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Transfer Pricing Forum: March 2018

Transfer Pricing Forum: March 2018

Transfer Pricing Forum: March 2018

1. Does your country specify permissible methods for evaluating an arm’s length interest rate on related party loans? What methods does it specify – or which does it permit if it does not specify methods (e.g., CUP, reference to interest indices, or percentage mark-ups over a base such as the national bank interest rate)? Do local tax inspectors tend to apply particular methods over others? What methods have you found to be effective, or do you see most often used for financial transactions, and what evidence do taxpayers or the government’s examiners use to establish the rate under those methods?

While there are many different methods an analyst may consider, the Comparable Uncontrolled Price (CUP) method is still one of the preferred transfer pricing methods of the OECD and the Belgian tax authorities with respect to the pricing of intercompany funding.1 In particular, where it is possible to locate internal comparable uncontrolled transactions, the CUP method is the most direct and reliable way to apply the arm’s-length principle and to determine the prices for the related-party transactions.

The CUP method evaluates the arm’s-length character of a controlled transaction by comparing the interest rate charged in the controlled transaction to the interest rate charged in a comparable uncontrolled transaction. This method may be used when data are available to establish the interest rate charged be-tween unrelated-parties under similar circumstances. The resulting CUPs define an arm’s-length range of interest rates that should be charged in the transactions occurring between related-parties.

Considering the substantial amount of publicly available information in relation to financial transactions between third parties, the CUP method appears to be the most appropriate transfer pricing method in determining an arm’s-length interest rate for an inter-company loan. However, the application of the CUP method requires a high degree of similarity of the loans in determining comparability between the con-trolled and uncontrolled transactions. If there are no differences between the controlled and uncontrolled transactions that would affect the interest rate, or only minor differences for which appropriate adjustments can be made, then the CUP method will generally be the most direct and reliable measure of an arm’s-length interest rate for the controlled transaction. If minor adjustments cannot be made, or if there are more than minor differences between the controlled and uncontrolled transactions, the CUP method may still be used, but reliability of the analysis in determining the arm’s-length result will be reduced. If there are material differences for which reliable adjustments cannot be made, the CUP method may not provide a reliable measure of an arm’s-length result.

In a Belgian context, two potential applications of the CUP method could be used, the first being the direct application, and the second a derivativee of the CUP method (hereinafter referred to as the ‘‘build-up’’ method).

Direct CUP method

Applied to financing transactions, the CUP method evaluates the arm’s-length character of a controlled transaction by comparing the interest rate charged in the controlled transaction to the interest rate charged in a comparable uncontrolled transaction. This method may be used when data are available to establish the interest rate charged between unrelated par-ties under similar circumstances.

As stated above, application of the CUP method re-quires a high degree of similarity of the loans in determining comparability between the controlled and uncontrolled transactions. If there are no differences between the controlled and uncontrolled transactions that would affect the interest rate, or only minor differences for which appropriate adjustments can be made, then the CUP method will generally be the most direct and reliable measure of an arm’s-length interest rate for the controlled transaction.

When defining an arm’s-length interest rate for an intercompany loan, the Belgian tax authorities would take into account the following characteristics of the loan, amongst others:

  • Purpose of the loan;
  • Credit rating of the borrowing company;
  • Amount;
  • Currency;
  • Maturity;
  • Issue date;
  • Country of the borrower/ lender;
  • Interest rate type (fixed or floating);
  • Collaterals (guaranteed or not);
  • Subordination level;
  • Fixed loan or loan facility; and
  • Early termination clauses.

Indirect CUP method or ‘‘Build-up’’ method

The ‘‘Build-up’’ method can be seen as an indirect application of the CUP method as it is subdividing an interest rate in different components, and is successively defining an arm’s-length rate/spread for each component identified based on market comparables.

Applying the ‘‘Build-up’’ method, one will add-up various components to arrive to an interest rate that takes into account the various characteristics and specificities of the intercompany loan to be documented.

