OECD Tightens Financial Transactions Transfer Pricing Grip: The New Landscape for Intercompany Loans
Antony Zack and Jonathan Lubick
Transfer pricing regulations concerning intercompany loans have evolved over time as international organizations and tax authorities have worked to develop frameworks to monitor the pricing of financing transactions within multinational enterprises (MNEs). We note that intercompany loans are often an essential part of a MNE’s business operations. Subsidiaries whose business operations are either starting up, or facing financial constraints, or whose operations need cash to grow its operations, will often seek funding from another stronger entity within its multinational structure. Taxing authorities may assess these intercompany loans, as the interest on the loan will reduce the net income of the related company borrower.
In particular, as transfer pricing transactions are almost always measured on either an operating profit before interest and taxes or at a gross profit level, the interest expenses will reduce the net earnings and thus the tax payments of the related company borrower. There can certainly be instances where significant borrowing by a subsidiary with the attending arm’s length interest charge can effectively reduce or eliminate the ultimate profit before taxes of the subsidiary. The United States in particular has its own set of thin capitalization tax regulations to ensure that significant or excessive interest payments do not eliminate the tax payments to be made by such a taxpayer. Regardless, borrowings do reduce taxable income. In many instances, straightforward assessments of an arm’s length interest rate may not be so forthcoming. We herein assess intercompany loans from an OECD perspective.
We note that outside of the United States, the OECD and various government tax authorities are delving deeper into the analytics pertaining to the arm’s length interest on loans, or alternatively, are assessing the various thin capitalization benchmarks to determine whether the interest expenses of a borrowing entity are deductible.
This article provides an overview of the transfer pricing regulations regarding financial transactions, and offers practical insights on various approaches to assess the arm’s length interest rate. Each of the approaches depends on the availability of data, and on the level of comparability within the transaction.
Evolution of Transfer Pricing Rules for Financial Transactions
1960s-1990s: Transfer pricing regulations began to take shape in the 1960s, with the primary concern being whether intercompany transactions, including loans, were conducted at arm’s length, i.e., that terms and prices transacted between related parties mirror the terms and prices which independent parties would have agreed upon.
1979: The Organization for Economic Cooperation and Development (OECD) first introduced transfer pricing guidelines for MNEs and tax administrations. However, there was minimal focus on financial transactions, and the Guidelines primarily targeted goods and services. At this point, the guidance for intercompany loans was limited to a general application of the arm’s length principle.
1995: The OECD revised its transfer pricing guidelines. This revision explicitly emphasized the importance of applying the arm’s length principle to all types of intercompany transactions, including loans. However, there was still relatively limited specific guidance on the pricing of financial transactions like loans, with more focus on traditional transfer pricing methods (e.g., for tangible goods).
2000s: The growing complexity of MNEs’ operations and the increase in financial transactions led to greater scrutiny of intercompany loans and other financial dealings. Tax authorities became concerned about the manipulation of interest rates on loans to shift profits to lower-tax jur
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² Transfer Pricing and Multinational Enterprises, Report of the OECD Committee on Fiscal Affairs, June 01, 1979
³ Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, Report of the OECD Committee on Fiscal Affairs, July 28, 1995
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Rates on loans to shift profits to lower-tax jurisdictions. With respect to the previous footnote’s working paper, we note that the working paper investigated the impact of thin capitalization rules (TCRs) on the capital structure of foreign affiliates of U.S. multinational firms. It specifically examined whether these rules effectively curb “debt shifting”. We note that the study found that thin capitalization rules have a statistically significant and substantial impact on how much debt an affiliate carries.
2006: The OECD released a report on the “Attribution of Profits to Permanent Establishments,” which further refined guidance on the pricing of intercompany loans, focusing on whether financial dealings between related entities adhered to arm’s length conditions. Note that the OECD’s guidance was to generall not recognize internal “loans” or “interest” payments between the PE and its head office. Further, it suggested as one approach to allow the PE to deduct a proportionate share of the actual interest expense paid by the enterprise as a whole to third-party lenders.
