Recent report on the guidance for transfer pricing – An overview
The Organisation for Economic Co-operation and Development (OECD) has finally released its report on the guidance for transfer pricing with respect to a financial transaction. On Feb 11th, 2020, the report was published as a follow up to the Base Erosion and Profit Sharing (BEPS) Action 4 and Actions 8-10 mandate. The newly published report aims to shed light on the application of its predecessor the OECD TPG which came out in 2017.
It particularly focuses on the accurate delineation analysis prescribed in Chapter 1, in relation to financial transactions. A noteworthy point about his report is that it is the first time that guidance is being provided in the application of transfer pricing to help decrease disputes and eliminate double taxation. It also hopes to clear the air on the interpretation of the arm’s length principle.
Multinational enterprises’ (MNEs) capital structures is one key aspect of the report that it addresses. It also expands on specific issues relating to treasury functions, intra-group loans, cash pooling, captive insurance, guarantees, and hedging. The report constantly provides instances and examples to help illustrate the mandates and principles that it seeks to clarify.
Some Key Points Discussed in the Report,
OECD Transfer Pricing Guidelines for MNE’s and Tax Administrations:
1. No financial solidity within group lenders:
In a country where human resources to manage and handle financial risks is inadequate, companies should evaluate the profit to be seen through intra-group lending. Yet, if the lending does occur, the report states that the lender would be entitled to only a risk-free return, and the rest would be allocated to the party who bears control over the investment risk.
2. Guaranteed loans explained:
The report is clear that guarantees on loans can be compensated if they provide measurable benefits like a reduction in interest costs of the borrower. However, if the borrower stands to gain in terms of borrowing capacity due to a related party, an accurate delineation analysis will split the transaction. One, a loan from the lender to the borrower, based on the latter’s capacity without the guarantee; and two, a loan from the lender to the guarantor, followed by a capital contribution to the borrower. The guarantee fee will be calculated only based on the former.
3. ATL and the terms of funding:
The Report reiterates the impact of the actual delineation of a financial transaction; for instance, a 10-year term loan could be delineated as a series of ten 1-year revolving loans. It is up to companies to see how all the terms of the funding are documented, not just the interest rate. These terms and conditions are to be at arm’s length.
4. Cash pools:
A cash pool head, according to the report does no more than the function of an agency. As the functionality is quite low, the report suggests that remuneration of the leader who provides the service will also be limited. Therefore, any company that enjoys income from a cash pool leader will have to prove the allocation of income on the basis of performance over control of credit, liquidity and other risks. The report recommends supplementary documentation.
5. Credit rating:
How the stand-alone rating of companies in a group is determined as well as the benefit of being a member of the group is extensively discussed in the report. It gives guidance on ascertaining the credit ratings of subsidiaries based on the group’s policies. It also particularly talks about considering the willingness and ability of the group to support troubled group companies.
The new guidance on financial transactions is an important step in the development of the OECD TPG. The value of the report stretches beyond the OECD countries as it has been given the nod by 137 members of the Inclusive Framework too. MNE groups who perform intra-group financial transactions should evaluate if their transfer pricing policies are in sync with the new guidance and ensure they have the supporting documentation in place to support these policies.