Transfer Pricing Circular for Transactions Under the Local File Threshold

12/07/2023

Further to our previous newsfeeds on this, the Cyprus Tax Department issued a circular for transactions falling below the threshold for the preparation of a Local File.

The circular applies to all taxpayers with related party transactions, known as “Controlled Transactions”, which are exempted from the obligation to be documented in a Cyprus Local File.

It is reminded that as per section 33 of the Income Tax Law, a Local File must be prepared by taxpayers if their Controlled Transactions exceed (or should have exceeded based on the Arm’s Length Principle) the amount of €750,000 per annum in aggregate per category of transactions (sale/purchase of goods, provision/receipt of services, financing transactions, receipt/payment of IP licencing/royalties, etc.).

The new circular provides for simplified documentation to be prepared for Controlled Transactions that do not exceed the threshold.

In addition, the circular introduces safe harbours for certain types of financing operations, as well as for low value-adding services, always under the condition that the Local File threshold is not exceeded.

For what concerns financing transactions, the threshold is determined by the principal amount of the loan including interest charged but not paid. There are ongoing discussions for a possible increase in the threshold for such transactions.

The main provisions of the circular are presented below:

1.         Simplified Transfer Pricing (TP) documentation requirements

The minimum documentation requirements for eligible taxpayers, are as follows:

a.         brief description of the functional analysis (functions undertaken, assets used and risks assumed);

b.         a description of the characterisation of the entity, based on the results of the functional analysis;

c.         the reasons for the chosen TP method being considered the most appropriate one;

d.        determination of the arm’s length price/remuneration based on the benchmarking analysis undertaken (comparability search results), using either external or internal comparables. The benchmarking approach may also include any other appropriate method provided by the OECD TP Guidelines for Tax Administrations and Multinational Enterprises (the “OECD TP Guidelines”) under the specific circumstances.

2.         Safe Harbours

Taxpayers engaged in Controlled Transactions which fall under the following subcategories are assumed to comply with the Arm’s Length Principle if those transactions are within the safe harbours. The circular introduces safe harbours for the following sub-categories of Controlled Transactions: 

a. Financing transactions such as loans or cash advances granted to related parties which are funded out of financial means (such as bonds, loans from related parties, interest free loans from the shareholders, cash advances and bank loans). The safe harbour applies regardless of whether the taxpayer assumes the risks of the financing activity.

b. Loans or cash advances receivable from related parties which have been funded out of own capital (e.g. issued share capital and share premium, non-return capital contributions, and retained earnings).

c. Funding received from related parties (through interest bearing loans, bond issuance, or cash advances) to the extent that the funds borrowed are used in the business.

d. Low value-adding services.

Use of a safe harbour is permitted only if the total value of Controlled Transactions in the particular sub-category, together with the value of the remaining Controlled Transactions which belong to the same main category as with the sub-category, should not exceed (or should have not exceeded based on the Arm’s Length Principle), the threshold of €750.000 per annum.

The safe harbours are the following:

 Remarks concerning the use of safe harbours:

•          The safe harbour amounts stated above are before the deduction of taxes.
•          For the first three cases above, in addition to the principal amount, the relevant safe harbour should also be applied to any interest charged but not paid.
•         The safe harbours are subject to review and may be amended from time to time depending on the prevailing market conditions or other factors.
•          In case a taxpayer has reliable internal comparables at its disposal, then the use of the safe harbour is not permitted.

The use of safe harbours will be subject to the DAC6 provisions of the Administrative Cooperation in The Field of Taxation Law and accompanying Regulations, under the automatic hallmark E1 on the use of unilateral safe harbours. However, the use of a mark-up on relevant costs for low value-adding services may be exempted from DAC6 reporting if the taxpayer fully complies with the guidance on how to apply the relevant methodology as set out in Chapter VII of the OECD TP Guidelines and the information and documentation prepared strictly follow the contents set out in those OECD Guidelines.

The use of safe harbours needs to be supported by some minimum documentation, such as:

a.         brief description of the functional analysis (functions undertaken, assets used and risks assumed);

b.         a description of the characterisation of the entity, based on the results of the functional analysis.

Additional information will be required depending on the nature of the transaction. For the financing transactions under 1,2 and 3 in the table above, such information must include a list of the relevant loans and certain details relating to those loans, the reasons why they meet the required criteria for using the safe harbour and numerical analyses and reconciliations for the purposes of arriving at the taxable income.

For what concerns low value-adding services, these follow closely those in Chapter VII of the OECD TP Guidelines with some slight variations. In general, services falling under the definition of low value-adding services are those which:

•         have a supportive character;
•         are not part of the core activities of the group;
•         do not involve unique and valuable intangibles;
•         do not involve the assumption or control of significant risk for the service provider.

Specific examples of services that would or would not fall within the category of low value-adding services are described in Section D of Chapter VII of the OECD TP Guidelines. Under the simplified approach for low value-adding services, documentation and information must be prepared which include justifications as to why the services are eligible for the simplified methodology of a mark-up on relevant costs and should also include certain analyses and calculations.

A taxpayer choosing to benefit from a safe harbour, must declare that to the Tax Department electronically by completing the relevant section in the income tax return/summary information table.

3.         Reporting and Other Considerations

The documentation required should be kept by the taxpayers on file to support their compliance with the requirements of the circular for their Controlled Transactions.

It should be made available, by the taxpayer or a person authorised to act as representative of the taxpayer, within 60 days from receipt of a request by the Tax Department.

Where the accounting profit from Controlled Transactions is higher than that resulting from a TP Study or the amount resulting from application of a safe harbour, the Tax Department will not proceed with any downward adjustment of taxable profits.