Acceptable margins on back to back loans

Cyprus Companies are widely used in international tax structuring mainly due to the flexible tax system and the extended network of double tax treaties between Cyprus and other countries. There are certain advantages that have made Cyprus also a favorable financing company jurisdiction.If Cyprus company is used as a Financing Company in the international tax structure it reduces the tax implications.

Provision of loans by Cyprus companies is regulated by the Section 33 of the Cyprus Income Tax Law, which states that all transactions of Cyprus companies must be conducted under arm’s length terms. This means that the interest rate on loans provided to or by a Cyprus company is established on an arm’s lenght basis. The Commissioner of Income Tax has the power to adjust a company’s taxable profit if he believes that the financial result of a particular transaction was affected by the fact that it took place between related or connected parties.

The Institute of Certified Public Accountants of Cyprus has recently reached an agreement with the Commissioner of Income Tax regarding the minimum acceptable profit margins on back to back loans between related parties.

Acceptable Profit Margins

The following minimum profit margins have been confirmed as acceptable from the year 2008 onwards:

Receiving and granting of interest-bearing loans
Amount of Loan                      Profit Margin
Less than €50m                              0.35%
Between €50m – €200m              0.25%
More than €200m                         0.125%

Receiving and granting of interest-free loans
The minimum acceptable profit margin is 0.35% irrespective of the amount of the loan.

For the tax year 2003-2007 the minimum acceptable profit margin is 0.30% regardless of the loan amount and whether the loan is interest bearing or not.

Scope

The above stated margins are applicable if a Cyprus company receives a loan from a related company or a bank (subject to guarantees from another company of the group)  and uses these funds to finance its related/connected party via loan within a period of six months.

The above stated margins are applicable for each individual loan provided by the company. It will also be applicable if a Cyprus company receives many loans and uses them to grant a single (consolidated) loan or vice-versa.

The margins will not apply:

  • if for financing of a related company were used funds obtained by a Cyprus company through the issue of share capital;
  • from the date when a liability under a loan received or granted by a Cyprus company is settled or written-off.

The above stated profit margins are presumed to be net profit margins, after deduction of expenses directly or indirectly related to the loan transaction.

Any foreing exchange differences should not have any impact on such calculation as they are treated as non-taxable in case of exchange profit and non-tax deductable in case of exchange loss.

The write-off of a loan received or a loan granted under back to back loan arrangment should not affect the taxable profit of the company since the write-off is treated as non-deductable or non-taxable event for tax purposes. In case where a Cyprus company write-off a loan granted to its related party then any interest incurred under loan received to finance the written-off loan will be treated as non-deductable for tax purposes.

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