Back to back loans and Cyprus companies
Generally, the provision of loans by Cyprus companies is governed by the Article 33 of the Cyprus Income Tax Law, which states that all transactions must be undertaken at arm’s length terms. However, for back to back loans a different tax treatment applies in order to ensure that a profit margin is left to the Cyprus company for taxation purposes. Back to back loans are considered to be the loans for which the Cyprus tax resident company borrows money from an associated company and it subsequently uses the funds from these loans to lend money to other related parties thus leaving a profit margin to the Cyprus company, whereas all other expenses and risks are undertaken from the other parties as the Cyprus company is used as an intermediate vehicle.
Conditions to be met for loans to be considered as back to back loans
– The loans must be made between associated parties.
– There must be a full matching of the amounts borrowed and granted.
– The ultimate shareholders of all companies involved must be non tax residents in the Republic.
– The loans borrowed and lent can be either interest free or interest bearing.
Minimum profit margins accepted by the Cyprus Tax Authorities (IRD) in relation to back to back loans
The taxation aspect in respect of the profit margins on back to back loans has been under discussions for a long time between the Cyprus Tax Authorities and the Institute of Certified Public Accountants of Cyprus (ICPAC). The discussions have resulted in an agreement between the two parties which was given out to all related parties in the form of tax guidance. Although, no official tax circular was issued by the IRD in respect of the above mentioned topic, the agreement between the ICPAC and the IRD released out can be used as a guidance for the minimum profit margins accepted by the IRD in respect of back to back loans. However, it must be noted that in cases of complex or uncertain situations as to the use of specific margins on specific back to back loans, it is recommended to request specific tax rulings by the Commissioner of Income Tax before proceeding with any actions. The profit margins acceptable by the IRD are set out below: From year 2008 onwards
(a) Raising and granting of interest bearing loans The following minimum profit margins apply: Level of loan Profit Margin € %200m 0,125
(b) Raising and granting of non-interest bearing loans The minimum acceptable profit margin, irrespective of the level of the loan is 0,35%. The above margins apply under the following conditions:
a) The transactions refer to loans between associated companies where a tax resident company in Cyprus receives a specific amount through an interest bearing or non-interest bearing loan from an associated company and uses the amount of the specific loan(s) to grant an interest bearing or non-interest bearing loan to another associated company.
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 loan from an associated company has been used.
b) 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 this company. Additionally in case the Cyprus tax resident company writes off a loan granted out, it will not allowed to claim any interest payable on the loan received for lending out this amount of money.
c) The time interval between the date the company receives a loan and the date it grants a loan, must not exceed six months.
d) If the loan received by a company is settled or written off before settlement of the loan granted, 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.
e) For the purposes of calculating the profit margins, any expenses (excluding exchange differences) that are directly related and/or correspond to these loans transactions will be deductible. It is therefore strictly noted that the above stated profit margins represent the net profit margins. Additionally, any exchange differences resulting from such loans, either realized or not, are not allowed as deductible expenses in case of loss and are not considered as taxable in case of profit.
f) The above profit margins apply for each separate loan that a Cyprus tax resident company receives and grant. They are also applicable in cases where a company is receiving more than one loan and it grants only one or it receives only one loan and uses the amount received to grant more than one loan.
g) The above provisions apply also in cases where the Cyprus tax resident company borrows from a third party (e.g. bank) and lends to a related company where the third party has received collaterals/guarantees from other related companies.
h) The above provisions apply also in cases where instead of a loan other financing products are used but in such cases the prior approval of the Commissioner of Income Tax is required.
Cyprus companies are widely used in international tax planning mainly due to the fact that Cyprus has become an attractive financing and investing jurisdiction as a result of an extensive network of double tax treaties signed with many countries as well as due to the low income tax rate. Based on the information explained above in relation to the tax treatment of back to back loans it can be easily concluded that the receiving and granting of such loans between associated parties with the use of an intermediate Cyprus tax resident company can provide significant benefits to the parties which are able in this way to finance the group activities by leaving a profit margin in Cyprus which will only be taxable at the rate of 10%. It is therefore obvious that such transactions with loans between related parties in combination with the low income tax rate, the island’s network of double tax treaties and the taxation aspect of securities can be used to set up favorable investing and financing structures.