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Mitigate transfer pricing issues

LIBOR phaseout: Mitigate transfer pricing issues

Mitigate transfer pricing issues

Jonathan Bernsen | Partner,

The LIBOR transition impacts tax and transfer pricing (TP) related documentation, agreements and systems enablement. Successfully mitigating this impact requires planning and the joint effort of internal and external stakeholders. Our third blog in this series looks at which issues to consider.

Challenges from a purely transfer pricing perspective

In this series of three blogs, we began by offering a timeline to prepare for the LIBOR transition and discussed the importance of assessing the transition’s impact with a coordinated approach between both internal and external stakeholders.

Our second blog identified some of the key transfer pricing challenges that you’ll face on the way to the deadline in 2021. In this final blog of the series, we’ll continue to look at specific transfer pricing challenges arising from the LIBOR transition.

Which LIBOR-related tax / transfer pricing questions are likely to pose challenges?

1. Different RFRs

The new risk-free rates set to replace LIBOR are known for all five major currencies – although the rate’s characteristics differ. Most notably, the USD (SOFR) and CHF (SARON) rates are based on the market of secured overnight funds, while GBP (SONIA), EUR (ESTER) and JPY (TONE) are based on the market of unsecured overnight funds.

It’s essential to consider the price component of secured funds vs unsecured funds for the LIBOR transition. And to continuously monitor these for any multicurrency arrangements where parties rely on more than one of the listed new RFRs. One way to cover the gap between LIBOR and one of the new RFRs is monitoring the spread between the curves and adjusting the applied margin over the reference rate to counter the impact of the transition. However, there may be other adjustments required, depending on the nature of the arrangement.

2. Credit risk in RFR

LIBOR rates inherently represented the credit risk of the borrowing banks. This characteristic will disappear with the introduction of the new RFRs, which is one of the reasons for RFR rates being lower than LIBOR for the same period.

This difference can serve as an argument for one-off revaluation should a simple change of reference rate be applied for the LIBOR transition. We recommend mitigating such risk preemptively by observing and planning for the potential impact before the new RFP’s introduction.

3. Term RFR

Although the O/N RFRs are already known, their term structures are still being defined. For certain currencies such as the USD, the forward-looking term-rate may not be set before the end of 2021. Comparatively, the National Working Group (NWG) has decided that a derivate-based term fixing is not possible for other currencies such as the CHF, and the use of compounded RFR (SARON) is recommended.

We suggest monitoring the development of the various term fixings and assessing the operational complexities that the various alternatives would generate for your organization.

What are the next steps?

1. Finalize your impact assessment and identify which areas are a priority based on both urgency and importance.
2. Prepare a timeline for the initiatives necessary to mitigate the LIBOR transition’s impact and coordinate the efforts of other teams affected by the transition (Treasury, Legal, etc.)

For further information, read the following articles: