April 7, 2022
Cypriot Tax Department publishes MDR FAQs
The Cypriot Tax Department (CTD) published, on 17 March 2022, a list of Frequently Asked Questions (FAQs) on its website, providing further clarifications and practical insights regarding the interpretation of key terms and provisions of the Cypriot Mandatory Disclosure Rules (MDR) Law (Law 41(I)/2021 of 31 March 2021, amending Law 205(I)/2012 on Administrative Cooperation in the Field of Taxation of 2012 (referred to as the Law))1 and further elaborating on the content of the Cypriot MDR guidelines (Ministerial Decree N. 438/2021, of 29 October 2021, hereinafter referred to as the Decree or the Guidelines).2
The FAQs cover different questions of general interest and can be split into four thematic categories: (i) general questions; (ii) questions relating to reporting mechanics; (iii) questions relating to the Main Benefit Test (MBT); and finally, (iv) questions relating to the hallmarks of the Cypriot MDR Law.
Key highlights of the issued FAQs are summarized below.
The FAQs clarify that the CTD will not rule out or advise upon whether an arrangement is a reportable cross-border arrangement, as it is the obligation of the intermediary and/or relevant taxpayer to decide on the reportable character and the relevant reporting obligations associated with an arrangement. Moreover, it is mentioned that the tax clearance certificates issued by the CTD for Corporate Income Tax purposes do not exempt an intermediary and/or relevant taxpayer from the obligation to submit information to the CTD for DAC6 purposes, even if the reporting obligation was created during the period covered under the tax clearance certificate.
In a similar context, with regards to companies that were liquidated, if the liquidation process was legally concluded before the date of entry into force of the Cypriot MDR legislation, i.e., before the 1 January 2021, there is no obligation for the liquidated company to submit information to the CTD for DAC6 purposes. For liquidations concluded on or after 1 January 2021, the reporting obligation of the company under liquidation is shifted to the liquidator appointed for the period of its appointment and before such company is dissolved according to the Cypriot Companies’ Law.
Furthermore, the FAQs provide further clarity on the “associated enterprises” of a relevant taxpayer that should be disclosed in DAC6 submissions, where necessary and depending on the facts of each case.
The FAQs also provide further details on “other affected persons,” as defined in the Guidelines, clarifying that these follow the definition of “person” and therefore can also be natural persons, among others. In addition, it is noted that in order for a person to constitute an “other affected person,” it should either be a “participant” in the arrangement, based on the relevant definition of the Guidelines (i.e., to have an active role in the arrangement and to be substantially related to the arrangement), or be affected by the arrangement from a tax or other economic perspective. Such persons may include the (direct or indirect) shareholders or the (direct or indirect) subsidiaries of the relevant taxpayer, an “associated enterprise” of the relevant taxpayer, or a non-related counterparty, provided that such persons are participants in the arrangement and are linked with a European Union (EU) Member State.
Finally, the FAQs provide three examples of when the amendment of an agreement can be considered as a “new arrangement” for Cypriot MDR purposes.
Reporting mechanics questions
As to the “Arrangement ID” and “Disclosure ID” numbers, the FAQs explain that, although both numbers are issued by the CTD upon submission of information to the “Ariadni” portal for DAC6 purposes, the “Disclosure ID” number constitutes the proof of such submission by an intermediary or relevant taxpayer. It is also mentioned that these numbers should be used by intermediaries or relevant taxpayers for the purpose of amending DAC6 submissions to the CTD.
Clarifications are also provided on various technical matters in relation to the correct preparation and processing of an XML file and the submission of such file to the CTD for DAC6 purposes, such as the content of specific fields of the file, e.g., “currency,” “Main Benefit Test,” “reason,” etc., the possibility of DAC6 submissions for testing purposes, along with the relevant steps to be followed, and the specific procedure for amending DAC6 submissions in cases of incorrect or incomplete reporting to the CTD.
Main Benefit Test
With respect to the MBT, the FAQs confirm that the application of the MBT can be done based on qualitative and quantitative measurements considering the value of the expected tax advantage compared to the value of any other (non-tax/commercial) advantage likely to be derived, which is consistent with the Guidelines. In addition, under the FAQs, the comparison in question should not be necessarily of a quantitative nature, due to the difficulty in attributing a quantitative value to non-tax/commercial benefits. On the contrary, this comparison should aim at identifying whether a specific cross-border arrangement would have been in place in total absence of the tax advantage. The FAQs state that it is important to understand the importance of the tax advantage and whether the arrangement was designed in such a manner to obtain a tax advantage vis-à-vis the alternative of the tax advantage being insignificant or insubstantial or incidental. A quantitative comparison would however be possible in cases where the tax position of a relevant taxpayer is significantly and substantially improved through its participation in a cross-border arrangement.
Additionally, it is also clarified that the fact that the remuneration of a Cypriot company, being involved in a related party transaction, satisfies the arm’s-length principle (as it is documented via a transfer pricing study) does not affect the application of the MBT. In the context of financial transactions, it is important to assess whether the interest expense is tax deductible in Cyprus and whether the interest income is taxable for the recipient.
Hallmarks A-E of the Law
The FAQs provide a number of clarifications in relation to specific hallmarks. These include among others, the following:
According to the FAQs, the waiver/write-off of an interest-bearing loan may trigger the application of hallmark B.2, on condition that the MBT is additionally satisfied.
The FAQs also confirm that hallmark B.2 can be met in cases of capitalization of interest-free loan receivables for which there is a transfer pricing adjustment in the jurisdiction of the creditor/lender.
