Transfer Pricing and the Arm’s Length Principle

Introduction

As international businesses expand, the importance of transfer pricing (TP) regulations has grown. These regulations aim to prevent profit shifting and ensure that companies report profits where economic activity takes place. In line with global trends, Cyprus has introduced robust TP rules that comply with the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations. This article provides a comprehensive overview of the TP rules in Cyprus, focusing on the Summary Information Table (SIT), Local and Master Files, Safe Harbour provisions, penalties, and compliance requirements. The 2026 reform includes important changes to Local File thresholds that significantly affect compliance obligations.

It is important to note that Cyprus TP rules apply to both cross-border and domestic (Cyprus-to-Cyprus) controlled transactions, as well as transactions involving permanent establishments of foreign companies operating in Cyprus.

1. What is Transfer Pricing?

Transfer pricing refers to the pricing of transactions between related companies, particularly in cross-border transactions. The key principle that underpins TP is the arm’s length principle, which dictates that related parties must price their transactions as if they were independent parties under similar circumstances.

Why Is Transfer Pricing Important?

Transfer pricing is essential for tax authorities to prevent tax base erosion and profit shifting. For businesses, compliance with TP regulations ensures proper allocation of taxable income, reducing the risk of penalties and double taxation. In Cyprus, TP rules aim to ensure transparency and fairness in transactions between related parties, thereby aligning Cyprus with global tax standards and enhancing its tax compliance framework.

For tailored support with transfer-pricing compliance and wider Cyprus tax matters, explore our tax advisory services.

Who Are Related Parties?

Under Article 33 of the Income Tax Law, two companies are considered connected (related) where the same person or group of persons holds — directly or indirectly — at least 25% of the voting rights, share capital, or the right to 25% of the income of both companies. A company is similarly connected with an individual where that person holds at least a 25% interest in the company.

2. Legal Framework for Transfer Pricing in Cyprus

Transfer pricing in Cyprus is governed by domestic law and international guidelines. The key elements include:

• Article 33 of the Income Tax Law (ITL) 118(1)/2002: Establishes the arm’s length principle. A company’s taxable income is adjusted where transactions with related parties yield terms that differ from what independent parties would have agreed — or should have agreed based on the arm’s length principle.
• OECD Guidelines: Cyprus follows the OECD’s TP Guidelines, which are automatically incorporated by reference into the Cyprus TP framework and updated as the OECD revises them.
• Regulations 273/2022 and 314/2022: Set out detailed documentation requirements and penalties for non-compliance.
• Circular 6/2023: Issued by the Commissioner of Taxation in July 2023 (effective from 1 January 2022), providing simplified documentation measures and Safe Harbour rules for qualifying entities.

Mandatory TP documentation requirements came into effect on 1 January 2022, covering all types of related-party transactions — both cross-border and domestic.

3. Arm’s Length Principle

The arm’s length principle is central to Cyprus’s TP regulations. It ensures that transactions between related parties are priced as they would be between independent entities. This prevents companies from shifting profits to lower-tax jurisdictions.

Applicability of the Arm’s Length Principle

The principle applies to a wide range of transactions between related parties, including:

• Sale of goods
• Provision of services
• Licensing of intellectual property
• Intra-group financing

The goal is to ensure that profits are taxed where they are earned, thus avoiding profit manipulation across jurisdictions. Importantly, Cyprus TP rules apply equally to domestic intragroup transactions (between two Cyprus-resident companies or between a Cyprus company and a Cyprus permanent establishment) — not only to cross-border transactions.

4. Documentation Requirements

The key to transfer pricing compliance is maintaining appropriate documentation. Cyprus requires companies to prepare and submit the Summary Information Table (SIT), Local File, and Master File, depending on the scale of their controlled transactions.

4.1 Summary Information Table (SIT)

The Summary Information Table (SIT) provides an annual summary of controlled transactions. It is mandatory for all companies engaging in related-party transactions, regardless of the value involved.

Who Must Submit the SIT?

All taxpayers engaged in controlled transactions are required to submit the SIT. This applies irrespective of the transaction values, meaning that no materiality threshold applies.

