Cyprus financing companies and minimum acceptable profit margins

A Cyprus company that earns interest in the normal course of its business/operations, including interest closely associated with its normal business/operations, is subject to income tax at the rate of 12.5%. Due to the beneficial corporate tax rate a large number of Cyprus companies have been traditionally used in international tax structures for providing financing to other group companies. The Institute of Certified Public Accountants of Cyprus has recently reached an agreement with the local tax authorities in relation to the minimum acceptable profit margins regarding transactions of a tax resident company in Cyprus, in respect of the raising and the granting of loans from and to associated companies. Profit Margin in this case represents the difference between the interest rate on the loan granted from the interest rate on the loan received. Based on this development, investors that choose Cyprus companies for their group financing needs may end up being taxed with a rate lower than 2% (margin 0.125% X 12.5% tax rate).

Specifically, the following minimum profit margins have been agreed in the case of back to back loans:

There are some minimum conditions in order for the above rates to be allowed, such as:

1. The time interval between the time the company receives the loan and the date it grants the loan cannot exceed 6 months.

2. The said profit margins will apply for each separate loan the Cyprus resident company receives and grants.

3. In case there is a non-interest bearing amount within the transaction, the minimum acceptable profit margin is 0.35%, irrespective of the loan amount.

4. A loan write off (receivable or payable) cannot result, directly or indirectly, in any tax liability or benefit. In case a Cyprus company writes off a loan receivable the only implication will be that any interest expense on the loan received to grant the specific loan written off will not be allowed for tax computation purposes.

5. The acceptable profit margins need to take into account charges related to the loans under the scheme in a way that the resulting taxable income will be net at the above rates.

6. Foreign exchange differences will not be taken into account for company tax computation purposes.

7. The above provisions also apply in cases where the Cyprus tax resident company receives a loan from a third party (e.g. a bank institution) and then finances a group company.

Practical example

A Cyprus company receives a Euro 20 million loan from a group company with an interest rate of 5% per annum. The loan is granted 1 January 2013. The Cyprus Company then lends the Euro 20 million to another group company at the same day. The company has no other transactions.

The Cyprus tax authorities will accept a rate as low as 5.35% for the loan receivable even if the loan agreement states a lower rate, meaning that the net profit to be taxed for 2013 is Euro 70,000 (Euro 20m X 0.35%) and tax payable will be Euro 8,750 (Euro 70,000 X 12.5%).

Other considerations – Withholding taxes

Understanding the implications of cross border transactions and withholding taxes involved (where applicable) is essential in international tax planning. The application of Double Taxation Avoidance Agreements and the relevant EU directives (if the transaction is within the European Union) are additional factors that need to be analyzed and taken into account for each scenario.

Sample structure

Plan

• Establish Cyprus company to be the Group finance company of EU/Non EU operations, capitalized by Equity or Loan

Benefit

• Tax on net finance margin of 12.5% minus expenses incurred wholly and exclusively for the productions of the income
• Access to EU directives and DTT network regarding interest
• Interest deductibility in borrowing