The building blocks to be taken into account should – or could – include the following:

  • A base (risk free) rate;
  • A company risk premium;
  • A country risk premium; and
  • Adjustments for subordination, guarantees, etc.


2. Does the country officially (or do tax inspectors in practice) express a preference for valuation methods or approaches that are different for outbound transactions (domestic lender/foreign borrower) than for inbound ones?

There is no (un)official difference in the approach followed by the tax inspectors with regard to outbound and inbound trans-actions. Furthermore, it is worth mentioning that, from a Belgian perspective, either abnormal or benevolent advantages received or granted could give rise to adverse tax consequences.

Where a Belgian enterprise grants an abnormal or benevolent advantage, the amount of the advantage is added back to the taxable base of the enterprise concerned unless the advantage is taken into account when determining the taxable base of the recipient of the advantage (cf. Article 26, Belgian Income Tax Code (BITC)). This should also be the case where the recipient is in a tax loss position. According to Article 207 BITC, tax losses and certain other tax attributes cannot be set off against income from so-called abnormal or benevolent advantages received from enterprises that are directly or indirectly related to the company receiving the benefit.

The Belgian company receiving the abnormal or benevolent advantage is not allowed to offset previous years’ nor current year’s tax losses nor other tax attributes from the profit corresponding to the received advantage. The Belgian tax authorities take the position that this results in the advantage being immediately taxed in the hands of the company receiving the advantage, irrespective of current year’s or prior years’ tax losses or other tax attributes available.

As such, the minimum taxable basis of a Belgian company includes the total amount of abnormal or benevolent advantages received. In the case of the adjustment, the tax loss carry for-ward is increased with the advantage effectively subject to tax.


3. Assume a typical related-party borrowing situation in your country: a foreign member of a multinational group has lent money to a domestic affiliate. It must be established whether the borrowing is on an appropriate arm’s-length basis. How are these issues dealt with in your country?

a. What factors are examined to establish the loan’s ‘‘bona fides;’’ that an advance or a loan agreement sets out genuine debt? Is it necessary to show that the loan would have been made by an unrelated lender, absent a guarantee? Is there a separate consideration of whether the ‘‘borrowing’’ is in fact an equity infusion? What happens if the loan is interest-free, and what happens if there is no written agreement?

As with other intercompany interactions, intercompany funding should be priced according to the arm’s-length principle, based on the terms that unrelated-parties would enter into similar agreements. Definitely, in building up a transfer pricing policy, one should support up-front the position that a third-party lender would have provided funding to the borrower, even in the absence of a guarantee, or that the borrower would have been able to fund itself in the market at the same conditions, without further guarantees, other than the implicit sup-port of the group it belongs, if any.

The transfer pricing analysis begins by identifying the commercial or financial relations between the parties and the corresponding conditions and economically relevant circumstances, in order that the controlled transaction is accurately delineated. Delineation becomes increasingly relevant when it helps prevent situations where a Belgian entity, for in-stance, is retaining an overall negative interest spread in its dealings, given by the difference between the interest rates of its borrowings and the interest rates applied in its lending activities. Indeed, it is likely that a third party would not enter into different transactions that create an overall negative result in its hands.

Even in the case where associated parties have classified a financing instrument as debt, it should be assessed as to whether the tax authorities could disregard the transaction as such by proving, based on the general anti-abuse rule of Article 344 of the BITC, that the structure has been put in place with the specific objective of abusing the law.

While the automatic requalification of debt as equity – also based on the general anti-abuse rule as modified in 2012 –might require particular efforts in the hands of the tax authorities, the latter still have at their disposal additional ways to deny to the taxpayer the tax deduction with respect to interest paid:

  • Thin capitalization rules; and/or
  • Hybrid mismatch rules.


In any case, evidence showing that the borrower is expected to repay the loan is important. Similarly, documentation showing that the borrower would have the capacity to repay its debt is equally important.

