Effect of COVID-19 on transfer pricing of intra-group loans

The current pandemic puts pressure on firms to keep positive cash flows and cash balances. Multinational groups are thus facing the issue of financing their companies. In the most affected industries, access to bank loans has worsened, leading to an increase in intra-group loans to cover operating expenses amid falling revenues and growing inventories due to absences of sales. In terms of transfer pricing, interest on intra-group loans should be at arm’s length and reflect the concrete conditions of the given financial transaction.

Multinational groups use intra-group loans to finance their entities and move cash to companies that need it most. When concluding loans, businesses should not just consider restrictions of tax-deductibility of interest (such as the ATAD Directive), but also the recently issued OECD Guidance on Financial Transactions, which will form a part of the OECD Transfer Pricing Guidelines.

OECD Guidance on Financial Transactions

The guidance contains a comprehensive description of setting and assessing transfer prices for financial transactions. At the same time, it provides guidance to the tax authorities on how to proceed in tax inspections, namely where the economic substance of the financial transaction is not properly supported. Under the current circumstances, when providing a loan to a related party, at the very beginning of the transaction, it is crucial to take into account what loan amount the debtor would have obtained from an unrelated creditor, solely based on their own financial health: excessive debt financing might be viewed as form of a capital contribution, and a portion of interest on the intra-group loans would thus not be tax-deductible.

Arm’s-length interest rate

Because of the availability of market data, the comparable uncontrolled price method is the preferred method to determine an arm’s length interest rate or interest. It is usually based on the debtor’s credit rating and the yield (to maturity) of comparable publicly traded instruments, usually bonds. However, the current volatility of the financial market makes predictions difficult. On one hand, the central banks’ reference rates are decreasing and bank guarantees are being provided by states; on the other hand,  yields on marketable bonds are growing considerably. This indicates that the financial markets also reflect the increased risk margins arising from the current situation in their interest rates. Future developments are therefore hard to estimate. However, we recommend monitoring the current market situation and reflecting it when setting interest rates on newly negotiated intra-group loans, and when renegotiating/repricing the existing ones.

Arm’s-length terms and conditions

The uncertainty on the financial markets also affects the terms and conditions of the loans being negotiated. Generally, maturities are getting shorter for newly issued bonds, and more short-term and less long-term financing is expected in the market. What’s more, multinational groups are postponing the instalments or extending the maturities of their existing loans. Hence, it is important to watch whether new conditions are still compatible with conditions that may be expected for unrelated parties.

We recommend supporting intra-group financial transactions with transfer pricing documentation that complies with the OECD’s new guidance and is supported by a comparability (benchmarking) analysis based on current data. It should also contain a consideration as to whether the total amount of intra-group loans may still be considered reasonable for the given sector. 

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