Contents of the SIT

The SIT must include:

• Names of related parties
• Tax residency and tax identification numbers (TINs) of related parties
• The value and category of transactions (e.g., goods, services, intellectual property, financial transactions)

Submission Deadline

The SIT must be submitted annually alongside the IR4 income tax return through the Tax For All (TFA) portal. For the 2026 tax year, the deadline is 31 December 2027 (submission follows the new corporate tax return deadlines outlined in the Assessment and Collection Law).

Penalties for Non-Compliance

A fine of €500 is imposed for failing to submit, submitting late, or failing to amend the SIT within the specified timeframe.

4.2 Local File

The Local File provides a detailed account of specific controlled transactions and is required for companies exceeding certain thresholds.

Threshold for Local File Requirement

↑ Increased 2026 A Local File is now required when controlled transactions exceed the following annual thresholds per category:

• €10,000,000 for financing transactions
• €5,000,000 for goods transactions
• €2,500,000 for other transactions (services, intellectual property, and other categories)

Local File Thresholds — History and 2026 Changes

If these thresholds are not met, the Local File is not required, but the SIT must still be submitted, and simplified TP documentation (see Safe Harbour section) may still apply.

Contents of the Local File

The Local File must contain:

• A detailed description of the taxpayer’s business and organization
• Financial information relevant to the controlled transactions
• A comparability analysis and functional analysis of related transactions
• Justification for the transfer pricing method used
• Copies of agreements and relevant contracts

Penalties for Non-Compliance

Failure to prepare or submit a Local File when required can result in fines:

• €5,000 if submitted between 61 and 90 days after the deadline
• €10,000 if submitted between 91 and 120 days
• €20,000 if submitted later than 120 days or not submitted at all

4.3 Master File

The Master File provides a high-level overview of the multinational group. It is required where the consolidated revenues of the multinational group exceed €750 million. However, only the Ultimate Parent Entity (UPE) or Surrogate Parent Entity (SPE) of a qualifying group is required to prepare the Master File. Cyprus subsidiaries of large groups are not required to prepare their own Master File, but must be in a position to produce the group’s Master File to the Tax Department within 60 days of a request.

Contents of the Master File

The Master File includes:

• A description of the group’s global operations and structure
• Transfer pricing policies applied across the group
• Details of intangible assets and intercompany financing

The Master File must be updated annually.

5. Safe Harbour Rules

Safe Harbour rules simplify compliance for certain low-risk controlled transactions. Introduced by Circular 6/2023 (effective 1 January 2022), they allow qualifying entities to be deemed compliant with the arm’s length principle without conducting a full independent benchmarking study, provided they meet specific criteria.

5.1 Eligibility for Safe Harbour

Safe Harbour rules are available only where all three of the following conditions are met:

1. The transactions are cross-border (not domestic Cyprus-to-Cyprus).
2. The entity’s aggregated related-party transactions in the relevant category are below the Local File thresholds — i.e., the entity is not required to prepare a full Local File in that category.
3. There are no reliable internal comparable data available. If the entity has its own market-based pricing data for similar transactions, it must use that instead of the Safe Harbour rates.

5.2 Safe Harbour Rates and Categories

Where the eligibility conditions are met, Circular 6/2023 provides the following Safe Harbour provisions across four categories:

1. Debt-funded financing (loans and advances): A minimum pre-tax return of 2.5% (after allowable expenses) on the average principal outstanding, including accrued interest, is deemed arm’s length.
2. Equity-funded financing: A minimum return equal to the 10-year government bond yield of the borrower’s country plus 3.5% is deemed arm’s length.
3. Loans payable (financing costs): Interest expense must not exceed the 10-year Cyprus government bond yield plus 1.5% to be considered arm’s length.
4. Low Value-Adding Services (LVAS): For routine intragroup support services that do not create significant unique intangible assets (e.g., back-office, IT support, HR services), a 5% cost-plus markup is accepted as arm’s length. If the Cyprus entity is the service provider, a 5% minimum markup applies; if it is the service recipient, a 5% maximum markup is accepted as a deductible cost.