The absence of a written agreement does not, per se, constitute a risk. Nevertheless, it should be pointed out that in the context of intercompany funding, proper documentation (e.g., agreements) that clearly identifies the pricing process and other terms and conditions (e.g., early repayment clauses) is important for substantiating the genuineness of the arrangement.


b. Under the current regulatory regime and case law, should the borrower be evaluated as a stand-alone borrower, or as a member of a multinational group benefiting from passive association with its group? Is implicit support from affiliates assumed, or what factors must be identified to suggest that such support might be given? Is this viewed as an exception to the traditional arm’s length standard or as a necessary interpretation of it, or something else?

A subsidiary generally receives some level of implicit benefit from its relationship with the parent entity. This benefit is referred to as the ‘‘passive association’’ benefit.

While, in accordance to the OECD2 an associated enterprise should not be considered to receive an intra-group service when it obtains incidental benefits attributable solely to its being part of a larger group of entities, and not to any specific activity being performed, the passive association should not be ignored when pricing intercompany funding.

The most commonly applied and accepted methodologies for taking into account the passive association, and thus the implicit guarantee, are provided by the Standard & Poor’s (S&P) and Moody’s (3) reports with regard to credit ratings determination. These are also being followed by the Belgian Service for Advance Decisions in Tax Matters and by the Belgian tax authorities in general.

S&P characterizes a subsidiary over a range from core entity (i.e., fully integrated part of the group) to non-strategic investment. This, in turn, results in a range of support from substantial financial help to less or no financial help.

Similarly, according to Moody’s, subsidiaries’ credit worthiness could be corrected depending on the likelihood of the group/parent to support them. This is determined based on an implicit support analysis that, according to Moody’s methodology, will improve the probability of default and therefore the associated credit risk.

There are 3 categories of implicit support (strong, medium or none) based on the following factors:

  • Control (board representation, ownership)
  • Strategic importance of the subsidiary
  • Relative size of subsidiary vs. group in terms of assets, revenues, debt, equity investment, intercompany loans:
    • Reputational risk for the parent
    • Operational integration
    • Political and partner relationship q Size of the subsidiary vs. its market
  • Regulation
  • Track record of the parent


c. What other factors than the borrower’s position as a stand-alone entity or member of a multinational group would be taken into account in evaluating the borrower’s credit worthiness?

With specific reference to the indirect CUP method or the ‘‘build-up’’ method, as explained above, the following can have a direct impact on the credit worthiness of an entity:

Country risk: a country risk adjustment should be per-formed on ta borrower’s credit rating that is based on the ‘‘build-up’’ methodology, in order to reflect country-specific differences in interest rates. If the borrowing entity owns a significant number of assets in countries other than its own, the corresponding risk adjustment should also reflect this. A weighted average index should be used if the entity is multinational, i.e., active in different jurisdictions.

Subordination: if an intercompany loan is subordinated, an upward interest rate adjustment should be performed in order to take into account the increased risk of default borne by the lending entity. In general, it would be considered appropriate to decrease the borrower’s credit rating by one to two notches to take into account the subordinated character of the loan.4 The impact of the subordinated character of a loan should be greater on medium to long-term loans due to the company’s financial volatility over this period, as compared to short term loans where one has a better view on the evolution of the company’s financial position.


d. What sources of data for comparable loan benchmarking are typically referenced when undertaking an intercompany loan analysis?

Thomson Reuters and Bloomberg databases are frequently used by taxpayers to price their intercompany financing arrangements. These databases are regarded as to be a valuable and reliable tools for identifying CUP transactions, when there are no internal CUPs available. The resulting CUPs define an arm’s-length range of interest rates that could be applied to the intercompany loans to be documented.

Thomson Reuters has bond coverage of corporate bonds, government bonds, preferred shares, mortgages, money market programs, syndicated loans and municipal bond. The database also provides detailed information on current deals in the market, deal pricing and market trends.

Taxpayers can use the Thomson Reuters database to search for comparable transactions, based on issue date, maturity of the loan, type of interests (floating/fixed), redemption features/dates, credit rating (Moody’s rating), collateral, the deal currency, the borrower region, exchanges, industry sectors and issuer types and security/market types.