2013: The OECD launched the Base Erosion and Profit Shifting (BEPS) project, a major international initiative designed to curb profit shifting and tax avoidance by MNEs. One of the primary concerns of BEPS was the manipulation of intercompany financing transactions, including loans, to erode the tax base in high-tax jurisdictions by shifting profits to low-tax jurisdictions.
- Action 4: BEPS Action Plan 4 specifically targeted interest deductions and financial payments. The report suggested that countries implement rules limiting interest deductions and apply consistent transfer pricing rules to intercompany loans to prevent excessive interest deductions in high-tax jurisdictions.
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⁴ Thin Capitalization Rules and Multinational Firm Capital Structure, Taxation Papers – Working Paper N. 42, European Commission, 2014
⁵ Report on the Attribution of Profits to Permanent Establishments, Part I: General Considerations, OECD Publishing, December 2006.
⁶ Limiting Base Erosion Involving Interest Deductions and Other Financial Payments, Action 4 – 2015 Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, 2015.
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2017: The OECD published its report on BEPS, which had a significant impact on transfer pricing regulations globally. As part of the BEPS initiative, the OECD emphasized the need for MNEs to ensure that the terms and conditions of intercompany loans (such as interest rates, collateral, repayment schedules, and loan agreements) were consistent with what unrelated parties would agree to. This period also saw the introduction of specific regulations in many countries requiring the benchmarking of interest rates on intercompany loans to ensure they reflected market rates. Among such countries were the U.K., Cyprus, Norway, Hong Kong and Switzerland.
2020: A major milestone was reached when the OECD released its Transfer Pricing Guidance on Financial Transactions in February 2020. This was the first time the OECD provided comprehensive guidance on the transfer pricing aspects of financial transactions, including intercompany loans. Key aspects of the guidance include: characterization of debt vs. equity, creditworthiness and risk, implicit support, risk-free vs. risk-adjusted rates.
OECD Guidelines: Current State of OECD Regulations
The OECD Guidelines describe specific methods for determining an arm’s length result for transactions between controlled parties. The Most Appropriate Method rule of the OECD Guidelines is to be applied to select the transfer pricing method likely to produce the most reliable measure of an arm’s length result. This evaluation includes reviewing the strengths and weaknesses of all methods, the appropriateness of the method given the circumstances of the controlled transaction, the availability of reliable information and the degree of comparability between controlled and potentially comparable uncontrolled transactions. From our experience, with respect to intercompany financial transactions, the most critical issue is the availability of reliable information, especially when dealing with small and medium-sized businesses.
The OECD Guidelines’ Chapter X provides guidance on transfer pricing aspects of financial transactions, which was issued as part of the January 2022 release of the OECD Guidelines. Section B describes the application of the principles of Section D.1 of Chapter I to financial transactions (i.e., comparability). Section C provides.
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⁷ Harmful Tax Practices 2017 Progress Report on Preferential Regimes, OECD Publishing, October 2017.
Broad Based Assessment Characteristics: Attributes of the Loan From The Lender’s and Borrower’s Perspectives
In considering the commercial and financial relations between the associated borrower and lender, and in an analysis of the economically relevant characteristics of the transaction, it may be important to take into account both the lender’s and borrower’s perspectives.
“In considering the commercial and financial relations between the associated borrower and lender, and in an analysis of the economically relevant characteristics of the transaction, both the lender’s and borrower’s perspectives should be taken into account, acknowledging that these perspectives may not align in every case. “ (OECD Guidelines, Chapter X, Article 10.51).
We note that there will likely be differences between each of their perspectives, and how each assesses the characteristics of the loan, especially with regards to its riskiness. It is important to consider the risks that the funding arrangements carry for the party providing the funds, and the risks related to the acceptance and use of the funds from the perspective of the borrower. These risks will relate to repayment of the amount transferred, compensation expected for the use of that amount (i.e., the loan) over time, and compensation for other associated risk factors such as for example whether the debt is subordinated, or issued in a currency with risk factors.
