OECD extensive guidance on intragroup financial transactions
On 3 July 2018, the OECD published the long awaited public discussion draft on financial transactions (the Discussion Draft).
The Discussion Draft provides guidance on general pricing issues in relation to intragroup financing, as well as on specific pricing issues regarding cash pooling, hedging transactions, guarantees and captive insurance structures. Although the Discussion Draft is not final yet, it will likely already be used as a source and support for discussions with the tax authorities, as many tax authorities currently audit the transfer pricing of financial transactions. The OECD invites interested parties to submit comments by 7 September 2018.
The Discussion Draft includes the following important preliminary views:
- Prior to determining what an arm’s length interest rate would be, it should first be determined what the maximum amount would be that an unrelated lender would have been willing to lend and what an unrelated borrower in comparable circumstances would be willing to borrow. Based thereon, it should be possible for tax administrations to (partially) not recognize a loan for the purpose of determining the arm’s length interest.
- An entity that lacks the capability, or does not perform the decision making functions in order to control the risk associated in investing in a financial asset should not be entitled to more than a risk-free return.
- In comparing the conditions of transactions between associated entities, the credit rating of the borrower can serve as a useful measure. So-called “implicit support” should be taken into account.
- In case of start-up companies, an independent lender would usually examine future cash-flow projections. Cash flow projections are therefore considered a relevant factor to be taken into account by taxpayers entering into such a loan with a related entity starting a new business.
- The CUP method is the most preferred method to determine an arm’s length interest rate on an intra-group loan; internal CUP’s should also be taken into account.
- Bank opinions regarding the terms under which a company could borrow funds do generally not provide evidence of arm’s length terms and conditions.
- The “cash-pool benefit” of a cash pool should be appropriately allocated to the various participants of the cash-pool.
- If a centralised treasury function arranges a hedging contract that other group companies enter into, this centralised function can be seen as providing a service, for which an arm’s length remuneration should be received.
- Guidance is provided on methods to determine an at arm’s length guarantee fee. In case of full “implicit support” no guarantee fee should be charged, as in such case an explicit guarantee would not enhance the credit worthiness of the borrower.
- The economic rationale for a taxpayer to use a captive should be properly substantiated and differences between third party (captive) insurance companies and group insurance companies (e.g. capital requirements) should be properly taken into account while setting intercompany prices.
These topics are relevant for (nearly) all taxpayers, as most taxpayers are involved in one or more of the covered transactions. Given the focus of numerous tax authorities on transfer pricing aspects of financial transactions, the Discussion Draft provides taxpayers and tax authorities new arguments to defend or challenge both existing and future intragroup financial transactions. We would therefore recommend verifying to what extent the new guidance may impact your financial transactions.
The status of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Authorities varies among different jurisdictions (i.e. in some jurisdictions the TP Guidelines have the status of legislation, in others it is merely used as guidance). It is likely that the view of the OECD will soon be adopted in various jurisdictions regardless of the status of the TP Guidelines, as the OECD is considered a leading authority in relation to transfer pricing policy. The Discussion Draft is open to comments until 7 September 2018.
If you have any questions or if you wish to provide comments to the OECD, we would be pleased to advise you. We will keep you updated on further transfer pricing developments.