OECD’s discussion draft on the transfer pricing of financial transactions

The discussion draft provides guidance on the pricing of common intra-group financial transactions, such as loans, cash pools, hedging transactions and guarantees.

In consistence with the previous BEPS reports, the draft calls for looking beyond the contractual terms of the transaction, with consideration to be given to the full set of circumstances surrounding the transaction and all options realistically available to both transaction parties. In particular, companies with limited or no control over the financial risks they contractually assume in intra-group financial transactions should not, according to the draft, be entitled to more than a risk-free rate of return.

The discussion draft specifically notes that the guidance is not intended to prevent countries from implementing approaches to address capital structure and interest deductibility under domestic law. However, it provides guidance for tax administrators on how to treat a certain part of debt as capital financing.

If the discussion draft is approved in its current wording, it may close the door on several pricing approaches still commonly used in intra-group financial transactions, including the use of a group’s average funding rate and bank quotes in pricing lending transactions, as well as the use of bank deposit rates in pricing positive balances in group cash pools.

How compliance with the arm’s length standard should be demonstrated in practice is not completely clear from the draft.  It is our view that the report is missing meaningful guidance when it comes to assessing the arm’s length quantum of debt. It also does not provide the detail required to guide taxpayers through to a clear conclusion.

Once finalised, the OECD report will represent the most comprehensive guidance on the transfer pricing of financial transactions, providing some certainty to taxpayers. However, the report will also provide tax agencies with a tool in tax audits, particularly where there is little substance or commercial rationale in the transactions. Groups with existing intra-group financial transactions should start considering whether their arrangements are consistent with the key principles in the discussion draft.

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