“ The economic conditions of loans should also be viewed in the context of regulations that may affect the position of the parties. For example, insolvency law in the jurisdiction of the borrower may provide that liabilities towards associated enterprises are subordinated to liabilities towards unrelated parties.“ (OECD Guidelines, Chapter X, Article 10.51)
“Currency differences are another potentially important factor. Economic factors such as growth rate, inflation rate, and the volatility of exchange rates, mean that otherwise similar financial instruments issued in different currencies may have. different prices. Moreover, prices for financial instruments in the same currency may vary across financial markets or jurisdictions due to regulations such as interest rate controls, exchange rate controls, foreign exchange restrictions and other legal and practical restrictions on financial market access.” (OECD Guidelines, Chapter X, Article 10.53)
“… it is important to bear in mind that, based on facts and circumstances, comparability adjustments may be required to eliminate the material effects of differences between the controlled intra-group loan and the selected alternative in terms of, for instance, liquidity, maturity, existence of collateral or currency.” (OECD Guidelines, Chapter X, Article 10.93).
The lender’s perspective in the decision of whether to make a loan, how much to lend, and on what terms, will involve evaluation of various factors (described below) relating to the borrower. It will also need to take into account wider economic factors affecting both the borrower and the lender, and other options realistically available to the lender for the use of the funds. An independent lender will generally speaking carry out a thorough credit assessment of the potential borrower to enable the lender to identify and evaluate the risks involved and to consider methods of monitoring and managing these risks. That credit assessment will include factors such as (a) understanding the business itself, (b) the purpose of the loan, (c) how the loan is structured, and (d) the source of its repayment. With respect to the source of repayment, other sub-factors will be important such as the borrower’s expected cash flow forecasts and the strength of the borrower’s balance sheet.
Note that in cases involving related parties, the above processes will need to be assessed by the transfer pricing analyst. The factors noted above effectively cover the following three categories of risk: creditworthiness, credit risk and economic circumstances.
We note as well at the same time, that the borrower as well will need to separately assess any terms of a loan it will receive. Perhaps such a borrower could obtain a similar loan with better conditions from a third party.
Alternatively, if there is full information, perhaps the lender itself is receiving borrowed funds at rates significantly lower than what a credit assessment of the borrower would determine. As such, there may be times when the lender’s conditions and terms be assessed distinctly from those of the borrower.
In assessing the arm’s length nature of interest charge on a loan, generally speaking one makes an assessment of the borrower for the determination of an arm’s length interest rate on a loan. The “creditworthiness” of the borrower is the focus. Creditworthiness refers effectively to specific loan based factors such as the borrower’s ability to repay the loan, and the term of time it will take to repay the loan.
Creditworthiness: Use of Credit Ratings
The creditworthiness of the borrower is one of the main factors that independent investors take into account in determining an interest rate charge. Credit ratings can serve as a useful measure of creditworthiness and therefore help to identify potential comparables or to apply economic models in the context of related party transactions. Furthermore, in the case of intragroup loans and other financial instruments that are the subject of controlled transactions, the effect of group membership may be an economically relevant factor that affects the pricing of these instruments. Determining credit ratings requires consideration of quantitative and qualitative factors.
On the quantitative side, key elements include financial metrics such as leverage ratios, interest coverage, cash flow stability, profit margins, liquidity, and overall debt burdens. It is also important to consider the issuer’s past financial performance, the diversity of its revenue streams, and its projected earnings growth.
From a qualitative perspective, the assessment often takes into account the company’s business model resilience, management quality, governance practices, competitive positioning, and exposure to regulatory, legal, and other types of risks. The interplay of these factors helps form a comprehensive picture of an organization’s ability to meet its financial obligations. We note that these factors are more “qualitative”, but they can certainly play a factor in bettering the terms of the loan for the borrower. Specific models can be created which work to take these qualitative factors into account.
