A basic introduction to switch pricing in Cyprus

All questions


As an internationally recognised business centre, Cyprus is a jurisdiction largely compliant with Organisation for Economic Co-operation and Development (OECD) standards, as recognised in the latest OECD progress report,2 and as such follows many of the OECD principles and practices, including the ‘separate legal entity’ approach, which is broadly accepted internationally (see the OECD definition of the international arm’s-length principle).3

Cyprus generally applies the above-mentioned international arm’s-length principle, which essentially requires that conditions and circumstances attached to a ‘controlled transaction’ are consistent with comparable transactions concluded in the open market.

The OECD has, over the years, produced the Transfer Pricing Guidelines4 and several reports refining their application and broadening their scope. The most recent and comprehensive reports comprise the Final Reports on BEPS Actions 8–10,5 which largely revise the previous Transfer Pricing Guidelines with the stated aim of taxing profits where economic activities take place and value is created, giving particular weight to the party undertaking and managing economically significant risks. In addition, the OECD issued for the first time additional Transfer Pricing Guidelines on financial transactions, in February 2020.

The OECD’s work in this area (i.e., the OECD Transfer Pricing Guidelines and reports) underpins the arm’s-length principle incorporated in the OECD Model Tax Convention6 and forms the basis of an extensive network of bilateral double-tax treaties; therefore, several jurisdictions are already applying this principle and the underlying transfer pricing methodology to either domestic or cross-border transactions.

The OECD Model Tax Convention contains the arm’s-length principle under the heading ‘Associated Enterprises’ (Article 9),7 which states:


  1. a. an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or
  2. b. the same persons participate directly or indirectly in the management, control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State, or
  4. and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.

The relevant Cyprus legal framework giving effect to this arm’s-length principle is replicated below.

In particular, the Income Tax Law8 provides the following:

  1. (1) Where–
  3. (a) a business in the Republic participates directly or indirectly in the management, control or capital of a business of another person; or
  4. (b) the same persons participate directly or indirectly in the management, control or capital of two or more businesses;
  6. and in either case conditions are made or imposed between the two businesses in their commercial or financial relations which differ from those which would be made between independent businesses, then any profits which would, but for those conditions, have accrued to one of the business, but, by reason of those conditions, have not so accrued, may be included in the profits of that business and taxed accordingly.
  8. (2) The provisions of sub-section (1) apply also in connection with any transaction between connected persons.

The above arm’s-length principle as enshrined by the Income Tax Law covers both physical persons and companies (the definition of which is set out below but note that this definition includes what are described as ‘corporations’ in other jurisdictions).

Companies, pursuant to the Income Tax Law, are defined to include under Article 2:

anybody with or without legal personality, or public corporate body, as well as every company, fraternity or society of persons, with or without legal personality, including any comparable company incorporated or registered outside the Republic and a company listed in the First schedule (comprising a list of several companies registered in other EU Member States); but it does not include a partnership.9

Additionally, the Income Tax Law and relevant regulations also explicitly stipulate that certain transactions should abide by comparable open-market terms. These transactions include, inter alia, ‘where the amount of new capital is introduced in the form of assets in kind, the amount of such capital . . . cannot exceed the market value of these assets on the date of their import’.10

The Cyprus arm’s-length principle is in line with the international arm’s-length principle that governs controlled transactions and facilitates potential compensating adjustments in the context of investigations into the tax affairs of taxpayers. It should be noted that the arm’s-length principle governs a wide range of trading and business transactions but generally does not apply to transactions involving ‘uncontrolled relations’ or of a capital gains nature involving immovable property located in Cyprus.

In 2017, Cyprus issued detailed transfer pricing regulations governing financial back-to-back (BtB) controlled transactions (BtB Regulations)11 (see below). Aside from these regulations, Cyprus has yet to issue detailed transfer pricing guidelines concerning controlled transactions, although in practice the principles underlying the OECD Transfer Pricing Guidelines are commonly cited to support the set transfer price in controlled transactions, in tax examinations; or to potentially initiate a conventional advance ruling application process (although a sophisticated advance pricing arrangement does not exist).

Touching briefly on empirical tax audit cases involving conditions underlying controlled transactions that deviate from open-market terms, the tax authorities do not hesitate in making upward adjustments to the taxable income of a Cyprus company in the absence of satisfactory evidence or an economic and commercial rationale underpinning concluded controlled transactions.

