TaxLegi 3.7.2023

• The Cypriot Tax Department issued a circular on 6 July 2023, with effect as of 1 January 2022, introducing simplification measures regarding intercompany transactions below the threshold of €750,000 in aggregate per category of transaction per tax year.
• Additional simplification measures have been introduced with regard to specific subcategories of intercompany transactions, allowing the application of a safe harbor rate, assuming adequate documentation is maintained.
• The newly introduced tax circular also affects taxpayers with cross-border intercompany transactions, considering that these arrangements are reportable under mandatory disclosure rules.

Executive summary

On 6 July 2023, with retrospective effect as of 1 January 2022, the Tax Department issued a tax circular (the Circular), providing guidance regarding documenting related-party transactions and introducing simplification measures for various types of intercompany transactions that may be applied if the taxpayer is not obliged to maintain a Cyprus Local File based on the provisions of Article 33 (9)(a) of the Income Tax Law (the ITL), N.118(I)/2022 (as amended):

1. Provision of financing to connected persons funded by debt instruments
2. Provision of financing to connected persons funded by equity
3. Receipt of financing from connected persons used for business purposes
4. Low value-adding services

Detailed discussion

The Circular provides guidance to tax residents in Cyprus, or permanent establishments in Cyprus of non-tax resident persons who are engaged in transactions with connected persons but do not have an obligation to prepare a Local File as per the provisions of Article 33 of the ITL. Such controlled transactions either do not exceed (or should have not exceeded based on the arm's-length principle) €750,000 in aggregate per category of transaction per tax year.

Arm's-length principle and minimum documentation requirements

The minimum documentation requirements for persons who carry out controlled transactions but are exempt from the obligation to maintain a Cyprus Local File include the following, irrespective of the type/category of the transaction:

1. Brief description of the functional analysis (functions performed, assets used, risks undertaken)
2. Company characterisation based on the functional analysis performed
3. An indication of the most appropriate transfer pricing method with regard to the transaction category and the reasons for selecting that method
4. Determination of the arm's-length price based on the internal or external comparability search results, or any other relevant analysis performed in accordance with the recommendations of the Organisation for Economic Co-operation and Development Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD TP Guidelines), such as the use of valuation models recommended for documenting financial guarantees

A taxpayer that is exempt from the obligation to maintain a Cyprus Local File and opts to use a simplification measure for one or more types/categories of controlled transactions should, at a minimum, comply with points (a) and (b) described above, in addition to the following specific provisions relating to the Simplification Measures.

General provisions for the application of the simplification measures

The types/categories of transactions subject to simplification measures are:

1. Provision of financing to connected persons funded by debt instruments
2. Provision of financing to connected persons funded by equity
3. Receipt of financing from connected persons used for business purposes
4. Low value-adding services

The general provisions for applying the simplification measures for all of the above types/categories of transactions are:

1. The use of the simplification measure should be accompanied by the minimum documentation requirements as detailed for each category.
2. Such documentation must be provided to the tax authorities within 60 days upon request.
3. The Tax Commissioner has the right to amend, from time to time, the minimum or maximum returns/profit mark-up considering, among other things, any relevant changes in the local and global market conditions.
4. In the absence of transfer pricing documentation supporting the arm's-length price of a transaction, no deviation from the minimum or maximum margin/profit mark-up stipulated in the simplification measures is allowed. If the accounting profit from controlled transactions is higher than the arm's-length profit determined based on a transfer pricing study or via the use of the simplification measures, the Tax Department will not proceed to any downward adjustment of taxable income (subject to the provision of Article 33 (5) of the ITL).
5. The taxpayer must disclose use of one or more simplification measures by including this information in the taxpayer's Income Tax Return/Summary Information Table form by the return's submission deadline.

For a taxpayer to use any simplification measure, the sum of all controlled transactions falling within the ambit of the relevant category as detailed in the Summary Information Table (e.g., Goods, Services, IP related. Financing, Others) may not exceed (or should not have exceeded based on the arm's-length principle) €750,000 in the specific tax year.

