Transfer Pricing: The New Era

Multinational Enterprises (MNEs) operating on the global stage, face multiple challenges, including market pressures, regulatory and non-regulatory constraints, and heightened competition. To navigate this complex landscape, enterprises must prioritise innovation and create efficiency to maintain a competitive edge.

With the advent of more advanced communication systems, MNEs have enhanced control over their global operations. Seeking efficiency gains, enterprises turn towards engaging in cross-border transactions among group entities. As a result, this practice splits the enterprise’s profits among various jurisdictions, highlighting the crucial role of Transfer Pricing rules in allocating the group profits efficiently.

As businesses operate on a global scale, they face the dual challenge of remaining competitive while adhering to regional and global market demands. Economic globalization has led countries, including Cyprus, to adopt measures safeguarding tax revenue and preventing profit shifting to favorable tax jurisdictions.

Overview of Transfer Pricing Legislation in Cyprus

Aligning with global trends and developments, Cyprus has enhanced its Transfer Pricing legislation. On 30 June 2022, the House of Representatives of Cyprus approved amendments to the Income Tax Law and the Assessment and Collection of Taxes Law in relation to transfer pricing, reflecting recommendations from the OECD Transfer Pricing Guidelines. The legislation, effective retrospectively from 1 January 2022, signifies Cyprus' commitment to international standards.

Before the legislative amendments, Transfer Pricing in Cyprus rested on the arm's length principle. The arm’s length principle required both taxpayers and Tax Authorities to evaluate transactions with connected parties in light of what independent enterprises would have agreed upon in a similar transaction. A controlled transaction met the arm’s length principle if the results of the transaction were consistent with those that would have been realized if uncontrolled taxpayers had engaged in comparable transactions under comparable circumstances. An uncontrolled transaction did not need to be identical to the controlled transaction but should only be sufficiently similar in order to provide a reliable measure of an arm’s length result.

The new transfer pricing legislation encompasses various transactions exceeding €5m under the category ‘Financing’ and €1m for all other categories of connected transactions (i.e. ‘Goods’, ‘Services’, ‘Intellectual Properties’ such as licensing, disposals etc., and other types of transactions).

Transfer Pricing Documentation

The legislation mandates comprehensive Transfer Pricing documentation for all connected party transactions entered into by Cyprus resident companies and foreign entities operating through a permanent establishment in Cyprus (subject to exemptions). For the purposes of this legislation the definition of ‘connected parties’ has the same meaning as under the Income Tax Law - where one party has a direct or an indirect relationship of at least 25% of the share capital or voting rights of another party.

The Transfer Pricing documentation must consist of the following:

1. Master file which provides a high-level overview of the taxpayer’s business, including the nature of their global business operations, their overall Transfer Pricing policies, and their global allocation of income and economic activity. A Master file must be prepared when the entity acts as the Ultimate Parent Entity (UPE) or Surrogate Parent Entity (SPE) of a multinational enterprise Group with a Country-by-Country Reporting obligation (e.g. with consolidated revenue above €750m).
2. Local file which provides detailed information regarding the specific intercompany transac-tions (entities involved, controlled transactions and financial information).
3. Summary Information Table which includes high-level information about the taxpayer’s annual transactions with connected parties regarding the nature / value of the transactions.

Transfer Pricing Study

Preparing a Transfer Pricing Study offers enterprises an opportunity to explain their transactions to the Tax Authorities, supporting the argument that transactions are on arm's length terms.

While the preparation of Transfer Pricing study entails significant costs, time and resources, it serves as a valuable tool for profit and function allocation between group companies, aligning with commercial goals.

As such, it should be treated as an investment in enhancing group operations and efficiency, avoiding tax adjustments which may result after a tax audit (in the absence of a transfer pricing study) and even lowering the tax base if the resulting margins benchmarked by the Transfer Pricing study are lower than the contractual margins agreed between the transactional parties. The study safeguards against penalties and defends the enterprise's Transfer Pricing position. A tax audit process not only brings the risk of penalties and interest to be imposed but carries with it a heavy burden in terms of defending the group’s Transfer Pricing position against a country’s Tax Authorities. 

Treating Transfer Pricing as a Business Process

Amid the complexities of a globalised landscape marked by market pressures, regulatory challenges, and human capital constraints, it becomes imperative for MNEs and other enterprises to underscore the importance of innovation and operational efficiency to sustain competitiveness. Consequently, the Transfer Pricing process should move beyond its conventional characterization as a regulatory formality and be acknowledged as an integral aspect of the operational cycle of every enterprise.

If you have any questions or require further guidance on navigating the rules and requirements of Transfer Pricing in Cyprus, please feel free to reach out to Marilena Stylianou at mstylianou@tridenttrust.com or Erodotos Koupatos at ekoupatos@tridenttrust.com in our Cyprus office.