New Guidance on the Transfer Pricing of Financial Transactions – Time to act
03 maart 2020
For the first time, the OECD have issued guidance on the transfer pricing of financial transactions (related-party loans, treasury functions, cash pooling, hedging, guarantees and captive insurance). This is a complex area of transfer pricing (with very different views and approaches historically being taken by tax authorities) and many tax authorities see this area as one for significant potential TP/tax risk.
It is a particularly important and noteworthy development in the field of transfer pricing, and is likely to mean that businesses will need to prepare a higher level of supportive transfer pricing analysis and documentation than they would have historically for financial transactions. It is also likely to lead to a significant rise in tax authority audit activity in this area.
The key points worth noting:
- Pricing of financial transactions must be aligned with the commercial and economic reality of the related parties - As with other areas of transfer pricing post the OECD’s Base Erosion and Profit Shifting (‘BEPS’) programme, it is necessary to identify the real substance of the commercial or financial relations between related parties. For related party loans, that will involve an evaluation of by whom, and where, lending risk is managed/controlled and where the capacity to bear that risk is allocated. A key consequence of this is that written contracts can be ignored when determining pricing If there is any inconsistency with a written contract (e.g. a loan agreement) then it is the actual activity and substance of the transaction that will determine how it should be priced.
- The new guidance does not address all issues - Although consensus of OECD member countries has now been achieved on a wider range of issues relevant to the transfer pricing of financial transactions, there remain others that are not definitively resolved. Also, financial transactions by their very nature can be complex and the analysis of them for transfer pricing purposes will reflect that complexity. As such, although the OECD’s objectives to ‘improve international consistency in the transfer pricing of financial transactions’ has been achieved in large part (and, therefore, the risk of double taxation reduced), some issues remain that have not been definitively addressed. A considerable scope for controversy between countries therefore still remains.
- Clearer guidance for taxpayers… - The expectations outlined by the new guidance now set a clear standard for taxpayers to comply with. The guidance also sets out a level of analysis for financial transactions that many will perceive as highly demanding.
- …but also clearer guidance for tax authorities - Tax authorities now have reasonably clear guidance on how to scrutinise the transfer pricing of financial transactions (and the greater certainty that this gives as to the consistent transfer pricing treatment of these transactions amongst countries). As a result, we expect tax authorities globally will increasingly challenge groups’ intra-company financial arrangements.
- Early preparation is strongly recommended - Taxpayers should begin preparing for this increased scrutiny now to avoid the risk of tax adjustments and penalties, economic double taxation and accounting provisions for uncertain tax positions, not to mention the cost of deploying internal and external resource to handle associated tax enquiries. Failing to prepare will also expose businesses to the reputational risks that can easily arise from major tax disputes and financial adjustments.
How BDO can help you?
There is a wide range of factors to consider when dealing with policies and pricing of cross-border financing transactions.
BDO has profound experience and capability in this challenging area of transfer pricing and an extensive range of credit scoring capabilities and pricing tools to underpin our analyses.
We can help you:
- Analyse your potential tax risk;
- Determine an appropriate supportable range of arm’s length pricing outcomes for related party debt, guarantee fees, cash pooling arrangements, factoring and other financial arrangements;
- Prepare supportive ‘fit–for–purpose’ documentation; manage transfer pricing disputes; and also advise on appropriate structures for financing arrangements.
Any advice in this area will not be complete without proper consideration of the potential application of hybrid mismatch provisions, corporate interest limitation rules, withholding taxes and CFC rules and other anti-avoidance in parallel. We draw upon that expertise in providing a rounded and holistic approach to financing transactions.
Our financing transactions transfer pricing specialists around the world can provide you with the fully considered analysis, and solutions, you need.
You might also be interested to read our brief and practical client communication ‘Transfer Pricing on Financial Transactions’ on this subject.