5.3 Simplified Transfer Pricing Documentation

Entities opting for Safe Harbour are still required to maintain simplified TP documentation, which must include at a minimum:

1. Brief functional analysis — functions performed, risks assumed, and assets used by the entity
2. Characterization of the entity based on the functional analysis (e.g., limited-risk distributor, routine service provider)
3. Rationale for the transfer pricing method applied and confirmation that the Safe Harbour rate is met
4. Arm’s length determination — a documented conclusion that the transaction meets the applicable Safe Harbour rate (a full independent benchmarking study is not required)

DAC6 Reporting Obligations

The use of Safe Harbour rules qualifies as a unilateral safe harbour under the DAC6 Directive. Therefore, cross-border transactions using these measures must be reported under DAC6, Hallmark E.1, as part of the taxpayer’s annual tax return.

6. Transfer Pricing Methods

The Cyprus Tax Department follows the OECD’s Transfer Pricing Guidelines in accepting the following methods:

1. Comparable Uncontrolled Price (CUP) Method
2. Resale Price Method
3. Cost Plus Method
4. Transactional Net Margin Method (TNMM)
5. Profit Split Method

Taxpayers must document the rationale behind their choice of transfer pricing method, ensuring that it best reflects the arm’s length principle. The OECD Guidelines — incorporated by reference into the Cyprus TP framework — are automatically updated as the OECD revises them, meaning Cyprus always applies the current OECD standard.

7. Corresponding Adjustments

In cases where the Tax Department makes an upward adjustment to a taxpayer’s profits, a corresponding adjustment may be granted to the counterparty, ensuring that both parties are taxed consistently. This is particularly relevant in mutual agreement procedures (MAP) under double taxation agreements (DTAs).

8. Advance Pricing Agreements (APAs)

Taxpayers can apply for an Advance Pricing Agreement (APA) to agree in advance on how transfer pricing will be applied to specific transactions. APAs provide certainty and reduce the risk of future disputes.

Timeline for APA Decisions

• The Tax Department has 10 months to decide on an APA request, with the possibility of extending the period by up to 24 months
• APAs are valid for a maximum of 4 years

Bilateral and Multilateral APAs

Where Cyprus has a double tax treaty in place with the relevant country, taxpayers may request a bilateral or multilateral APA. In such cases, the taxpayer must submit the same request and supporting documentation to the foreign tax authority as well. The Commissioner of Taxation may then consult with the foreign tax authority through the Mutual Agreement Procedure (MAP) provided under the applicable treaty.

9. Penalties for Non-Compliance

Non-compliance with Cyprus’s TP regulations can result in significant penalties, depending on the type and severity of the violation.

SIT Penalties

• A fine of €500 is imposed for failure to submit the SIT by the deadline, late submission, or failure to amend the SIT

Local and Master File Penalties

• €5,000 if submitted 61 to 90 days late
• €10,000 if submitted 91 to 120 days late
• €20,000 if submitted later than 120 days or not submitted at all

10. Transfer Pricing Audits

The Cyprus Tax Department can conduct TP audits, reviewing a company’s transfer pricing documentation. If a taxpayer fails to provide sufficient documentation within 60 days of a request, penalties will apply.

Conclusion

Transfer pricing regulations in Cyprus are designed to ensure fair taxation of controlled transactions, aligned with international best practices. Compliance requires businesses to prepare and submit the required documentation — including the Summary Information Table, Local File (where thresholds are exceeded), and Master File — and adhere to the Safe Harbour rules where applicable. The 2026 increases to Local File thresholds (the second upward revision since the rules launched in 2022) provide significant further relief for many companies, while maintaining robust documentation standards for larger transactions.

Key areas to watch in 2026 and beyond include the new director-as-related-party rule, the expanded LVAS Safe Harbour for service companies, and the continued applicability of TP rules to domestic transactions. Businesses must take a proactive approach to ensure their transfer pricing practices comply with the law, minimising the risk of audits and penalties. For professional advice and assistance, consulting a tax advisor is highly recommended.

Disclaimer

Please note that the information provided here is for general guidance only and does not constitute professional tax advice. Tax laws and interpretations are subject to change, and individual circumstances can significantly affect tax obligations and benefits.

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