Back to back are loans which the Cyprus tax resident company borrows, and in turn, lends this amount to related parties.
This arrangement is widely favored by international companies that use a Cyprus company to redistribute their profits, leaving a small profit margin in Cyprus. The ultimate shareholders of all the companies involved must be non-tax residents. A Cyprus tax resident company is used as an intermediate company to borrow and in turn, lend the funds to a related non-tax resident company. No circular has been issued by the Commission of Inland Revenue yet, but the tax treatment is described in the correspondence between the Inland Revenue Department (IRD) and the Institute of Certified Public Accountants in Cyprus (ICPAC) dated 27/6/11.
Why is the agreement between the IRD and ICPAC important?
- The provisions of section 33 of the Income Tax Law which states that transactions between related parties must be at arm’s length, do not apply to back to back loans, meaning that back to back arrangements can be carried out with interest-free or low-interest rates.
- The certainty of the tax treatment of back to back loans which were previously not clear.
- No restriction of interest paid with respect to back to back loans when the company possesses assets that are not used in the business.
- No imposition on notional interest income in case of a waiver of the receivable loan.
Which loans fall under back to back loans?
- Loans between group companies
- The loans borrowed and lent can be either interest-free or interest-bearing.
- The matching of the funds must be supported, ie the fund borrowed are the funds which are lent.
- If part of the funds lent is derived from own funds (capital/ reserves) only the part of funds lent which is derived from the borrowed funds will be considered back to back. On the remaining balance of the loan, market rates will apply.
Minimum profit margins accepted by the IRD
- From 2008 for interest-bearing loans the below minimum profit margins are accepted by the IRD:
|Amount of Loan||Profit margin|
|50- 200 million||
- From 2008, for interest-free loans, the minimum profit margin irrespective of the amount of the loan is 0.35%.
- For the years 2003- 2007 the minimum profit margin for back to back loans is 0.3%.
Other requirements for the application of the agreed profit margins
- In case of a waiver of the loans, this will not result in either taxable income or tax loss in the Cyprus intermediate company. If a waiver occurs for one side of the arrangement then it ceases to be considered as back to back and the agreed profit margins apply until the date of the waiver. If the payable loan is waived then the Cyprus company will be taxed on interest at market rates on the receivable loan. If the receivable loan is waived, the payable interest on the payable loan will not be tax-deductible.
- The loan granted by the Cyprus company must be lent within 6 months from the date is borrowed the funds.
- The minimum profit margins accepted are net, ie all expenses directly attributable to the arrangement as well as a proportion of overheads must be deducted in arriving at the profit margin.
- Foreign exchange differences which may arise in cases where the loan borrowed and that lent are in different currencies are not taxable in case of gains and are not tax-deductible in case of losses.
- The agreed profit margins are applicable for each back to back arrangement individually.
- The agreed profit margins are applicable also in cases where the Cyprus intermediate company borrows one loan and in turn, uses these funds to grant more than one loan as well as in cases where more than one loan is borrowed and only one loan is granted.
- The above profit margins are also applicable when the Cyprus company borrows from outside the group (eg a bank) as long as guarantees are provided by other group companies.
- In cases where the Cyprus company borrows from within the group but lends the funds to a company outside the group, the profit margins may apply upon a written ruling request to the IRD.