Under no circumstances may a taxpayer use the simplification measures for a controlled transaction that falls within a category for which the taxpayer is obligated to maintain a Cyprus Local File (i.e., the total of controlled transactions in the specific category exceeds, or should have exceeded based on the arm's-length principle, €750,000 in the specific tax year). Moreover, simplification measures may not be used if internal comparables as detailed in paragraphs 3.27 and 3.28 of the OECD TP Guidelines are available.

DAC6 reportability relating to the use of the simplification measures

The simplification measures described above, should constitute "unilateral safe harbor" rules for the purposes of the relevant DAC6 legislation (Law Cypriot DAC6/MDR law (Law 41(I)/2021). A cross-border arrangement involving the use of "unilateral safe harbor rules" should be considered as a reportable cross-border arrangement for the purposes of Hallmark E.1. Intermediaries and taxpayers should be aware of the reporting obligations that may arise following the introduction of the Circular.

Simplification measures

1. Providing financing to connected persons funded by debt instruments

• This simplification measure captures all activities involved in granting loans or advances to related entities remunerated by interest (or should have been remunerated by interest) and funded through public debt issuance, private loans from related companies or persons including interest free loans from the shareholders of the company, cash advances and bank loans from credit institutions.
• The application of this simplification measure does not depend on the company's functional characterization or financial capacity to undertake risks, nor does it consider other characteristics of the financing transaction such us its nature, tenor or other characteristics.
• The company shall be deemed to comply with the arm's-length principle if it receives a minimum return of 2.50% before taxes in relation to the controlled transactions under consideration.
• The minimum 2.50% return is applied to the value of loans receivable to the extent that they are financed by financial instruments based on the average capital of the loan receivable during the tax year under consideration, including the interest accrued but not paid.
• Companies that opt to apply the above simplification measures should, at a minimum, maintain additional information and documentation, such as:
  • A detailed description of the loans for which the simplification measure is used (including loan agreement date, amounts and balances of the loans at tax year end, repayment dates, guarantees, interest rates, details of any amendments to the loan terms, etc.)
  • Justification that the loans fall within the category "Provision of financing to connected persons funded by debt instruments"
  • Financial analyses, reconciliations and explanations regarding the use of the simplification measure on controlled transactions for the purpose of determining the taxable income of the liable person

2. Providing financing to connected persons funded by equity

• This simplification measure refers to any activity related to granting loans or cash advances to related persons that are (or should have been) remunerated with interest and financed from the company's equity funds (i.e., funds from issued share capital or shares at a premium, nonreciprocal capital contributions or retained earnings).
• A company that undertakes financing transactions as described above shall be deemed to comply with the arm's-length principle if it receives, in relation to the controlled transactions under consideration, a minimum return equal to the 10-year government bond yield of the jurisdiction in which the borrower operates, increased by 3.5% before taxes.
• The 10-year government bond yield of the jurisdiction in which the borrower operates is determined with reference to the 31st of December of the year before the tax year under consideration.
• The minimum return of 3.50% is applied to the value of loans receivable to the extent they are financed by financial instruments based on the average capital of the loan receivable during the tax year under consideration, including the interest accrued but not paid.
• If the company provides loans to persons from various jurisdictions, each loan shall be examined separately based on the yield rate of the 10-year government bond of the state in which each borrower operates, increased by 3.5% before taxes.
• The reference interest rate of the 10-year government bond of the state in which the borrower operates is equal to the interest rate on 31st of December of the year preceding the tax year in question. If the reference rate is negative, it will not be considered in the calculation of the minimum return and the minimum return in these cases is equal to 3.5% before taxes.
• If the 10-year government bond yield rate as detailed above varies from year to year, the minimum return as described above will be adjusted for each tax year.
• Companies that opt to apply the above simplification measures should maintain the additional minimum content of information and documentation:
  • Detailed descriptions of the loans for which the simplification measure is used (including loan agreement date, amounts and balances of the loans as at tax year end, repayment dates, guarantees, interest rates, details of any amendments to the loan terms, etc.)
  • Justification that the loans fall within the category "Provision of financing to connected persons financed out of equity funds"
  • Financial analyses, reconciliations and explanations regarding the use of the simplification measure on controlled transactions for the purpose of determining the taxable income of the liable person

