On 24 January 2022, the Cyprus Tax Authority (CTA) issued Frequently Asked Questions (FAQs) with reference to the Interpretive Circular 3 dated 30 June 2017 with title "Tax treatment of intra-group back-to-back financing transactions" (Back-to-Back Circular).

The Back-to-Back Circular, which is effective from 1 July 2017, provides guidance in terms of substance and transfer pricing (TP) documentation requirements with respect to on-lending financing transactions.

The answers to the FAQs are applicable to all transactions that fall within the scope of the Back-to-Back Circular and relate to loan agreements concluded as at the date of the issuance of the FAQs and thereof (i.e., 24 January 2022), as well as to those loan agreements which were concluded prior to that date and have not been examined by the Tax Department by that date.

The FAQs as published on CTA website are provided below:

1. "Will TP studies be required to be submitted to the Tax Authority as part of the Annual Tax Filing process? The TP studies will be submitted to the Tax Department upon request.
2. Who is eligible to prepare a TP study? As per paragraph 29 and bullet point 4 of the Back to Back Circular, "A TP study is prepared by a TP expert."
3. Who is considered to be a TP expert? A TP expert is someone who possesses sufficient practical experience, competence and technical knowledge to prepare a TP study in accordance with the OECD TP Guidelines, as amended and the provisions of the Cyprus Tax Legislation, as amended.

A TP expert is qualified by sufficient evidence of his/her technical expertise, training and knowledge in TP matters.

1. Is the company required to prepare a TP study when it opts to apply the simplification measures as described in section 4 of the Back to Back circular? A company which opts to apply simplification measures (2% margin after tax) because it is functionally reduced as it is purely an intermediary financing entity should only prepare a functional analysis.
2. In case a company does not support its controlled transactions with a TP study and the Tax Department makes an upward adjustment on taxable profit, how will such an adjustment be made? The Tax Department may assess the company's taxable profits on the basis of the available information and at its own discretion in the absence of a TP study.
3. Should a Transfer Pricing study be prepared every tax year or only if something changes with regards to the intra group loans? A TP study should be prepared when an intra group loan is initiated and updated when: (i) new loans are provided or received by the company, or (ii) significant terms of the existing loans change or amended, or (iii) the functional profile of the company changes, or (iv) the market and economic conditions change significantly (if applicable).

The above list is indicative and it is not exhaustive.

The term "Control over risk" is described both in the Back to Back Circular and in the OECD Transfer Pricing Guidelines for Multinational Enterprise and Tax Administrations, as amended.

Extracts from the OECD TP Guidelines: 1.65 "Control over risk involves the first two elements of risk management defined in paragraph 1.61; that is (i) the capability to make decisions to take on, lay off, or decline a risk-bearing opportunity, together with the actual performance of that decision-making function and (ii) the capability to make decisions on whether and how to respond to the risks associated with the opportunity, together with the actual performance of that decision-making function. It is not necessary for a party to perform the day-to-day mitigation, as described in (iii) in order to have control of the risks. Such day-to-day mitigation may be outsourced, as the example in paragraph 1.63 illustrates. However, where these day-to-day mitigation activities are outsourced, control of the risk would require capability to determine the objectives of the outsourced activities, to decide to hire the provider of the risk mitigation functions, to assess whether the objectives are being adequately met, and, where necessary, to decide to adapt or terminate the contract with that provider, together with the performance of such assessment and decision-making. In accordance with this definition of control, a party requires both capability and functional performance as described above in order to exercise control over a risk […]" .

The required level of the specialization of the personnel is analogous to the functional profile of each entity.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young Cyprus Limited, Transfer Pricing Services, Limassol

• Charalambos Palaontas | charalambos.palaontas@cy.ey.com
• Yernar Fazylov | yernar.fazylov@cy.ey.com