Ιt is worth noting that article 33 of the Cyprus Income Tax Law does not apply to transactions where no controlled relationship exists between the parties or to certain transactions that constitute capital transactions or which involve immovable property in Cyprus. Nevertheless, the Income Tax Law does contain anti-avoidance tax provisions granting the Cyprus Tax Office (CTO) authority to disregard artificial or fictitious transactions, or to replace disposal proceeds with market values of property on the date of disposal, as appropriate.
In general, from June 2017 and up to now, the only type of arrangements that were subject to TP requirements in Cyprus were intercompany financing arrangements between related parties.
A big change in practice
According to the Cypriot legislation, the new Transfer Pricing rules apply to transactions between related parties (legal persons and individuals). Ιt is important to mention that, for legal entities, the new law provides detailed rules as to the meaning of the term “related parties” in an effort to capture different relationships where there is a “control” situation.
The main rule of the law is that when one legal entity participates in the share capital of another legal entity through the direct or indirect holding of shares of at least 25 per cent, the two parties are considered related parties.
The new TP rules also impose documentation requirements for certain transactions undertaken with related parties (“controlled transactions”) and are expected to provide clarity as to the proper and adequate documentation of controlled transactions, so that taxpayers can demonstrate adherence to the arm’s length principle.
The first one is to submit a Summary Information Table (SIT) which includes intercompany transactions, general information about the group, the profile of the business and the transfer pricing method used. The SIT reporting obligation is applicable for all liable taxpayers on an annual basis and needs to be submitted to the Tax Department electronically, together with the Income Tax Return for the relevant tax year.
The second requirement is to prepare a Transfer Pricing documentation (TP) on an annual basis, comprising of a Cyprus Local File and a Master File (in limited cases).
The amended Law provides for the option to taxpayers to request for an Advance Pricing Agreement (APA) from the Cyprus Tax Department, with respect to current or future controlled transaction.
In practice, an APA is a voluntary agreement between the taxpayer and one or more tax authorities that determines, in advance of the controlled transactions, an appropriate set of criteria for determining the transfer pricing of the controlled transactions in question, with such criteria including critical assumptions, relevant market conditions, appropriate TP method to be used, comparable transactions and appropriate adjustments thereto. The APA will be valid for period of up to four years.
The new law provides specific penalty provisions. In the event of late submission of the summary information table a €500 (five hundred euros) administrative penalty is imposed. Further, in case the documentation is not made available to the Tax Commissioner within 60 days from the notification of a request, an administrative penalty of €5,000 (five thousand euros) is imposed. If it is not made available from the 61st (sixty-first) day until the 90th (ninetieth) day an administrative penalty of €10,000 (ten thousand euros) is imposed, while if it is not made available at all or made available after the 90th (ninetieth) day an administrative penalty equal to €20,000 (twenty thousand euros) is imposed.
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