Meet Elena and her company

Elena is the founder and managing director of CyTech Solutions, a growing technology firm based in Nicosia, Cyprus. Her company specialises in software development and digital transformation solutions. As part of a wider corporate group, CyTech collaborates with two affiliated entities: one in Germany responsible for marketing and branding, and another in Romania providing data analytics services.

The three companies frequently engage in intercompany transactions: shared service arrangements, intercompany financing, royalty payments for intellectual property, and cross-border operational support. Elena is now faced with a vital question: how should these transactions be priced to comply with Cyprus’s tax laws and international best practices?

This brings us to the heart of transfer pricing

What Is transfer pricing?

Transfer pricing refers to the pricing of transactions between companies that are part of the same corporate group. These transactions can include:

• The sale or purchase of goods

• Provision of services (e.g., IT, marketing, consulting)

• Licensing of intellectual property

• Intra-group financing (loans, guarantees, cash pooling)

The key principle underpinning transfer pricing is the Arm’s Length Principle (ALP). This means that the price charged in a transaction between related parties should be the same as if the transaction had taken place between two independent, unrelated entities under similar circumstances.

This ensures that profits are correctly allocated across jurisdictions, avoiding artificial shifting of income to low- or no-tax territories.

Why is transfer pricing so important in Cyprus?

Cyprus’s corporate tax rate of 12.5% makes it a competitive and attractive location for international business. However, with this attractiveness comes scrutiny. Authorities must be vigilant in ensuring that profits reported by Cypriot companies reflect genuine economic activity within the country.

To reinforce this, the Cypriot government introduced comprehensive Transfer Pricing legislation effective from 1 January 2022, fully aligning the domestic framework with the OECD Transfer Pricing Guidelines and recommendations from the BEPS (Base Erosion and Profit Shifting) project.

The overarching aim is to:

• Ensure profits are taxed where economic value is created

• Establish transparency and consistency in cross-border reporting

• Reduce disputes with foreign tax authorities through proper documentation

What qualifies as a related-party transaction?

Companies are considered related when there is direct or indirect control of 25% or more of share capital, voting rights, or rights to profit. Examples of controlled transactions include:

• Sales of products or goods to group companies

• Provision of software development, IT support, or consulting

• Royalty payments for trademarks or patents

• Intercompany loans, credit facilities, or guarantees

In Elena’s case:

• CyTech Cyprus develops a mobile app and charges CyTech Germany €1.2 million

• CyTech Cyprus pays a €300,000 royalty to Germany for using their branding assets

• CyTech Cyprus lends €2 million to CyTech Romania for a new data analytics centre

Each of these transactions must be evaluated under the transfer pricing rules.

When Does Transfer Pricing Documentation Become Mandatory?

If these thresholds are exceeded, the taxpayer must:

• Prepare a Local File: Detailed documentation of the Cyprus entity’s intercompany dealings, pricing rationale, and supporting analysis

• Submit a Table of Summary Information (TSI): A summary of all controlled transactions, regardless of amount

Additionally, if the group’s consolidated global turnover exceeds €750 million, a Master File must also be maintained at group level.

What Should the Local File Contain?

The Local File provides comprehensive support for the pricing applied in related-party transactions. It must include:

• Description of the local entity’s business activities and strategy

• Organisational structure and ownership chart

• Functional analysis (functions performed, assets used, and risks assumed)

• Industry overview and economic context

• Detailed description of controlled transactions

• Chosen transfer pricing method and rationale

• Benchmarking analysis (comparing the company’s results to those of similar independent companies)

Choosing the Appropriate Transfer Pricing Method

Cyprus follows the five OECD-approved transfer pricing methods. Choosing the right one depends on the nature of the transaction, availability of data, and functions performed.

 
1. Comparable Uncontrolled Price (CUP)

• Compares prices charged in similar transactions between independent enterprises

• Ideal for standardised goods or services with market price data

 
2. Cost Plus Method

• Applies a mark-up to the costs incurred in delivering the product or service

• Common for intra-group service arrangements

 
3. Resale Price Method

• Deducts a standard margin from the resale price to determine the transfer price

• Often used for distribution businesses

4. Transactional Net Margin Method (TNMM)

• Compares net profit margins with those of similar independent companies

• Most widely used when direct price comparables are unavailable

5. Profit Split Method

• Splits combined profits between related parties based on their contribution

• Appropriate where transactions are highly integrated or involve intangible assets

For financial transactions, methods such as the Capital Asset Pricing Model (CAPM) and Expected Loss Model may be used. These assess the credit risk of the borrower and ensure interest rates reflect market conditions.

Simplified Approach for Small Transactions | Safe Harbours

To reduce the compliance burden on smaller taxpayers, Cyprus offers safe harbours for certain types of transactions below the documentation thresholds.

Using these safe harbours simplifies documentation and reduces audit risk, provided the conditions are met.

A Practical Example | Elena’s Year-End TP Compliance

At the end of the financial year, Elena reviews her company’s intercompany dealings:

• €1.2 million in software services to Romania

• €300,000 in royalties paid to Germany

Since the services exceed the €1 million threshold, Elena must:

• Prepare the Local File explaining why she used the TNMM, along with industry comparables

• Submit the TSI to the Cyprus Tax Department

Elena also considers applying for an Advance Pricing Agreement (APA) to obtain pre-approval for her pricing methods going forward.

Advance Pricing Agreements (APA) | Planning with Certainty

An APA is a formal agreement with the Cyprus Tax Department, confirming the pricing method for future related-party transactions. It provides:

• Advance certainty for 4 years

• Reduced risk of tax audits and penalties

• Potential for bilateral/multilateral agreements with other countries

To apply, the company must submit a proposal covering:

• Business and functional profile

• Proposed methodology

• Financial assumptions

• Duration of agreement and relevant facts

• The Tax Department must respond within 10 months, extendable to 24 months.

Penalties for Non-Compliance

Failure to submit documentation upon request within 60 days leads to penalties:

Avoiding these penalties requires being proactive, well-organised, and keeping documentation up to date.

Elena’s Transfer Pricing Action Plan

Here’s a simple checklist Elena (and every business) should follow:

• Identify all related-party transactions

• Determine if thresholds are exceeded

• Select appropriate TP methods

• Benchmark against market data

• Prepare the Local File and TSI

• Submit on time with corporate tax return

• Monitor for regulatory updates

• Review annually for changes in structure or strategy

Conclusion | Transfer Pricing as a Strategic Compliance Tool

While transfer pricing may appear to be a compliance-heavy requirement, it is also a strategic opportunity to improve transparency, strengthen governance, and enhance investor confidence.

With the right advice and planning, businesses like Elena’s can navigate the rules confidently, demonstrate substance and fairness, and stay aligned with global best practices.

This article was prepared by the AccountingWise.