Publicly available financial tools are designed to calculate credit ratings. Broadly, these tools depend on approaches such as calculating the probability of default and of the likely loss should default occur to arrive at an implied rating for the borrowing. This can then be compared to a market database in a search for comparables to arrive at a price or price range for the borrowing. In considering whether the application of these tools results in a reliable assessment of the credit rating of controlled transactions, potential issues that need to be borne in mind include that the results are not based on a direct comparison with transactions between independent parties but are subject to the accuracy of the input parameters, a tendency to rely more on quantitative inputs at the expense of qualitative factors, and a lack of clarity in the processes. The credit rating methodology used in publicly available financial tools may differ in certain respects from the credit rating methodologies applied by independent credit rating agencies. For instance, publicly available tools generally use only a limited sample of quantitative data to determine a credit rating. We note that the Bloomberg database is one such source for determining credit rates, but its data sources are finite. We note that official credit ratings published by independent credit rating agencies such as S&P, Moodies, or Fitch are usually derived through rigorous analytic processes that that includes quantitative analysis of historic and forecast entity performance, as well as detailed qualitative analyses of, for instance, management’s ability to manage the entity, industry specific features and the entity’s market share in its industry. We note that from a transfer pricing perspective, these qualitative issues can certainly be included in an analysis to determine an arm’s length interest rate, but the assumptions behind these qualitative factors ought to be solidly validated.
Methods for Pricing Financial Transactions
We provide below a summary of the various means of determining arm’s length interest rates for related party transactions. We note that generally speaking, the primary methodology to determine an arm’s length interest rate is based on the Comparable Uncontrolled Price (“CUP”) method. However, the “directness” of the CUP may be compromised. In many instances, one may be relying on a “modified” CUP.
CUP Method
The arm’s length interest rates can be sought based on consideration of the credit rating of the borrower or the rating of the specific issuance taking into account all of the terms and conditions of the loan and comparability factors. The widespread existence of markets for borrowing and lending money and the frequency of such transactions between independent borrowers and lenders, coupled with the widespread availability of information and analysis of loan markets may make it easier to apply the CUP Method to financial transactions than may be the case for other types of transactions. Information available often includes details on the characteristics of the loan and the credit rating of the borrower or the rating of the specific issuance.
There are multiple ways of applying the CUP method to intercompany loans analysis. We provide the explanation for the most common methods relied on, and also provide several alternative approaches for circumstances when external data are lacking, or for when the ability to make a credit assessment based on the factors noted above is compromised.
A. Comparable Loans or Comparable Alternative Financial Instruments Method
To determine the arm’s length interest rate for a loan based on the CUP, one approach would be to rely on comparable loans. For this method a three staged process needs to be performed. First, one needs to rely on the financials or either the borrower or the lender (usually the borrower) or both entities to determine a credit assessment (credit score) for the entity under examination. A Credit score can be established though a synthetic credit rating exercise. The synthetic credit approach is an established and accepted method to measure the riskiness of the loan, and can also allow for flexibility regarding adjustments for qualitative factors. Financial ratios of the entity tend to serve as the basis for the credit rating analysis, however there may also be company specific arguments which can elevate or downgrade the credit rating.
The second step in this approach is to engage in a search for third party loans under comparable conditions. Among the conditions that need to be assessed to be comparable are the term of the loan, the currency of the loan, the credit rating of the borrower, and the type of loan (fixed or variable). We note that in practice, there is unlikely to be a single “market rate” but a range of rates.
We further note that per the CUP, an arm’s length interest rate can in theory be based on the return of realistic alternative transactions with comparable economic characteristics. Depending on the facts and circumstances, realistic alternatives to intra-group loans could be, for instance, bond issuances, loans which are uncontrolled transactions, deposits, convertible debentures, or commercial papers.
In the evaluation of those alternatives as potential comparables it is important to bear in mind that, based on facts and circumstances, comparability adjustments may be required to eliminate the material effects of differences between the controlled intra-group loan and the selected.
“To achieve comparability requires that the markets in which the independent and associated enterprises operate do not have differences that have a material effect on price or that appropriate adjustments can be made.” (OECD Guidelines, Chapter X, Article 10.30)
Comparability adjustments might include correcting for differences in credit risk profiles (e.g., adjusting for different credit ratings of borrowers), tenor/maturity mismatches (e.g., aligning the time horizon of repayment terms), currency differences (e.g., normalizing for foreign exchange risks), liquidity or marketability disparities (e.g., reflecting the relative ease of converting an instrument into cash) and collateral arrangements (e.g., accounting for secured versus unsecured lending).
