OECD releases Transfer Pricing Guidance on Financial Transactions
The OECD released the long-awaited final version of a report on the pricing of related party financial transactions, which is part of BEPS Action Plans 4, 8-10 and will be implemented into the OECD Transfer Pricing Guidelines. The report focuses on intra-group loans, guarantees, cash-pooling and various risk insurance arrangements.
The report contains a comprehensive description of how to determine and assess transfer prices for financial transactions. It also provides guidance to the tax authorities on how to put forward arguments during tax inspections, especially where the economic substance of a particular financial transaction is not properly supported.
The main points of the report are as follows:
- Economic substance of a provided loan: The report explicitly specifies areas that should be considered during a particular transaction. Emphasis is put on the economic substance of a financial transaction and the functional and risk profile of the parties to the transaction. The tax authority may seek inspiration in the methodological framework relevant for the financing classification assessment, considering various perspectives such as short-term vs. long-term financing, debt vs. capital financing, and other parameters.
According to the report, e.g., creditors who do not have the necessary personnel, functions and assets/debt capacity at their disposal to manage credit risk, may only be entitled to no more than a risk-free interest rate. The remaining part of interest should then be allocated to the entity that is actually exercising control over this risk. This may involve, for example, shared service centres that perform the treasury management function within groups of companies on a central basis.
- Debtor’s credit rating: The report also mentions possible methods to assess a debtor’s credit risk. When evaluating creditworthiness, it is also necessary to consider the level of implicit support provided by the group based on the debtor’s position within such a group. The credit rating of a strategically significant company should, e.g., approximate the credit rating of the group to which the company belongs, whereas a less significant company should be viewed more like a stand-alone debtor (stand-alone rating).
- Offers from external banks: The use of an (indicative) offer from an external bank as a comparable transaction to an intra-group loan is seen as problematic in the report, as an offer from a bank does not represent a transaction that has actually been carried out and, therefore, does not meet the criteria for applying the comparable uncontrolled price method.
- Cash-pooling: Cash-pooling structures should be analysed from an overall perspective, focusing on the evaluation of functions and risks as well as benefits for participants. If the cash-pool leader only performs coordination activities and does not bear any significant risks, the leader’s remuneration should also be “administrative”, i.e. should correspond to the limited risks assumed and functions performed. At the same time, the report does not exclude the possibility that the cash-pooling leader’s scope of activities may be wider and, as a result, the related remuneration may be determined based on other approaches stipulated in the report, but only if such a pricing model is properly documented and any non-standard activities are well-supported.
Following the issuance of the OECD report, it can be expected that the tax authorities will pay increased attention to financial transactions. We recommend reviewing the setup of the existing intra-group financing structure, focusing on whether the distribution of functions and risk controls correspond to the distribution of interest income among recipients. We also recommend performing a review/update of transfer pricing documentation, making sure that the economic substance forms the basis for setting the contractual conditions of intra-group financial transactions and related remuneration.