The OECD releases its report on the transfer pricing aspects of financial transactions
The OECD has released a final report with guidance on the transfer pricing aspects of financial transactions. The guidance, which will be included in the OECD Transfer Pricing Guidelines, addresses the transfer pricing aspects of financial transactions and includes illustrative examples. This new guidance focuses on the following areas:
Taxpayers should welcome this new guidance, since it may promote more consistent interpretations of the arm's-length principle in relation to financial transactions. As a result, taxpayers should review their current transfer pricing policies, arrangements and analysis of financial transactions to assess whether there are any inconsistencies with the finalized OECD guidance.
The OECD released a discussion draft in 2018 that focused on the transfer pricing aspects of financial transactions. This draft was based on a BEPS Actions 8-10 report released in 2015 that identified the need for follow-up work on the transfer pricing aspects of financial transactions.
This 2018 discussion draft clarified several principles from the 2017 edition of the OECD Transfer Pricing Guidelines, and discussed economically relevant characteristics that should be considered when analyzing the terms and conditions of financial transactions. In addition, the report addressed specific issues related to the pricing of financial transactions, including treasury functions and intra-group loans, among others.
Interaction with the Transfer Pricing Guidelines
In the report, the OECD provides guidance on applying the principles in Section D.1 of Chapter I of the Transfer Pricing Guidelines, "The Arm's-Length Principle", to financial transactions. In particular, the OECD focuses on analyzing all relevant facts and circumstances and the substance of financial transactions, through accurately delineating the transaction. This broad analysis takes into account factors including:
In the final guidance, the OECD also provides flexibility for jurisdictions to apply alternative approaches to determine an acceptable debt to equity mix.
Further, the guidance acknowledges that contractual arrangements may often not provide sufficient detail on the terms and conditions of the financial transaction. Thus, it may be necessary to look to other documents or the conduct of the parties to establish this detail.
In light of this new guidance, taxpayers are encouraged to consider whether their analysis of material financial transactions is sufficiently detailed to cover the items identified by the OECD.
Overall, taxpayers should ensure that related party loans have terms and conditions that best reflect the economic circumstances at hand and actual uses of the funds being advanced.
In addition, taxpayers should ensure that financial transaction agreements and other documents sufficiently document intended terms.
The guidance considers the functions performed and risks borne by parties to transactions, including the control of risks, which taxpayers should consider to ensure returns are aligned with risk control functions and capacity to bear financial risk. Otherwise, a reallocation of returns to the jurisdiction with the control of risk could apply.
The OECD guidance also considers credit rating analysis for intra-group loans. For this issue, the OECD places greater emphasis on ensuring qualitative factors are taken into account in credit rating analysis and ensuring that the financial data used in the credit rating analysis is not influenced by non-arm's length transactions.
The updated guidance further endorses considering implicit support when estimating the applicable credit rating for related party borrowings.
The OECD guidance on considering implicit support for credit ratings is consistent with current Canadian case law.
The OECD notes in its guidance that guarantee fees should only be payable where explicit guarantees with a legal obligation provide a party with access to lower borrowing costs after considering implicit support, and that the guarantor should have the financial capacity to bear the risk of providing the guarantee. Further, the OECD states that guarantees that are provided in lieu of additional capital contributions to a subsidiary should generally not give rise to guarantee fees.
In its new guidance, the OECD places a level of scrutiny on captive insurance arrangements. In particular, the OECD focuses on whether control of risk occurs and whether there has been a genuine undertaking of an insurance business by the captive.
For more information, contact your KPMG advisor.
Information is current to February 18, 2020. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500
© 2020 KPMG LLP, a Canada limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
KPMG International Cooperative (“KPMG International”) is a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.