“… In the evaluation of those alternatives as potential comparables it is important to bear in mind that, based on facts and circumstances, comparability adjustments may be required to eliminate the material effects of differences between the controlled intra-group loan and the selected alternative in terms of, for instance, liquidity, maturity, existence of collateral or currency.” OECD Guidelines, Chapter X, Article 10.93)
As seen from the above, this comparable loans approach as an array of comparability issues associated with it. These comparability issues will likely not “invalidate” the approach, but rather will need to be highlighted and evaluated. Generally speaking, if the related entity has not taken an identical loan from a third party, this approach will be the most reliable, in spite of the comparability issues which are inherent in the approach.
B. Build-up Method Approach
The Build-Up approach determines an arm’s-length interest rate for intercompany loans by starting with a baseline risk-free rate and adding a credit risk premium that reflects the borrower’s creditworthiness. The risk-free rate, typically derived from government bond yields, is chosen to match the loan’s currency and term.
The credit risk premium is added to account for the borrower’s likelihood of default. This is determined based on the borrower’s standalone credit rating. Derivation of the credit rating is described earlier in the article. We note that there may be circumstances when a thorough credit rating assessment may be difficult to derive based on lack of data for the taxpayer. In such instances, an external assessment may be necessary.
Market data such as corporate bond spreads or credit default swap (CDS) spreads for entities with similar credit ratings and in the same currency may be used to estimate this premium.
Adjustments may also be made for specific loan features, such as a higher premium for subordinated loans or a reduction for loans secured by collateral.
C. Internal CUP Approach
It may be possible to identify potential comparable loans within the borrower’s or its MNE group’s financing transactions with an independent lender(s) as the counterparty. If such loans exist, it will be important to assess the conditions of such loans to determine whether adjustments are needed to make such loans comparable to the intercompany loan under assessment. This often may be the most direct approach, though again, issues regarding comparability of the loans will be important to assess.
D. Cost of Funds Approach
In the absence of comparable uncontrolled transactions, the Cost of Funds approach could be used as an alternative to price intra-group loans in some circumstances. This model assesses the interest rate from the lender’s perspective, rather than the borrower’s. It is relied on in circumstances when it is difficult or unreliable to assess a credit rating for the borrower. Such a case may arise for early stage companies, or for companies where there is little to no reliable data to assess a credit rating for the borrower. The Cost of Funds will reflect the borrowing costs incurred by the lender in raising the funds to lend. To this would be added the expenses of arranging the loan and the relevant costs incurred in servicing the loan, as well as potentially a risk premium to reflect the various economic factors inherent in the proposed loan, in addition to a profit margin. The application of the Cost of Funds approach requires consideration of the options realistically available to the borrower. We note that this alternative approach to determine the arm’s length interest rate is another form of a CUP analysis, but more focused on the borrower’s side of the transaction.
E. Economic Modeling Approach
Certain industries rely on economic models to price intra-group loans by constructing an interest rate as a proxy to an arm’s length interest rate. In their most common variation, economic models calculate an interest rate through a combination of a risk-free interest rate and a number of premiums associated with different aspects of the loan – e.g., default risk, liquidity risk, expected inflation or maturity. In some instances, economic models would also include elements to compensate the lender’s operational expenses. The reliability of economic models’ outcomes depends upon the parameters factored into the specific model and the underlying assumptions adopted. In evaluating the reliability of economic models as an approach to pricing intra-group loans it is important to note that economic models’ outcomes do not represent actual transactions between independent parties and that, therefore, comparability adjustments would be likely required. However, in situations where reliable comparable uncontrolled transactions cannot be identified, economic models may represent tools that can be usefully applied in identifying an arm’s length price for intra-group loans.
