Financial transaction guidance from the Organisation for Economic Cooperation and Development (OECD) concerns entities that have international related-party dealings involving financial transactions, treasury services, guarantees, and captive insurance arrangements. The OECD transfer pricing guidance requires taxpayers to revisit intra-group financial transactions.
Yesterday’s TaxNewsFlash discussed the relevance of the transfer pricing guidance to Australian businesses, and explored the guidance relating to debt and funding arrangements.
The following discussion examines treasury functions relating to intra-group loans, cash pooling, financial guarantees, and captive insurance, and outlines some key actions for taxpayers.
As a general proposition, the OECD considers that treasury services will typically be considered a “support service” role (p10.45), which lends itself to a “cost plus” pricing arrangement. This is particularly the case for cash pool arrangements.
The OECD guidance acknowledges there may be instances when pricing could be based on third-party reference points and uses an example of when treasury is also responsible for raising third party/external funds.
Within the treasury section, the guidance also discusses pricing of intra-group loans. It notes credit rating analysis will typically be useful for determining the credit risk of a borrower, and highlights that both quantitative and qualitative factors need to be considered. Given the subjective evidence that is often considered for credit rating analyses (particularly with respect to qualitative factors), it highlights the need to undertake corroborative analyses when relevant.
Consistent with industry practice, the OECD guidance suggests implicit support is a relevant factor to consider for benchmarking an intra-group loan. This is in line with the findings in Chevron Australia Holdings Pty Ltd v. Commissioner of Taxation  FCAFC 62, which considers that the Australian taxpayer is not to be treated as an “orphan.” However, note that case law both in Australia and around the world generally placed a low value on implicit support.
The comparable uncontrolled price (CUP) will typically be the most frequent method for benchmarking loans, and a (narrow) range of results may be an appropriate outcome, as outlined in the OECD guidance. Further, for ancillary costs (such as upfront fees), care needs to be taken as to whether these are comparable for the tested transaction (i.e., the tested agreement might not have such costs incurred with respect to the provision of that finance).
Beyond the CUP method, other benchmarking approaches considered include the cost of funds (albeit the OECD guidelines do recognise that average group cost of funds is likely not an appropriate pricing reference—which may be seen by some as discounting current ATO practice), credit default swaps, and economic modelling (valuations). Bank opinions/quotes are not considered a reliable source for benchmarking purposes (p10.108).
According to the OECD guidance, careful consideration is required regarding cash pooling, including when a cash deposit is to be considered as something else—for example, a long-term loan.
The OECD guidance states that entering into a cash pool would not make the participant worse off than the realistic alternative, and if the cash pool leader is only doing coordination activities (and is not controlling or bearing key risks such as credit risk), then a routine service fee would typically apply. Further, consideration may be required as to whether the participant would benefit from any group synergies. At a practical level, this would be difficult to measure due to issues such as information availability.
The OECD guidance notes that the provision of a guarantee would provide a benefit to the guaranteed entity. Further, the benefit for which a guarantee fee would need to adjust for any implicit support.
Other key issues that need to be considered, as outlined in the OECD guidance, would include the purposes of the guarantee. For example, a guarantee to increase borrowing amount may be (to some degree) a contribution of equity. The financial capacity of the guarantor also needs to be accounted for.
A variety of options are put forward for pricing guarantees including a CUP method, yield approach, cost approach, an expected loss approach, and a capital support approach.
The OECD guidance provides (p10.199) a number of factors that may help support that a captive insurance entity is one of substance. This includes evidence of diversification and pooling of risk, the degree of regulation present, and the skills and experience of the captive insurance provider. It also highlights a number of potential pricing approaches for benchmarking captive insurance including CUPs, profitability analyses, and group synergy considerations.
Given this new guidance will be incorporated in Australian transfer pricing law, taxpayers need to consider examining their intra-group financial transactions to:
For more information, contact a tax professional with KPMG’s Global Transfer Pricing Services practice in Australia:
Tim Keeling | +61 2 9455 9853 | email@example.com
Jane Rolfe | +61 3 9288 6341 | firstname.lastname@example.org
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