Transfer pricing and the way forward for Cypriot entities
Valentinos G. Pavlides 10:46 - 29 September 2023
Why Cypriot entities need to navigate the complexities of this field and how they can go about it
In today’s globalised business environment, multinational enterprises (MNEs) often face the challenge of determining appropriate transfer prices for transactions between related entities. Transfer pricing has become an increasingly important and complex issue in the global business landscape. Transfer pricing refers to the pricing of goods, services or intangible assets exchanged within a company’s different divisions or a group’s constituent entities, particularly when these entities are located in different countries. The objective is to ensure that transfer prices reflect the fair market value and prevent the shifting of profits to low-tax jurisdictions, thereby avoiding tax obligations.
Cyprus, a prominent international business hub, has increasingly become a destination for MNEs to establish their regional headquarters or holding companies due to its favourable tax regime, robust legal framework and strategic geographical location. Cyprus has attracted numerous multinational companies, especially in the areas of finance, shipping and services. As a result, the Cypriot tax authorities have intensified their focus on transfer pricing to safeguard the integrity of the tax system and ensure that profits are appropriately allocated.
The Organisation for Economic Co-operation and Development (OECD) has published its Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, which serve as a framework for countries to develop their transfer pricing regulations and practices. As a member of the European Union (EU) and the OECD, Cyprus has incorporated these guidelines into its domestic legislation as of 2022, aligning its transfer pricing rules with international best practices.
These rules aim to prevent base erosion and profit shifting (BEPS) practices while providing clarity and consistency in determining transfer prices. The regulations require that related-party transactions be conducted at arm’s length, meaning that the prices should be comparable to those between unrelated parties in similar circumstances.
It is important to note that the new Transfer Pricing rules capture all types of transactions (goods, services, financial services, transactions involving intellectual property, etc.) carried out between related companies, if such transactions exceed (or should have exceeded, based on market conditions) the annual threshold of €750,000 per category of income. Each transaction should be assessed separately as well as cumulatively with other transactions within the same category of income, to assess whether the annual threshold is met. For companies that meet the threshold, there is a statutory obligation to prepare a Local File, which must be updated annually.
To facilitate compliance with transfer pricing regulations, Cyprus has introduced specific documentation requirements for companies. These include the preparation of a Master File, Local File (and Country-by-Country Report for MNE groups with consolidated revenues exceeding €750 million). The Master File provides an overview of the MNE group’s global business operations, while the Local File contains detailed information about the specific transactions involving Cypriot entities.
The content of the Local File should provide, among others, a background of the company, a description of the controlled transactions undertaken, a functional profile analysis, a benchmarking study, as well as the reasoning for the transfer pricing methodology selected. In addition to the Local File, all Cyprus companies that engage in controlled transactions must prepare and submit a Summary Information Table (SIT).
Compliance with transfer pricing regulations is crucial for Cypriot entities to avoid penalties and reputational risks. By adopting best practices in transfer pricing, businesses can enhance transparency, mitigate tax risks and maintain a positive relationship with tax authorities. The following are key considerations and steps for Cypriot entities to ensure effective transfer pricing:
Transfer Pricing Study
Conducting a thorough analysis of related-party transactions is essential to determine the most appropriate transfer pricing method. This study should consider the functions performed, risks assumed and assets employed by each entity involved in the transaction.
Assessing the comparability of transactions is crucial in determining arm’s length prices. Cypriot entities should identify comparable companies and transactions, considering factors such as industry, product, market conditions and geographical location.
Maintaining comprehensive transfer pricing documentation is essential to demonstrate compliance with the regulations. This should outline the economic analysis, methodologies applied and supporting data used to determine transfer prices.
Advance Pricing Agreements (APAs)
Cypriot entities may consider entering into APAs with tax authorities to establish upfront certainty on transfer pricing arrangements. APAs provide a binding agreement between the taxpayer and the tax authorities, reducing the risk of transfer pricing disputes.
Staying informed about evolving transfer pricing regulations and guidance is crucial. Regular monitoring and review of transfer pricing policies and practices will ensure that Cypriot entities remain compliant with changing requirements.
Transfer pricing is a critical aspect of international business for Cypriot entities. Adhering to the arm’s length principle and implementing robust transfer pricing policies and documentation are vital for complying with the regulations and mitigating transfer pricing risks.
Looking ahead, Cypriot entities can anticipate increased scrutiny and stricter enforcement of transfer pricing regulations. The global focus on BEPS and efforts to combat tax avoidance require businesses to demonstrate transparency and accountability in their transfer pricing practices. As a member of the EU and the OECD, Cyprus is expected to align its transfer pricing regulations with evolving international standards to ensure a level playing field and fair taxation.
Even though the administrative and compliance costs of Cypriot entities will increase, they can navigate the complexities of this field by proactively managing their transfer pricing practices. Regulating transactions conducted among affiliated entities will have a dual impact on bolstering Cyprus’ standing as a trusted financial hub and effectively showcase its unwavering dedication to upholding the utmost levels of transparency and substance. In addition, this measure will ultimately lead to financial gains in the foreseeable future, as esteemed investors consistently seek these qualitative attributes within a jurisdiction, alongside a favourable tax framework, prior to making investment decisions or establishing their enterprises.
By Valentinos G. Pavlides, Director, Tax Services - Transfer Pricing Services, Baker Tilly South East Europe
(This article was first published in the Cyprus Journal of Wealth Management. To view it click here)