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10.2. Financing Regimes

Cyprus can successfully serve as the jurisdiction for a financing company. In fact, an increasing number of large groups of companies have been using Cyprus to channel their financing taking advantage of its low tax rate.

Below are the main advantages of using Cyprus for setting up a financing company and making back-to-back loans.

The term Cyprus Financing Company is purely a description of the activities of a Cyprus company and does not refer to specific legal form. Therefore, a Cyprus Private Company can be incorporated and be used for financing activities i.e. receive and grant loans.

The structure used:

https://itp.orbitax.com/filestore/api/PreSignedDownload/Embedded/?token=c8db8669-0581-4a1f-ba0b-5c85c8456d8b

The EU or non-EU parent company establishes a Cyprus company (hereafter referred to as ""CypCo"") to be the group finance company.

CypCo borrows funds from another group company, usually situated in a low/zero tax jurisdiction. CypCo then lends the funds it borrowed to another group company which will use the funds for the group operations. We will call the company receiving the loan from CypCo as ""Target Company"".

As a result:

  • Low/zero tax company has interest income.
  • Target Company has interest expense.
  • CypCo has both interest income and expense.

The Tax Implications

  • Zero/low tax: company Corporation tax - this company will have interest income from CypCo. If incorporated in a low/zero tax jurisdiction then this interest income will suffer low/zero tax.
  • CypCo: The Cyprus Tax Authorities issued guidance on the acceptable spreads for back-to-back loans as follows:
Loan Amount (EUR) Spread
Up to EUR50m 0.35%
EUR 50m - EUR 200m 0.25%
Over EUR 200m 0.125%

Corporation tax - the net taxable income is calculated by multiplying the applicable spread with the loan amount. The net taxable income is taxed under corporation tax at the rate of 12.5%. This is illustrated by the following example: CypCo has a back-to-back loan of EUR2,000,000. Assume that it borrows the EUR 2,000,000 at an interest rate of 5%. Using the guidance above, it will have to lend the EUR 2,000,000 at a rate of 5.35% so that a net spread of 0.35% is generated. This will leave CypCo with a taxable income of EUR 7,000 ( EUR 2,000,000 x 0.35%) and a tax liability of  EUR 875 ( EUR 7,000 x 12.5%).

Withholding tax - Cyprus does not impose any withholding tax on interest payments to non-Cypriot tax residents. Therefore, interest payments will leave Cyprus with no tax being withheld.

  • Target Company

As stated above, the Target Company will most probably use the funds borrowed from CypCo to finance its operations. Therefore, it will have to pay taxes in its home country on the income it generates.

In most countries, interest expense associated with a company's operations is treated as tax deductible (i.e. reduces its taxable income on which tax is calculated). Therefore, tax deductible interest expense will decrease the taxable income of Target Company.

Withholding tax - if the country in which the Target Company is incorporated has a double tax treaty with Cyprus then the Target Company can take advantage of reduced/nil withholding tax on interest payments to Cyprus. If the Target Company is incorporated in another EU Member State then the EU Interest & Royalties Directive could be applicable which means 0% withholding tax.

Things to look out for

  • Back-to-back financing - the above spreads are applied by the Cyprus Tax Authorities only in cases where a back-to-back relationship can be demonstrated. In other words, the above tax advantages apply to companies borrowing and lending the same amounts.
  • Company activities - it is very important to make sure that a pure financing company is used so as to ensure taxation under corporation tax and not under special defense contribution (passive income, i.e. income not directly related to the company's activities, is taxed under special defense contribution and such passive interest income is taxed at 30%). This can be achieved relatively easily by incorporating a company that is only used for financing purposes but a tax ruling would always be advisable.
  • Tax deductibility of interest expense - as discussed above, in most countries interest expense is treated as tax deductible if associated with a loan used to finance income generating activities that lead to taxable income. In this respect, one should be careful as to the use of the loan by the Target Company and if a tax ruling can be obtained then this would be highly recommended.
  • Transfer Pricing – From 1 July 2017, minimum profit margins will no longer be accepted for back-to-back intragroup loans from 1 July 2017, and all related-party financing will require a transfer pricing study from that date based on OECD guidelines (See Sec 13.4).