On July 3rd 2018, the Organisation for Economic Co-operation and Development (“OECD”) published a discussion draft that aims to provide extensive guidance on how tax authorities and Multinational Enterprises should assess the arm’s length remuneration on intra-group financial transactions. The public discussion draft explores the possibility of adding a new chapter to the 2017 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, dealing exclusively with intra-group financial transactions, an aspect that so far lacked specific guidance. The OECD invited any stakeholder to comment on the content of the draft by September 7th 2018, with further follow-on discussions to be expected early 2019.
In the discussion draft, the OECD starts by pointing out certain important positions on which it is seeking input from stakeholders, such as on:
- the possibility to determine the maximum amount of debt that should be taken into consideration, based on the amounts an unrelated lender would be willing to lend, allowing the tax authorities to requalify the excess amounts into equity; or
- the remuneration with nothing more than a risk-free return for entities that lack the capability to control the risk associated with the investments they entered into.
With regards to intra-group loans specifically, the discussion draft states that one should take into account different factors affecting the borrower and lender and that in order to determine the creditworthiness of the borrower, it is recommended to consider the credit ratings of the tested target entity as these are often readily available in many lending markets. If no such rating is available, one may use specific commercial tools that have been designed to rate debt borrowings. The belonging to a group should not be completely ignored as an independent lender would have included the fact that the borrower may benefit of implicit group support in its assessment. As a result of this, one should be able to not only determine the appropriate debt-to-equity ratio at the level of the borrower but also an adequate level of remuneration for the funds made available.
Regarding the remuneration of the transactions, the OECD suggests a two-step approach. In the first phase, one should determine a risk-free rate of return on a specific investment by taking into account the prevailing facts and circumstances. As a reference, the OECD recommends taking government issued securities with a similar maturity and issuance date. In a second phase, the risk-free rate of return should be adjusted in order to reflect the effective financial risk assumed by the funder. The OECD also recommends using the comparable uncontrolled price method (“CUP”) to define the applicable interest rate on the transaction. As an alternative to the CUP, the cost of fund method could be used in situation where a lender used a third-party loan to finance a group member.
In addition to the explanations on intragroup loans, the draft provides a similar analysis and invites the readers to comment on transfer pricing issues regarding other activities such as cash pooling, hedging activities, guarantees and captive insurances.