3. Receiving financing from connected persons used for business purposes

• This simplification measure refers to any activity related to the receipt of loans, bonds or cash advances from related companies or from affiliated persons that bear interest (or should have been remunerated by interest) to the extent that such loans or financial facilities are used business purposes.
• A company that is engaged in financing transactions as described above, shall be deemed to comply with the arm's-length principle if the borrowing costs of the company do not exceed the yield rate of the 10-year government bond of the Republic of Cyprus, increased by 1.50% before taxes.
• The 10-year government bond yield of the Republic of Cyprus is determined with reference to the 31st of December of the year before the tax year under consideration and is applied on the amount of the average amount of the loan payable (including interest accrued but not paid) to the extent that loan is used in accordance with the provisions 5(1) and 5 (2) of the ITL.
• If the reference rate is negative, it will not be considered in calculating the maximum return, and the maximum return in these cases is equal to 1.50% before taxes.
• If the 10-year government bond yield rate as detailed above varies from year to year, the maximum return as described above will be adjusted for each tax year.
• Τhe use of the simplification measure is only applied in cases where the interest expense under review is considered as deductible for Cypriot tax purposes under the provisions of the ITL.
• Companies that choose to apply the above simplification measure for the loans falling under the subcategory "'Receipt of intercompany financing" should prepare the following additional minimum information and documentation:
  • Detailed descriptions of the loans payable for which the simplification measure is used (including loan agreement date, amounts and balances of the loans as at tax year end, repayment dates, guarantees, interest rates, details of any amendments to the loan terms, etc.)
  • Justification that the loans fall within the category "Receipt of financing from connected persons used for business purposes"
  • Financial analysis, reconciliations, and explanation regarding the use of the simplification measure on controlled transactions for the purpose of determining the taxable income of the liable person.

4. Low value-added services

• If a company engages in controlled transactions that involve low value-added services, the arm's-length remuneration for the company should be set at a 5% profit mark-up on the costs related to those services. It is important to note that if the company is receiving the low value-added services rather than providing them, the 5% profit mark-up is applied to the costs and is considered as the maximum profit margin.
• Relevant guidance for applying the provisions of low-value added services is detailed in the relevant sections of the OECD TP Guidelines.
• Moreover, in accordance with the provisions of paragraph 7.45 of the OECD TP Guidelines, low value-adding intra-group services for the purposes of the simplified approach are services performed by one member or more than one member of an MNE group on behalf of one or more other group members that:
  • Are of a supportive nature
  • Are not part of the MNE group's core business (i.e., not creating the profit-earning activities or contributing to the group's economically significant activities)
  • Do not require the use of unique and valuable intangibles and do not lead to the creation of unique and valuable intangibles
  • Do not involve the assumption or control of substantial or significant risk by the service provider and do not give rise to the creation of significant risk for the service provider

For further examples, please refer to paragraph 7.49 of the OECD TP Guidelines.

• The following activities would not qualify for the simplified approach outlined in this section:
  • Services constituting the core business of the MNE group
  • Research and development services (including software development, unless falling within the scope of information technology services in 7.49)
  • Manufacturing and production services
  • Purchasing activities relating to raw materials or other materials that are used in the manufacturing or production process
  • Sales, marketing and distribution activities
  • Financial transactions
  • Extraction, exploration or processing of natural resources
  • Insurance and reinsurance
  • Services of corporate senior management (other than management supervision of services that qualify as low value-adding intra-group services under the definition of paragraph 7.45)
• Companies that choose to apply the above simplification measure for loans falling under the sub-category "low-value added services" should prepare the following additional minimum information and documentation:
  • Description of low value-added services provided
  • Identity of the recipients of the services
  • Reasons justifying that each category of the service is an intra-group service of low value-added nature
  • Description of the costs-allocation method
  • Determination of costs pool, allocation keys and application of the selected profit level indicators
  • Calculations showing the application of the profit level indicators
  • Financial analyses, reconciliations, and explanations regarding the use of the simplification measure on controlled transactions for the purpose of determining the taxable income of the liable person