Bloomberg is a self-contained, stand-alone data feed that provides for a broad range of services. Bloomberg has that bond coverage of corporate bonds, government bonds, preferred shares, mortgages, money market programs, syndicated loans and municipal bonds, among others. Bloomberg could be used to define arm’s-length interest rates, introduction fees, guarantee fees, etc.

In the absence of an available public rating, a company’s credit rating may be determined by using Moody’s credit risk tool ‘‘RiskCalc.’’ This tool generates a forward-looking default probability by combining financial statement data and equity market information, resulting in a stand-alone credit rating estimation.


e. What, if any, safe-harbor rates or indicative or ‘‘suggested’’ margins are provided? Does the tax authority have (or has it indicated) an intention to provide such guidance?

The corporate tax reform law of December 29, 2017, has introduced some certainty on the definition of ‘‘market rates’’ in the framework of Article 55 of the BITC on the deductibility of interest expenses. Article 55 now states that, for interest payments on non-mortgage loans with no fixed maturity, other than those paid to affiliated companies acting as a treasury center or under a centralized cash management agreement (e.g., a cash pool arrangement), as referred to in Article 198, paragraph 4, of the BITC, the market interest rate is linked to monetary financial institutions (MFI) interest rates. In particular, the ‘‘market rate’’ will be the one established by the National Bank of Belgium for loans granted for an amount less than EUR 1.000.000 to non-financial companies for less than one year, concluded in November of the calendar year preceding the calendar year to which the interest relates, increased by 2.5%. The rate so obtained represents the maximum interest rate to be applied.

Nevertheless, other than the provision discussed above, which does not cover all the intercompany financing arrangements, there are no safe-harbor rates or indications provided by the tax authorities in Belgium for financial transfer pricing purposes.

From a transfer pricing perspective, interest rates on inter-company funding should, generally, still be determined based on market data, taking into account the credit rating of the borrower and the maturity of the arrangement, in particular. Particular attention should be paid to arrangements entered into with related parties located in jurisdictions where suggested margins exist (e.g., Switzerland, the U.S., etc.), since an inter-company transaction, and an intercompany funding in particular, should always be assessed on both ends, including a sanity check on the Belgian side as well. While the interest rates applied might be prima facie acceptable in other jurisdictions, corroborative analyses based on actual market data should always be recommended in Belgium.


f. How do you deal with negative interest rates in the context of deposits (e.g., in related financing institutions or similar situations)? How do you deal with base rates that are negative (such as Euribor, which as this is written are negative)?

When loan agreements or/and methodologies do not provide a rate ‘‘floor’’ on the base rate, it is likely that the Belgian tax authorities might conclude that in the interest rate calculation, the base rate should be capped at zero, to make sure that the interest rate is not less than the spread applied, or even less than zero.

In defense of the above view, it should be noted that capping the base rate at zero is also a common approach being followed by external banks when granting loans, thus giving a clear indication of the behavior of third parties in the market.

Deposit rates could be capped at 0, when and if negative rates apply, to incentivize the group entities to deposit at the level of the cash pool, if available. However, we observe that banks are also charging negative interest rates to their depositing clients. Hopefully, the OECD draft paper on intercompany financing to be issued later this year will provide further guidance in this respect.


g. Does intra-group lending present other issues under your country’s tax system, and how are those dealt with by taxpayers?

Currently, interest expenses are, in principle, tax deductible insofar as thin capitalization limits (i.e., 5/1 debt/equity ratio) are respected and the interest is at an arm’s-length rate.

However, the law on the corporate tax reform (Law of December 25, 2017) introduces, as from 2020, the Earning Stripping Rules (ESR) in Belgian law. These rules are based on EU ATAD I, and might potentially affect many corporates.

The ESR have similarities with thin capitalization, as explained under question 7 below, as both essentially focus on whether the amount of debt and, hence, the interest deduction is excessive. Thin capitalization determines the issue of excessiveness by reference to a debt to equity ratio. Under, the ESR, excessiveness is determined by referencing the quantum of a company’s interest expense (intercompany and third-party) to its profit before tax.


