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Cyprus financing company

 

The plan

Foreign investors wish to set up a Company in a favourable tax jurisdiction (i.e. Cyprus) to use it as a financing company in order to finance other associated companies. 

  1. An EU/ Non EU parent company establishes a Cyprus company which it finances by means of a loan.
  2. The Cyprus Company in turn lends the funds to its own EU / non EU associate company / companies
  3. Associated companies will use the funds to finance their operations
  4. Cyprus Company receives interest from associate companies and pays interest to Parent Company

 Cyprus Tax Consequences

–        Provided that one of the major business activities of the Cyprus Company is that of financing activities, the Cyprus Company will be taxed at a Corporation tax rate of 12,5% on interest profit margin (i.e. interest received less interest paid);

–        Low or no withholding tax on interest payments due to the favorable Cyprus double tax treaty network or EU directives;

–        Deductibility of interest expenses in the borrowing company;

–        No withholding tax on interest payments from Cyprus at all times;

 

Cyprus Company Corporation tax on interest profit margins at the rate of 12, 5% – 2 options available

  1. Taxed in accordance with article 33 arms length principle and not considering Cyprus back to back loans arraignment
  2. Taxed under Cyprus back to back loans arraignment.

 

1.      Cyprus Company Corporation Tax calculation based on arms length principle and not considering Cyprus back to back loan arrangement

Cyprus Company will be taxed at a Corporation tax rate of 12, 5% on interest profit margin (interest received less interest paid) in accordance with article 33 (arms length interest rates).

Arm’s length interest rate interpretation.

There are no official guidelines as to what is considered to be an arm’s length interest rate. An interpretation of the law by the Cyprus tax authorities is that an arm’s length interest rate is the interest rate that would have applied if the parties have been unrelated.

Cyprus tax authorities’ also examine:

–        If interest rate charged covers over and above the directly related cost of borrowing

–        If interest rates are in line with prevailing market rates i.e. currency used etc.

–        Possible risks involved

–        Terms of the loan (e.g. duration, repayment terms etc).

–        Other possible factors not mentioned above

Further aspects of determination of taxable income

The net income is calculated after deducting from net interest income, the costs incurred wholly and exclusively for the purpose of generating income

Illustrative example

CypCoA

 

Interest received (trading income) (Arms length rate)

 

500,000

Interest paid (Arms length rate)

 

(400,000)

Net interest income

 

100.000

Less expenses:

 

 

Wages and salaries

10,000

 

Rentals (Contract agreement)

5,000

 

Maintenance expenses

10,000

 

Accounting fees

3,000

 

Audit fees

3,000

 

Other expenses directly related

5,000

 

Travelling expenses

10.000

 

Entertainment expenses

10,000

 

Administration expenses

4,000

(60,000)

 

 

40,000

Taxation:

Income tax

 

12.5%

 

(5,000)

Net income after tax

 

35,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Possible Foreign tax – tax deducted from other jurisdictions are given as credit. Ie. If in the above example, the Company paid € 4,000 foreign tax then the Cypriot tax will be € 1,000.

2.      Corporation Tax calculation based on Cyprus back to back loan arrangement.

Cyprus Company will be taxed at Corporation tax rate of 12, 5% on interest profit margin (interest received less interest paid) in accordance with Cyprus back to back loan arrangement. It’s worth noticing that if a loan does not constitute a Cyprus back-to-back loan, then the interest rate charged by the Cyprus lending company should equate to a market value rate for that currency. In practice, the focus is on leaving sufficient margins in the Cyprus tax resident company that acts as the group treasurer.

Cyprus back to back loans interest margins

Following discussions between the private sector and the Cyprus Inland Revenue Department conclusions have been drown as to what margins would be acceptable from the use of back to back loans. Such margins are shown below.

a.      Corporation tax under Cyprus back to back loans arrangement – interest bearing loans

Cyprus Financing Companies can have the option to be taxed under Cyprus back to back loan arraignment on interest profit margin (i.e. interest received less interest paid); It does not matter what the actual interest rates are. The important think from Inland Revenue perspective is the profit margin. Following discussions between the private sector and the Cyprus Inland Revenue Department conclusions have been drown as to what margins would be acceptable for Cyprus back to back loans.

The following loan minimum profit margins have been indicated as acceptable profit margins.

