Article 33 (Arm’s length principle) of the Cyprus Income Tax Law gives power to the Commissioner of Income Tax to adjust a company’s taxable profit where it believes that the financial result of a certain transaction was influenced by the fact that the parties to the transaction were related or connected.
Therefore, it is required that interest on loans provided to or by a Cypriot company is established on an arm’s length basis.
Until recently, the practice of the Commissioner of Income Tax, and based on Article 33, was to impose deemed interest on the market interest rates on any financial transactions between related parties provided that the specific financial transactions did not satisfy the arms-length principle.
On 14 July 2011, the Institute of Certified Public Accounts of Cyprus (ICPAC) has announced that the Commissioner of Income Tax has agreed to certain minimum profit margins that may be applicable to related-party financial arrangements. Under the Cyprus Tax Legislation, an exemption is given from the 10% special contribution for defense arising from interest received provided that this interest derives from or is closely connected to the ordinary course of business of the company. The Commissioner of Income Tax has set the minimum acceptable interest rate profit margins on the so-called “back-to-back” intra-group financing arrangement between 0,125% -0,35%, applicable as from the tax year 2008 and onwards (subject to conditions).
| Amount of each Loan (EUR) | Profit Margin | |
| Interest bearing loan | Interest-free loan | |
| < 50m | 0,35% | 0,35% |
| 50m – 200m | 0,25% | |
| > 200m | 0,125% | |
The above-mentioned margins are applicable where a Cypriot company uses the borrowed funds to finance its related/connected party via loan(s) within a period of six months, with such funds being obtained:
- From another related/connected party or a bank (subject to guarantees from another group company);
- In the form of a loan(s) or other credit instruments (subject to conditions).
The margins apply for each financing arrangement separately.
The margins will not apply:
- Where the funds lent have been raised by a Cypriot company through the issue of share capital;
- From the date when liability in relation to the funds borrowed or lent by a Cypriot company is settled or written-off.
The margins concerned should be calculated after the deduction of any expenses directly related and/or attributable to the financing arrangement entered by the company. Any foreign exchange differences (either realized or unrealized) should be treated as non-tax deductible in case of foreign exchange loss and non-taxable in case of foreign exchange profit.