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Are your financial transactions BEPS-proof?

  • Erika van Everdingen, Expert |

The release of the OECD paper on financial transactions ("Paper") earlier this year and the COVID-19 pandemic have put more emphasis on the importance of the internal treasury function and the resulting intercompany transactions. The scarcity of cash has increased the importance of internal treasury to manage cash and disburse funds (quickly) throughout the Group, resulting in a more heavy reliance on intercompany financing and increased activity in this area.

Now that we are getting accustomed to the "new normal" is an excellent time to take a step back and review these transactions to ensure their compliance with BEPS requirements as set out in the Paper.

The release of the OECD paper on financial transactions ("Paper") earlier this year and the COVID-19 pandemic have put more emphasis on the importance of the internal treasury function and the resulting intercompany transactions. The scarcity of cash has increased the importance of internal treasury to manage cash and disburse funds (quickly) throughout the Group, resulting in a more heavy reliance on intercompany financing and increased activity in this area.

Now that we are getting accustomed to the "new normal" is an excellent time to take a step back and review these transactions to ensure their compliance with BEPS requirements as set out in the Paper.

What is the Paper all about?

  • It is not only about the arm's length character of the interest rate.
  • Before anything else, it has to be established whether the disbursement can be qualified as a loan or equity.
  • This requires accurate delineation of a financial transaction, mainly focusing on:
    • the terms and conditions underlying the transaction; and
    • the functional analysis describing the functions performed, assets used, and risks assumed by each of the parties to the transaction.
  • The above needs to be supported by economic analyses following a two-sided approach (i.e., from lender's and borrower's perspective) focusing on:
    • the quantum of the loan, i.e., showing that the borrower can service the loan; and
    • the interest applied.
  • The most appropriate method to price intercompany financial transactions is the CUP (comparable uncontrolled price) method, acknowledging that, in some instances, the cost-of-funding method might also be an alternative.

The Paper not only focuses on loans, but also provides specific guidance on the internal treasury function, guarantees, cash pools and captive insurance. Tax Authorities are already picking up on this, and we see an increase in audit activity across all regions when it comes to financial transactions. Overall, most European countries are in alignment with the new guidance, with some exceptions, such as Germany.

How to know whether you are on the right road

Based on the above, here are some key questions that you need to ask yourself to quickly evaluate your position:

Does my transfer pricing process covering financial transactions include:
 

  1. Functional analysis and substantiation of the key terms and conditions used?
  2. Analyses supporting the quantum of the debt?
  3. A two-sided approach, outlining the options realistically available to both parties?

If the answer to any of the above questions is no, it is probably a good time to perform a high-level review of your financial transactions set-up. This will allow you to identify any opportunities and gaps and ensure compliance with the Paper.

Conclusion

Although it may seem that BEPS has taken a bit of a back-seat in comparison to COVID-19, companies should not be fooled into this thinking. Cash-starved Tax Authorities are not letting untapped revenue go by and will start to look into this sooner rather than later. Whilst it may seem onerous at first, once the process is set up properly, it is easy to follow and will keep companies on the straight and narrow. Staff-starved Treasuries may wish to get external help and even larger Treasuries may feel more comfortable signing on external help until they are set up correctly.

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