Contacts:

• Charalambos Palaontas, Head of Transfer Pricing Services
• Panayiotis Tziongouros, ITTS DAC6/MDR offering leader
• Yernar Fazylov, Senior Manager

The main reason why business owners choose to run their business via a Limited Liability Company rather than sole trading is to benefit from the limited liability protection that it brings. Limited Liability provides the security that in case the business fails or gets bankrupt the personal assets of the Company’s officers cannot be seized in an effort to repay obligations and/or outstanding liabilities of Company. 

This provides the illusion that the Officers cannot in any way be held liable for their actions and Company’s tax misconduct. This is of course not the case, especially for VAT/GST related matters.  In the majority of countries around the globe, an officer can be held personally liable for a Company’s VAT misdoing however the rules of each country of course can vary.

·       Understanding  Officers’ liability under Cyprus VAT law

As a starting point, when a VAT offence is committed by a Company in Cyprus (such as mis-compliance with VAT obligations, false documentation, wrong application of VAT provisions, VAT frauds, evasion etc) the Company can face apart from civil liability (i.e. monetary fines) criminal liability as well (i.e. criminal penalties, confiscation orders, business prevention orders).

However, the Cyprus VAT legislation makes it clear that when a criminal offense under VAT Law is committed by a legal entity, the liability for the offence can be borne in addition to the legal entity itself, by the directors or the executive officials of the legal entity.  This means that when a VAT crime is committed by a Company, the Cyprus Tax Department can initiate criminal proceedings against the Company’s officers too. This will often be the case where the Company fails to rectify its actions or respond to any of the authorities’ warnings for an extended period of time.

In such circumstances, the officers in question can face criminal prosecution, fines and/or imprisonment for the Company’s VAT misdoing. Civil Liability though falls only to the Company- person.

An "executive officer“ for the purposes of the VAT legislation means any director (including nominee directors and non-executive directors) or other similar official of the legal entity carrying out a managerial role. Secretaries are also captured under the officer’s definition.

·       A ‘Strict Liability Offence’

Case law of the Cyprus Supreme Court of Justice also clarified that the Criminal liability of the Officers for VAT misconduct is a ‘strict liability offence’ – meaning not a ‘criminal’ mens rea/ mindset is needed for an officer to be convicted.  Thus, an officer can be held liable even if he or is she is unaware of such offence.

‘’There is no such a thing such as ‘typical directors’’ the Court stated in many instances.  If you are an officer of the Company, you are deemed to know the Company’s affairs including tax related matters and take all necessary steps for the Company to be VAT compliant.

It is therefore difficult for officers to deny liability merely on the reason that they were not really involved the tax/ VAT affairs of the Company. Once a person is appointed as an officer of a Company, he or she has all relevant responsibilities and obligations defined in the relevant Cyprus corporate and tax laws at the time (i.e., exercise reasonable care, skill and diligence etc)

It is also to be noted that that insurance policies do not (in most instances) cover tax liability offences.

·       Precaution is the key!

Considering the above, officers must take some precautionary measures/actions to avoid imposition of criminal liability for VAT offences including the following:

Timely VAT Registration: Officers must ensure that their Companies are registered for VAT purposes with the Cyprus Tax Department, following the applicable thresholds and deadlines.

1. Accurate VAT Reporting: Officers should ensure that the company's VAT returns are prepared accurately and submitted within the prescribed timeframes.
2. VAT Payments: Officers must ensure that VAT liabilities are paid to the tax authorities within the specified deadlines.
3. Record-Keeping: Officers should maintain comprehensive and accurate records of all VAT transactions, invoices, receipts, and related documentation. These records must be retained for the required period of 6 years in Cyprus to facilitate VAT audits and inquiries.
4. VAT Opinions and Rulings: Officers must ensure that they have an informed and well supported and documented Opinion on VAT matters (especially in grey- controversial VAT areas) and/or obtain relevant VAT rulings from the Cyprus Tax Department
5. Data quality: Officers should also pay attention to the quality of data maintenance and verification, the implementation of ERP configuration processes and ways to enhance business automations for reducing risks and increasing visibility.