As will be illustrated in this chapter, the OECD Transfer Pricing Guidelines are generally accepted and widely used in either of the cases mentioned above, with the aim of demonstrating that the selected controlled transaction reflects arm’s-length conditions. However, in the process of assessing a controlled transaction, the tax authorities weigh up the case for a detailed and comprehensive transfer pricing methodology against the intention not to interfere with the economic development and growth or undue burdening of the taxpayer, and currently tend towards the latter.

During the process of a tax audit, it is generally essential for the contemplated controlled transaction to be underpinned by sound commercial and economic reasoning and the defined transfer price generally to fall within a reasonable range of expected prices after considering relevant economic circumstances, functions performed, assets used and risks assumed.

Cyprus’s transfer pricing regulations are expected to be expanded to cover a broad range of items and transactions. This will be achieved either through the enactment of new legislation incorporating transfer pricing regulations or by the Commissioner of Taxation (Commissioner) of the Cyprus tax office (Tax Department) issuing a revised transfer pricing decree. The guidance is expected to be aligned with the OECD Transfer Pricing Guidelines12 (even if in a simplified form). In the interim, the discussion in this chapter is based on the arm’s-length principle found in Cyprus law and how transfer pricing applies in practice, and on the BtB Regulations.

Broader taxation issues

i Diverted profits tax

The arm’s-length principle in Cyprus law does not apply to transactions where no controlled relation exists between the parties or to certain transactions that constitute capital transactions.

Although there is no specific diverted profits tax provision, the law enshrines the following general anti-avoidance tax provisions (from the Assessment and Collection of Taxes Law and the Capital Gains Tax Law respectively), which govern applicable situations and complement the arm’s-length principle.

Where the Director is of the opinion that in respect of any year of assessment the object of the tax of any person is reduced by any transaction which in his opinion was artificial or fictitious, he may disregard any such transaction and assess the persons concerned on the proper object of the tax.32In case of a disposal between related persons, as such term is interpreted by the Income Tax Law in force, where the disposal proceeds declared is an amount which is less than the market value of the property, there shall be deemed as disposal proceeds the amount of the market value of the property at the date of its disposal, as this is ascertained by the Director.33

In addition, the new EU Anti-Tax Avoidance Directive (effective from 1 January 2019) may be employed to deny a tax benefit or recharacterise transactions in the event that ‘an arrangement or a series of arrangements’ is intended, exclusively or mainly, to exploit tax incentives.34

ii Double taxation

Cyprus has a very broad tax treaty network and generally applies the mutual agreement procedure (MAP) in response to its obligations under its bilateral double-tax treaties (which are mainly based on the OECD Model Convention – therefore giving effect to the specific OECD MAP Article 25, where applicable) or the EU Arbitration Convention35 pursuing the elimination of double taxation.

Prima facie, the MAP procedure may also be invoked in the context of primary adjustments under transfer pricing for the corresponding adjustment to apply, thereby eliminating or mitigating the possibility of double taxation.

Currently, there is limited practical experience of invoking an MAP for transfer pricing. In addition, the Income Tax Law36 provides that if the tax authorities make an upward adjustment to a taxpayer’s tax calculation during their audit, a corresponding downward adjustment should also be made in the books of a connected controlled party. The resulting corresponding adjustment may be allowed as a deduction for the purposes of determining the connected controlled party’s tax calculation if, under the normal rules, the subject matter of the corresponding adjustment would have qualified for deduction.

In providing for such a corresponding downward adjustment to be made, the law provides a framework for mitigating cases of double taxation, at least within Cyprus.

Outlook and conclusions

Notably, the arm’s-length principle in Cyprus law is in line with the international arm’s-length principle as envisaged in the relevant OECD Model Convention and Transfer Pricing Guidelines, and it governs controlled transactions in Cyprus; indeed, in practice, the tax authorities accept transfer pricing studies indicating that the set transfer price is not affected by the connection between the parties in a controlled transaction.

However, in the absence of a formal requirement on detailed transfer pricing documentation (except for BtB financial controlled transactions) and specific guidance on the governing methodology, the tax authorities’ approach is pragmatic, reflecting a balancing exercise in fostering international business while at the same time not allowing unreasonable controlled transactions lacking a business or commercial rationale to take place.

As a result, the process is relatively less cumbersome from the perspective both of the taxpayer (with regard to preparing and furnishing adequate evidentiary documentation underpinning a set controlled price) and of the tax authorities (with regard to using their limited resources to rigorously examine a particular controlled price), especially where transactions occur primarily within the context of small or medium-sized businesses.

The anticipated issuance of Cyprus regulations stipulating the nature of transfer pricing documentation and methodology to be followed will mark a shift in the tax authorities’ current approach, as these will require per se specific documentation to be in place and a certain methodology to be applied with regards to controlled transactions.