Raising and granting of interest bearing loans   

Level of loan

Profit margin

%

< 50m

0,35

50-200m

0,25

> 200m

0,125

Additionally there is a possibility of obtaining advance rulings from the Cyprus Inland Revenue Department regarding minimum acceptable spreads especially in sizeable transactions and in other financing instruments such as bonds etc.

CypCoA initial profit margin is 0,40%

 

Interest received

 

290,000

Interest paid

 

(250,000)

 Net interest income

 

40.000

Less administration expenses

 

(5,000)

 Income before tax

 

35,000

Taxation:

Income tax

 

12.5%

 

(4,375)

 Net income after tax

 

 30,625

Effective profit margin

 

35,000

Effective profit margin % (35k / 10m)

 

0, 35%

It is highly recommended that the overall effective margin should not be less than the minimum profit margin i.e. (0, 35%) after deducting administration and general expenses.

 

b.      Corporation tax based on Cyprus back to back loans arrangement – non interest bearing loans

        Raising and granting of non-interest bearing loans

The minimum acceptable profit margin, irrespective of the level of the loan is 0,35%.

A group may structure an intra group loan with 0%. The Cyprus Company will need to make a tax adjustment equal to 0 ,35% when calculating its taxable income. The accounting records of the company will only be affected by the tax charge.

CypCoA initial profit margin is 0%

 

Interest received

 

0

Interest paid (Arms length rate)

 

(0)

 Net interest income

 

 0

Less administration expenses

 

(5,000)

 Income before tax

 

 (5,000)

Taxation:

Income tax (tax adjustment equal to 0, 35% i.e. on €35,000)

 

12.5%

 

(4,375)

 

C.      Cyprus back to back loans payable as one amount and receivable by many and visa versa.

Cyprus back to back loan rates are applicable for individual back to back loan and not on a cumulative basis. For instance if the Cyprus company receives a loan as one lump sum and in turn gives it out to a number of associated companies. This can apply visa versa.

 

d.      Cyprus company borrows from a bank using collateral from other group companies.

Cyprus tax resident company borrows from a third party (e.g. bank) and lends to an associated company where the bank has relevant guarantees from other associated companies.

 

e.      In addition Cyprus back to back loan provisions will apply also in cases where instead of a loan other financing products are used but in such case the prior approval of the Commissioner will be required.

Cyprus back to back loans should also comply with the following conditions:

  1. The ultimate beneficial owner of the related companies must not be a Cyprus tax resident. We emphasize that the identity of such a person is not disclosed to the Inland Revenue Department in cases where nominee shareholders are used.
  2. The transactions refer to loans between associated companies where a tax resident Cyprus Company receives a specific amount through an interest bearing or non­interest bearing loan from an associated company and using the amount of the said loan grants an interest bearing or non-interest bearing loan to another associated company.
  3. In case where part of the loan granted has been financed by share capital, these provisions apply only for the amount of the loan that is financed through a loan. Thus it must be fully substantiated that for purposes of granting the loan from the Cyprus tax resident company, only the amount received as a loan from an associated company has been used.
  4. Writing off a loan, either the loan granted or the loan received by the Cyprus tax resident company will not bring about directly or indirectly any tax benefit or tax obligation to the Cyprus company and additionally in case the Cyprus tax resident company writes off a loan it granted, it will not be allowed to claim any interest payable on the loan it received.
  5. The time interval between the date the company receives a loan and the date it grants a loan, will not exceed 6 months.
  6. If the loan received by a Cyprus Company is settled or written off before settlement of the loan it grants, or vice versa, the transaction is considered as being outside the scope of these provisions as from the date of settlement or write off. A loan for which the conditions are met and for which the current provisions were applied, will be followed until its settlement or write off
  7. Exchange differences resulting from such types of loans, realized or not, will not be allowed as deductible expenses in case of loss and will not be taxable in case of profit
  8. The said profit margins will apply for each separate loan that the Cyprus tax resident company will receive and grant.

(Published: Oct. 2014)

 

PKF / ATCO Limited is a member firm of the PKF International Limited network of legally independent firms and does not accept any responsibility or liability for the actions or inactions on the part of any other individual member firm or firms. This publication is for information purposes only and should not be considered as professional advice.