F. TNNM/CPM Method
When the lending entity acts solely as a pass-through entity, providing administrative services without bearing significant financial risk or performing substantial financing functions, it may be more appropriate to assess its activities using a Transactional net margin method (TNMM, also called Comparable Profits Method (CPM) in US transfer pricing regulations) rather than directly pricing the loan. This approach focuses on the operational costs incurred by the lending entity in providing its support services and applies an appropriate markup to determine an arm’s-length return.
Under this model, the borrowing/lending entity (i.e., the pass through entity) is not viewed as a true financier because it does not assume credit risk, make substantive decisions regarding the funding, or contribute significant value to the financing process. Instead, its role is limited to administrative functions such as managing loan documentation, monitoring repayments, and processing funds. The cost base for the analysis would include all direct and indirect costs incurred by the entity in performing these activities.
To determine the arm’s-length markup, comparable independent service providers offering similar administrative or back-office services are analyzed.
This approach aligns with the principle that a pass-through entity should only earn a return commensurate with its low-risk, limited-function role. By applying a Net Cost Plus (NCP) methodology, the focus shifts from analyzing the loan itself to appropriately compensating the entity for its actual contributions, ensuring compliance with transfer pricing rules without over-allocating profits to the pass-through entity.
V. What is the Right Approach?
The selection of the appropriate transfer pricing method for intercompany loans depends on the specific circumstances of the transaction and the results of a detailed functional analysis. Factors such as the roles and responsibilities of the parties, the level of risk assumed, the economic environment, and the terms of the loan must all be carefully considered. Within this assessment, oftentimes the specific financial characteristics of the borrower or in some cases the lender then also need to be analyzed.
In many cases, no single method provides a definitive answer, and it may be necessary to evaluate multiple methods to ensure the resulting pricing aligns with the arm’s-length principle. Further, the correct approach also relies on the data available to perform an appropriate analysis. Many of the models above require significant data and information, and often such information is either not available or less reliable. All the factors need to be included to perform a reliable analysis.
The intercompany lending transaction between the related companies requires careful consideration of functions, assets and risks (FAR) from a transfer pricing perspective.
The proper allocation of functions, assets and risks (FAR) will be the basis for determining the appropriate pricing of the transaction and will be crucial in ensuring compliance and minimizing potential disputes with tax authorities.
In summary, to choose the appropriate methodology to derive the arm’s length interest rate, we provide below a non comprehensive list of the potential functions of the borrowing/lending entity depending on the data available:
- Lending Operations: The borrowing/lending company is likely to be primarily engaged in lending activities, which may involve assessing creditworthiness, managing loan agreements, and monitoring repayments.
- Management and Administration: The entity may perform administrative functions related to the loan, such as documentation, compliance, and reporting.
- Advisory Role: If the borrowing/lending company provides any financial advice or strategic input, this function must also be considered in the transfer pricing analysis.
In an intercompany lending transaction where a company lends money to a related company several potential risks may arise. Here is a detailed breakdown of these risks:
- Credit Risk: The primary risk is the possibility of default by the borrower (the related company). The lender needs to evaluate the creditworthiness of the related party.
- Market Risk: Fluctuations in interest rates or economic conditions can impact the lending rates and the value of repayments.
- Currency Risk: If the loan is denominated in a currency different from the currency of the related company, fluctuations can affect repayment amounts.
- Operational Risk: Any inefficiencies or errors in the loan management process can lead to financial losses.
Generally speaking, Cyprus entity is unlikely to own any significant assets, however there a few notable exceptions that might affect the transfer pricing analysis:
- Intangible Assets: If the Cyprus company possesses any proprietary financial models, software, or trademarks related to its lending practices, these assets should be identified and taken into account.
- Human Capital: The expertise and capabilities of the personnel involved in managing the lending operations can also be considered an asset, impacting the company’s overall risk profile.
Wave of New Transfer Pricing Regulations on Cyprus
Cyprus has progressively developed its transfer pricing regulations to align with international standards, particularly those set by the OECD. The evolution of these regulations reflects the country’s commitment to fair taxation, transparency, and compliance with global practices, while also maintaining its attractiveness as a business hub. In 2022, Cyprus introduced significant changes to its transfer pricing regulations followed by frequently asked questions (FAQs) released initially in September of 2023 with additional questions added as recent as September of 2024. Key aspects of the current Cyprus transfer pricing regulations are presented below:
1. Definition of Related Parties: A 25% threshold defines the relationship between entities. Entities are considered related if one party directly or indirectly holds at least 25% of the voting rights, share capital, or rights to income of another entity.
