New OECD guidelines on intra-group financial transactions

New OECD guidelines on financial transactions

In recent years, intra-group financial transactions have been increasingly scrutinized in tax audits.

Marc Oliver Birmans

Director, Tax

KPMG AG Wirtschaftsprüfungsgesellschaft


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New OECD guidelines

Push-back by the tax authorities often leads to substantial additional taxes and double taxation.

On 11 February 2020, the OECD published the long-awaited guidelines on financial transactions. This is the first time that multinational groups are provided with global OECD guidelines on how to structure and price intra-group financial transactions.

In over 40 pages the guidelines cover various areas – from loans and cash pooling to guarantees, hedging and captive insurance.

In this article, we highlight three core aspects.

At arm’s length-conditions: a closer look

Up to now, many companies and tax audits merely focused on the appropriateness of the transfer prices – e.g. the interest rate. In the future, companies will also have to answer the following questions:

  1. Is the capital provided to be classified as debt? 
  2. Are the other contractual terms and conditions at arm’s length?

To answer these questions, the perspectives of both the lender and the borrower need to be considered. 

  • Does the lender has sufficient economic substance and financial capacity? In other words, does the lender has the personnel to manage the corresponding risks? And is there enough equity to bear the risks? 
  • Based on the liquidity and business plan, can the taxpayer demonstrate that the borrower was able to service the debt, i.e. the amortization charge and the interest from the very beginning? Which debt-to-equity ratio is appropriate? Why did both parties agree on an unsecured loan and did not include any existing collaterals of the borrower in the arrangement? Are prepayment options for the borrower at any time generally arm’s length?

Credit Rating

The main question arising when pricing most financial transactions is how the borrower’s or guarantor’s creditworthiness can be determined. It is generally agreed that this is done by a credit rating analysis. However, a wide range of rating approaches have been observed in practice – these range from a standardized group rating applied to all group companies, over the individual stand-alone ratings to ratings reflecting implicit group support effects, the so-called "halo effect".

The OECD guidelines state what taxpayers should consider when determining individual ratings. In particular, they focus on the effects of implicit group support – for example, driven by the strategic importance of a particular group company. 

In addition, the OECD clarifies that the credit rating of a specific financial instrument may differ from the issue credit rating of the receiving group entity.

Cash pooling

In many cash pools, the intra-group debit and credit rates are set similar to the market rates that the cash pool leader has agreed with a bank. This results in a large spread between debit and credit rates, and therefore in a netting profit for the cash pool leader. From a tax perspective, a main question is whether and how the cash pool participants should benefit from saving bank interest payments and such netting profits.

The OECD guidelines recommends that cash pools should be analyzed holistically. 

  • The key focus point should be on how the netting profits are distributed to cash pool participants. The interest rates agreed for the cash pool should explicitly not be compared with current account and lending interest rates from third-party transactions, instead the benefits of cash pooling should result in more advantageous interest rates for the cash pool participants.
  • Further, a cash pool manager should generally only perform a coordination role and accordingly, should only be entitled to a limited remuneration i.e. the cash pool leader should not earn most of the cash pool benefits. If the functional and risk analysis demonstrates that the cash pool leader bears economically significant risks (especially liquidity, credit and currency risks), the cash pool leader can continue to receive a larger part of the cash pool benefits as remuneration. This requires sufficient economic substance on the part of the cash pool leader, resulting from the people functions performed on the one hand and the capital (equity) employed on the other hand. 

Furthermore, in line with the ConocoPhilips case law in Norway, the OECD confirms that long-term balances in the cash pool should be priced like longer-term loans.

Our recommendations

The OECD's publication could be the ideal external trigger for treasury managers to review the contractual, economic and pricing arrangements of the various business relationships in intra-group financing together with their colleagues from the tax department in course of FY 2020. 

Our recommendation is to design transfer pricing guidelines that help the treasury department to implement a pricing logic in its day-to-day business that is appropriate from a tax perspective and simultaneously reducing the administrative workload for the tax department in preparing transfer pricing compliance documentation for treasury transactions. 

Our experts are happy to assist you with this endeavor.

Source: KPMG Corporate Treasury News, Edition 99, March 2020

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