4. In light of BEPS Action 2 (Hybrid Mismatch Arrangements) a number of countries during the last year have been enhancing, modifying, or adopting rules that affect transfer pricing of financial transactions. If changes have recently been made to your country’s rules, what changes are those, and when do they take effect?

Through the Law of December 25, 2017, Belgium enacted corporate tax reform, which will take place in three steps in 2018, 2019 and 2020, and contains several major changes. One of the most important aims of the corporate tax reform is to neutralize the effects of hybrid mismatches. As such, Belgium has first introduced definitions of hybrid mismatch, hybrid entity and hybrid transfer in its tax law.

With respect to hybrid financial instruments, mismatches concern situations where the tax treatment of a financial instrument differs between two jurisdictions. A hybrid transfer means any arrangement to transfer a financial instrument where the underlying return on the transferred financial instrument is treated for tax purposes as derived simultaneously by more than one of the parties to that arrangement.

The newly introduced Belgian measures, which will be effective as of tax year 2020 (income year 2019), mirror the EU directive rules (namely primary and secondary rules) by foreseeing the following:

  • Denying the deduction in the state of which the payer is a resident; and
  • Including the payment in the country of the payee jurisdiction


As an exception, in specific situations payments made by financial traders do not give rise to hybrid mismatches provided that certain requirements are met.

Additionally, according to the Belgian law, no hybrid mismatch is deemed to exist when the non-inclusion is due to differences resulting from the application of transfer pricing rules.


5. How do your country’s rules for attribution of income to a permanent establishment work with the rules on debt financing? In particular does the ‘‘distinct and separate enterprise’’ view of a PE’s income calculation permit (or require) separate entity evaluation of the PE?

From a Belgian standpoint, the authorized OECD approach on the attribution of profits to permanent establishments (PEs) indicated in the OECD 2010 Report on the Attribution of Profits to PEs (July 22, 2010) should be considered when assessing PEs and their dealings.

The authorized OECD approach states that ‘‘the profits to be attributed to a PE are the profits that the PE would have earned at arm’s-length, in particular in its dealings with other parts of the enterprise, if it were a separate and independent enterprise engaged in the same or similar activities under the same or similar conditions, taking into account the functions per-formed, assets used and risks assumed by the enterprise through the permanent establishment and through the other parts of the enterprise.’’

However, in the presence of intercompany funding, and with specific reference to the determination of the creditworthiness of a PE, one should also make reference to paragraph 31 of the OECD 2010 Report on the Attribution of Profits, which states that, in general, the factual situation of a PE determines that it necessarily has the same creditworthiness as the enterprise of which it is a part. In contrast, a subsidiary may or may not have the same creditworthiness as its parent.

It remains to be seen whether the upcoming OECD guide-lines on financing transactions will overrule/moderate this provision.


6. If a foreign affiliate provides an explicit loan guarantee, when do your country’s rules or your country’s practice indicate that a guarantee fee must be accounted for? (If it must, when can it be an adjustment to the interest rate, or when must a separate guarantee fee be deemed to be paid to the foreign affiliate?) How is the appropriate charge for a guarantee determined?

As previously mentioned, a subsidiary generally receives some level of implicit benefit from its relationship with the group/parent company. This type of association and related benefit is deemed passive in nature and is increasingly recognized in Belgian transfer pricing cases.

However, an associated enterprise should not be regarded as receiving an intra-group service when it obtains incidental benefits attributable solely to its being part of a larger group, and not to any specific activity being performed. For instance, no guarantee would be received where a related-party by reason of its affiliation alone has a credit-rating higher than it would if it were unaffiliated, but an intra-group guarantee would usually exist if the higher credit rating were due to a guarantee by an-other group entity, or if the enterprise benefitted from deliberate concerted actions put in place by the group or another group member.