Moreover, hallmark B.2 can be met in cases where interest-bearing loan receivables are capitalized and the lender did not receive any interest income in the past, due to the borrower’s inability to repay the debt. However, the inability of the borrower to repay the loan shall be taken into account when performing the MBT analysis.
The FAQs provide that hallmark B.3 will not apply in cases where there is no circular flow of funds (cash or cash equivalents), e.g., where there is only a mutual set-off of balances.
Moreover, it is clarified that, in identifying whether the jurisdiction of origin of the funds is the same with the jurisdiction of destination of such funds for the purpose of hallmark B.3, only the jurisdiction of tax residence of the participants should be taken into account and not the jurisdiction of the banking institution(s), where the bank accounts of the participants are maintained and via which the relevant payments are processed.
The FAQs clarify that in cases where only part of the cross-border payment is deductible for tax purposes at the jurisdiction of the payor, the arrangement as a whole falls within the scope of hallmark C.1, as a part of the payment satisfies the relevant condition of the hallmark. The fact that part of the expense is not tax deductible is irrelevant and the arrangement will be reportable if all other conditions necessary for the fulfillment of the hallmark are met.
It is further noted that for the purpose of hallmark C.1, if a borrower utilizes the loan proceeds to generate taxable income and claims a corresponding deduction for the interest payment, it will be irrelevant whether taxable income is generated at the jurisdiction of the payor, as this is not a constituent element of the hallmark.
In a similar manner, the FAQs mention that the fact that the remuneration of a Cypriot company being involved in an intragroup “back-to-back” financing arrangement, satisfies the arm’s-length principle (as it is documented via a transfer pricing study), is irrelevant for the application of hallmark C.1, as it is not a constituent element of the hallmark. Similarly, the fact that transfer pricing documentation may have been prepared by the relevant taxpayer is irrelevant for the application of hallmark C.1.
With regards to the use of nominee shareholders, the FAQs note that this should not necessarily trigger hallmark D.1, as it is not considered to have the effect of undermining the reporting obligation under the national laws implementing EU legislation or equivalent agreements on the automatic exchange of information on Financial Accounts, including agreements with third countries (e.g., CRS/DAC2).
The FAQs clarify that even if the beneficial owners of a company are not directly identifiable in the financial statements of the company, hallmark D.2 should not be triggered if there are other legal sources available to the CTD to identify them, e.g., via the Register of Beneficial Owners of the Department of Registrar of Companies and Intellectual Property (Companies Section).
In addition, it is mentioned that where nominee shareholders are used, if this is stated in the financial statements of the company and the beneficial owners can be identified if requested by the CTD or by any other legal sources available, then hallmark D.2 should not be met. However, the hallmark will be met if the nominee shareholder appears as the beneficial owner of the company in order to purposefully mislead the CTD and obscure the identity of the real beneficial owner.
The FAQs highlight that where, for intragroup “back-to-back” financing arrangements, the relevant taxpayer does not prepare a transfer pricing study documenting the margin (in accordance with the relevant circular3), hallmark E.1 will be met even if the margin applied in Cyprus is higher than the safe harbor margin provided in the circular (which is 2.29% before tax / 2% after tax), as this constitutes the minimum taxable margin to be reported in Cyprus.
Furthermore, it is clarified that hallmark E.1 will be met irrespective of the fact that the use of the safe harbor margin is included in the tax return of the relevant taxpayer.
As to the determination of the trigger event for the 30-day deadline for DAC6 submissions, the FAQs provide that, assuming a relevant taxpayer has taken a final decision to apply the safe harbor, the reporting obligation should be within 30 days from the date the decision to apply the simplification measure/safe harbor was made, but no later than the date the tax return for the relevant tax year is due for submission (considering any deferrals of the submission date by the CTD).
On that respect, the FAQs also note that tax positions adopted via a tax return, where the safe harbor margin is used on an annual basis, do not create an annual reporting obligation for the relevant taxpayer.
With regard to the transfer of legal rights by the Contractor (Developer) to the Principal (IP owner) under a Research and Development (R&D) agreement, it is clarified that no “transfer” of (rights to) hard-to-value intangibles takes place within the context of hallmark E.2, provided that the legal and economic ownership of the IP assets remains with the Principal.
The FAQs note that interest income should be taken into account in the calculation of three-year projected earnings before interest and taxes (EBIT) for the purpose of hallmark E.3. This should apply in the case of companies where their only or main business activity is the provision of intragroup financing, as interest is their main source of income. The same should apply for financial institutions.
Further, it is highlighted that hallmark E.3 also applies to intragroup cross-border transfers of assets and/or functions and/or risks to natural persons, e.g., shareholders of a company. In addition, it is clarified that hallmark E.3 also applies to intragroup cross-border transfers even if the arrangement will not result in a decrease of tax revenues for Cyprus or another EU Member State.
Finally, the FAQs clarify that it is important to consider the whole arrangement in aggregate rather than the individual steps which comprise an arrangement. In the event that there is a transfer of a loan which is subsequently capitalized as part of the same arrangement, hallmark E.3 will not be applicable as there is no “transfer of assets” as the loan does not exist at the end of the arrangement. In this example, hallmark B.2 may be met if the MBT is additionally satisfied.
Determining if there is a reportable cross-border arrangement raises complex technical and procedural issues for taxpayers and intermediaries. Due to the scale, complexity and significance of the Cypriot MDR rules, taxpayers and intermediaries who have operations in Cyprus should review their policies and strategies for documenting and reporting arrangements so that they are fully prepared for meeting their obligations and relevant deadlines as non-compliance entails financial penalties.
For additional information with respect to this Alert, please contact the following:
EY Cyprus Advisory Services Limited, Nicosia