2. Documentation Requirements:
- Local File: Entities engaged in controlled transactions exceeding €5 million for financial transactions and exceeding €1 million for all other transactions (for example, goods, services, royalties) annually must prepare a Local File detailing these transactions. The threshold is measured on a per-category aggregate basis using the absolute annual transaction values, i.e. sum of all payments and receipts in that category.
- Master File: Applicable to entities that are the ultimate or surrogate parent of a multinational group with consolidated revenues over €750 million. The Master File provides an overview of the group’s global business operations and transfer pricing policies.
- Summary Information Table (SIT): All entities with related-party transactions must submit an SIT alongside their annual tax return, summarizing intercompany transactions.
3. Advance Pricing Agreements (APAs): Taxpayers can apply for APAs to agree in advance on the transfer pricing methodology for specific transactions. The Tax Commissioner is expected to respond within 10 months, with a possible extension to 24 months. APAs are valid for up to four years.
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⁸ Article 33 & Article 33C of the Income Tax Law with effect as from 1st January 2022
⁹ Frequently Asked Questions with reference to Article 33 & Article 33C of the Income Tax Law, Κ.Δ.Π. 314/2022 and Κ.Δ.Π. 273/2022
¹⁰ Initial rules in 2022 set a threshold at €750 thousand for all transactions, however the updated threshold was retroactively introduced in February 2024.
¹¹ Simplification rules apply in particular circumstances such as “safe harbor” rules. The simplification rules are described in the Cyprus Tax Department Circular 6/2023.
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4. Penalties for Non-Compliance:
- Non-submission of SIT: €500 penalty.
- Late Submission of Local or Master File: Penalties range from €5,000 to €20,000, depending on the delay duration.
In regard to the back-to-back intercompany loans, the Cyprus Tax Department issued a circular (Circular 7/23) establishing the CUP as the preferred method of the analysis and referring to the OECD Guidelines:
“The widespread existence of markets for borrowing and lending money and the frequency of such transactions between independent borrowers and lenders, coupled with the widespread availability of information and analysis of loan markets may make it easier to apply the CUP method to financial transactions than may be the case for other types of transactions…” (OECD Guidelines, Chapter X, Article 10.90)
However, these rules apply only if the intercompany transaction meets two criteria: it’s a back-to-back intercompany loan and the borrower have no capacity to assume risks based on the functional analysis of the entity. For other transactions, the CUP method is not necessarily a preferred method, however the Cyprus Tax Department require a justification for the use of the alternative method.
Wave of New Transfer Pricing Regulations on Cyprus
Cyprus has progressively developed its transfer pricing regulations to align with international standards, particularly those set by the OECD. Pricing intercompany loans with the Cyprus entity becomes more complex. However, international well-established transfer pricing practices can help navigate this new regulatory landscape. Leading with the detailed functional analysis followed by the application of the appropriate approaches adjusted for the company specific characteristics will provide an efficient and flexible way to pricing the intercompany transaction.
Due to the new conditions of the market, transfer pricing tax consulting will require greater expertise and experience in the art of combining straight forward quantitative analytics with unique circumstances of each deal whilst also unconditionally adhering to the new transfer pricing regulations.
Overall, new Cyprus TP regulations provide an insignificant challenge for the Cypriot entities, however will require additional external expertise to overcome new compliance hurdles and maintain intergroup funding schemes and tax optimization strategies.
In a significant move to align with OECD guidelines, Cyprus has recently introduced new regulations on transfer pricing for intercompany loans. As an essential part of the country’s broader efforts to enhance tax transparency and address base erosion and profit shifting (BEPS), these rules impact how MNEs structure and document their intra-group financial transactions. The regulations have established new requirements for the interest rate charge, as well as for the loan terms themselves, as well as the transfer pricing documentation standards.