In this respect, and in accordance to the OECD Guidelines, passive association should be distinguished from active promotion of the MNE group’s attributes.5

Typically a guarantee enables less financially solid companies to borrow greater funds and/or at more advantageous rates than would be possible independently. The transfer pricing question arises as a guarantee is similar to an insurance policy in which the guarantor promises to meet the borrower’s obligations in the event of a default. The price of the policy can be established based on the risks undertaken and profit margin taken in the market.

One of the commonly applied and accepted methods for substantiating the guarantee fee consists of the interest rate differential. The methodology aims at estimating the benefit of the guarantee to the beneficiary, i.e., by quantifying the lower interest rate charged by banks as a result of the guarantee. However, the outcome of this approach should be seen as a maximum, considering that a third party would not be ready to pay a guarantee fee that is higher than the advantage that it will receive from the lender through a lower interest percentage. In practice, through the interest rate differential, one should calculate the spread between what the guarantor and the beneficiary would have to pay for a similar loan in the market. The difference in credit rating between guarantor and the borrower is often taken as a basis for the quantification thereof.

Please note that a comfort letter might have little legally binding effect. The letter, indeed, gives no guarantee for the re-payment of the projected loan but offers the bank the comfort of knowing that the subsidiary has made the parent company aware of its intention to borrow; the parent also usually sup-ports the application, giving, at least, an assurance that it in-tends that the subsidiary should remain in business and that it will give notice of any relevant change of ownership.

A comfort letter, therefore, has little legal bearing on the obligations of the loan. It is therefore highly unlikely that a com-fort letter constitutes a valuable service to the borrower that should be paid for separately.


7. If your country has adopted interest deduction limits, such as the OECD’s suggested ratio or group ratio approach, what are those measures? Do you expect that those measures will reduce the need for strict enforcement of transfer pricing in regard to related-party loans, by making it less tax-efficient to erode the domestic tax base through interest charges? Do thin capitalization or other specific limits such as debt vs. equity rules limit the operation of transfer pricing more generally? If so, how do these affect decisions that companies might make?

The corporate tax reform law, published in the Belgian official gazette on December, 29 2017, includes measures addressing interest deduction limits that will be effective as from assessment year 2021 (that is, for tax periods beginning as from January 1, 2020).

Through the corporate tax reform, the EU anti-tax avoidance directives (ATAD I and II) will be implemented. A limitation of deductible interest will apply for the greater of EUR 3 million or 30 percent of EBITDA (earnings before interest, tax, depreciation and amortization).

The new limitation will only apply to interest on loans concluded as of June, 17 2016. The current 5:1 thin cap rule will remain applicable to arm’s-length interest payments for:

  • Interest paid to beneficial owners located in tax havens (regardless of the date); and
  • Intragroup interest paid pursuant to a loan agreement for which it has been demonstrated that it was concluded prior to June 17, 2016, and not ‘‘fundamentally’’ modified since then.


For the calculation of interest and EBITDA, an ad hoc consolidation will be made. While non-deductible interest will be transferable without limit to subsequent years, there is also the possibility of transferring it to other group companies. Finally, stand-alone entities and financial companies will be excluded from the rule mentioned above.


Dirk Van Stappen, Yves de Groote, and Eugena Molla

Orginal Source: Bloomberg Tax


1 It appears that in practice, the application of other methods is difficult considering the fact that those methods are rather focusing on tangible products or typical group services.

2 OECD, Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, paragraph 7.13, July 2017.

3 Moody’s Investors Service, The Incorporation of Join-Default Analysis into Moody’s Corporate, Financial and Government Rating Methodologies, February 2005.

4 Also in line with Moody’s approach in its ‘‘Moody’s Proposes Update to Notching Corporate Instrument Ratings Based on Differences in Security and Priority of Claim’’, July 2014.

5 As stated during the 2017 OECD International Tax Conference, the OECD guidelines to be released on financing transactions will provide important guidance to multinationals on their intercompany funding, including cash pooling arrangements. The WP6 has already expressed its intention to produce extensive guidance ad-dressing guarantees. It remains to be seen which positions will be taken with respect to implicit and explicit guarantees.


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