·       Conclusion

Officers in Cyprus bear significant responsibilities when it comes to adhering Company’s VAT rules. Understanding their compliance obligations and remain well-informed about any updates in VAT regulations is crucial for minimising risks and maintaining effective governance. This includes ensuring that their teams and other Company members carrying out day-to-day VAT tasks are well informed and remain up-to date with new legislation updates. Afterall, officers are human beings and especially in large organisations where delegation comes to play it is impossible to keep an eye on every single business task. So proper management and delegation is a key.

Seeking professional guidance from reputable and trusted advisors can also provide valuable assistance in navigating the complexities of VAT compliance and mitigating director's VAT liability risks. To navigate the intricate landscape of VAT compliance and mitigate the risks associated with VAT liabilities engaging the services of reputable advisors who offer professional guidance can be proven invaluable.

It is also important for officers to arrange the adoption or upgrade of the Company’s technology systems to take advantage of technological development opportunities i.e. facilitation of  VAT compliance processes, automations, gathering and transmission of information, validation of invoices etc.

Lastly, it is advisable for officers to consider adopting some internal VAT audits and compliance checks occasionally, to ensure that their business runs in accordance with VAT updates and recent practices. Identifying potential VAT errors in advance and arrange for their rectification timely is crucial in avoiding future possible conflicts and challenges from the tax authorities.

Contacts:

• George Liasis, Partner - Indirect Tax
• Ioanna Drousioti, Senior - Indirect Tax

On Thursday 13 July 2023, the Cyprus Parliament enacted the introduction of a super reduced 3% VAT rate and extended the application of 0% VAT for goods used by people with disabilities.

0% VAT applicable (pre-amendment VAT for those products at 5%):

• Typewriters with Braille characters and special electronic typewriters (electronic pocket communication devices) C.N. 84.69 and new type embossing typewriters C.N. 84 72 90 80 for people with disabilities
• Wheeled and other vehicles for the disabled, including those with motor/otherwise within C.N. 87.13 exclusively for personal use by people with disabilities

Goods subject to 3% VAT:

• Books, newspapers and periodicals provided in either physical or electronic form or both (including brochures, prospectuses and similar printed material, children's illustrated books and tracing - coloring books, printed or handwritten musical scores, hydrographic charts) excluding publications intended mainly for advertising purposes and publications consisting wholly or mainly of video or audio content music; production of publications by non-profit organizations and services related to the production of such. C.N. 49.01 – 49.05
• Books for people with disabilities C.N. 85.23
• Special lifting devices (stairs, lifts, similar lifting equipment) for people with disabilities
• Wheelchairs and other vehicles for people with disabilities
• Orthopedic items and appliances including medical surgical belts of bandages and crutches
• Splints and other devices/items for fractures, Prosthetic items, Devices and hearing aids for the deaf and other devices that are hand-held, carried by persons, or inserted into the human body for the purpose of filling a deficiency or treating a disability. Parts and accessories of the aforementioned goods are excluded.

Services subject to 3% VAT:

• Street cleaning, sewage and refuse collection, excluding services provided by state, local authorities and public law bodies.
• Waste treatment or waste recycling.
• Entry from the first performance of theatrical, musical, dance or classical plays.

Next Steps for Businesses

Businesses trading in goods – services affected by this legislation should consider wider obligations including aspects around stock taking and tax points before implementing new VAT rates.

Our EY VAT Team is at your disposal for any assistance needed.

Contacts:

• George Liasis - Partner, Indirect Tax Services
• Georgios Pitsillis - Director, Indirect Tax Services
• Maria Raspa - Director, Indirect Tax Services
• Elpida Papachristodoulou - Director, Indirect Tax Services
• Iacovos Kefalas - Senior Manager, Indirect Tax Services
• Simos Simou - Senior Manager, Indirect Tax & Controversy