Conor O'Sullivan and Neil Casey of our Transfer Pricing team examine below the notable TP developments during 2020 that Irish business should be considering.
New Irish TP rules, enacted by Finance Act 2019, took effect for accounting periods commencing on or after 1 January 2020.
The principal aspects of the new Irish TP rules include:
The inclusion of ‘non-trading’ transactions and previously ‘grandfathered’ transactions within the scope of Irish TP rules has had a substantial impact in respect of financial transactions.
Furthermore, in February 2020, the OECD augmented the 2017 OECD TP Guidelines with Guidance on Financial Transactions (OECD FT Guidance).
This new guidance is directly applicable to any transaction covered under Ireland’s international tax treaties but is not yet formally introduced into Irish law for domestic transactions. Irish Revenue has indicated an intention to consider this OECD FT Guidance in their review of loan and other similar financing arrangements and it is expected this will be made explicit when the Revenue’s guidance on transfer pricing is issued later this year.
An appropriate amount of debt is a concept that is used by some countries to restrict the amount of intra-group funding that for tax purposes qualifies for an interest deduction. If the recipient has too much debt and too little equity capital, then it may be deemed to be thinly capitalised and the debt may be reduced for tax purposes to an amount that is deemed more appropriate.
Ireland has never had thin capitalisation or other specific rules restricting, for tax purposes, the amount of debt a company could borrow or the amount of interest that could be paid.
The 2017 OECD TP Guidelines now introduced into Irish law require a consideration of the quantum of debt that a taxpayer has borrowed and not merely the rate of interest applicable to the loan. This is a matter of most relevance to highly-geared structures.
There is an ongoing debate as to what the 2017 OECD TP Guidelines mean for companies with high levels of debt. There has been suggestion that there is a ‘right’ amount of debt that a company can borrow. It has been claimed that the appropriate amount of debt is measured under the arm’s length principle by referencing the debt to equity ratios of unrelated borrowers. Such gearing ratios simply derive from unrelated borrowers that took on an amount of debt at a price they were willing to pay, but the observed gearing does not provide a basis for claiming that the debt was an appropriate amount. The observed gearing does not show that unrelated borrowers could not have obtained more debt, or that unrelated lenders were not prepared to lend higher amounts.
Our view is that the 2017 OECD TP Guidelines are clear and should be applied to highly geared companies as follows. If a loan arrangement has the legal and economic characteristics of debt, if it is commercially rational, and if it can be priced, then it should be priced as debt regardless of any perceived ‘right’ amount of debt in the group/sector. This process of accurate delineation of a loan transaction as debt or equity requires assessing the amount of debt that could (as opposed to would), in the circumstances, be borrowed from a third party.
There are established TP practices that taxpayers and experienced TP practitioners can rely on to conduct this assessment. The availability and reliability of data used to conduct this assessment will be critical to taxpayers defending their position. This assessment needs to be conducted for all existing and future loan transactions.
The OECD FT Guidance introduces a wide range of additional considerations which must be applied to financial transactions in general. Few of these concepts are new to experienced TP practitioners, but they represent a substantial body of new considerations from an Irish TP perspective.
As discussed above, this guidance directly applies in the case of treaty transactions and we understand will now also be applied in practice by Revenue to all domestic and non-treaty transactions.
Pricing loan transactions will need to be based on a more rigorous analysis using tools such as loan benchmarking and credit rating agency models to determine standalone credit ratings etc. The use of indicative quotes from banks is discouraged. Groups will also need to adequately consider the concept of ‘implicit support’ in establishing credit ratings and hence interest rates for borrower entities.
In addition, the various other financial transactions which arise, such as financial guarantee arrangements, cash pooling, treasury activities, and captive arrangements will require accurate delineation and pricing.
One particular area of interest to Irish taxpayers relates to treasury functions, including cash pooling, which have been a focus for a number of European tax administrations. The guidance contains a normative presumption that treasury activities are usually a support service, unless they can be shown to be bearing and controlling financial risk. Assessing the appropriate characterisation and pricing for such entities should therefore be prioritised.
The impact of COVID-19 has been felt across all aspects of Irish business. As a result of these serious challenges, many companies have needed to collaborate and renegotiate with key suppliers and customers to find mutually beneficial ways of maintaining supply and servicing demand. As groups continue to respond to these external challenges and key business relationships, it is also becoming clear there is a need to review, suspend or temporarily modify existing intra-group transfer pricing arrangements – not least because it reflects how third parties are behaving in these circumstances.
Due to the largely unforeseen and uncontrollable nature of the crisis, it is appropriate to revisit all TP arrangements to address issues that are arising in relation to supply chain reconfiguration, liquidity/cash flow management, capacity planning and ‘right-sizing’, workforce management etc.
Depending on the circumstances, it may be appropriate that significant exposure to market shock and associated costs or losses are shared proportionately across the group. The options available vary according to the specific facts and circumstances.