Introduction

Intra-group financial transactions attract the attention of tax administrations because they are increasingly perceived to lead to base erosion and profit shifting (BEPS), for example through the use of excessive interest payments on related-party or third-party debt. 

The existing guidance on transfer pricing aspects of financial transactions is relatively limited. The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines) do not yet include a separate chapter on financial transactions. However, the general transfer pricing principles outlined in the OECD Guidelines do apply to financial transactions. In order to determine the consequences of intra-group finance transactions, countries use, among others, the following rules: (i) thin capitalization rules, (ii) debt-to-equity ratios and (iii) guidance on when capital should be regarded as debt or equity or when interest should be reclassified as a dividend. Each of these rules is applied alongside the general or specific transfer pricing rules. 

In response to the problems posed by BEPS, the OECD published its OECD BEPS Action Reports. In one way or another, the reports on Actions 2, 4, 5, 6, 9 and 13 may impact MNEs who deal with intra-group financing transactions. A number of these final reports relate directly or indirectly to transfer pricing. The author will deal with Actions 9 and 13. 

Action 9

The report on Action 9 of the BEPS project seeks to ensure that transfer pricing outcomes are in line with value creation. Action 9 provides guidance with respect to the allocation of risk. The OECD introduced, among others, the following six-step approach with regard to risk:

(1)identification of economically significant risks with specificity;

(2)determination of contractual assumption of the specific risk;

(3)functional analysis in relation to risk;

(4)interpreting Steps 1 through 3;

(5)allocation of risk; and

(6)pricing the transactions, taking into account the allocation of risks.

Step 1 concerns the identification of economically significant risks. The significance of a risk depends on the likelihood and size of the potential profits or loss arising from the risk.

Step 2 relates to the contractual assumption of risks. The type of risk that is assumed and the party or parties assuming the risks would typically be laid down in a contract. This must be in line with the relevant substance and people functions. The contract should, for example, provide the relevant details to this arrangement and how particular risks are managed and mitigated by the treasury company and for the local entity, potentially in combination with agreements with other related or unrelated parties.

Step 3 concerns the functional analysis with regard to risk. It is important to understand the roles and people functions undertaken at the level of the parent, the subsidiaries and the treasury company, especially as they relate to control over risks. Further, it is important to examine which party to the transactions has the financial capacity to assume the risks identified in Step 1 (this could, for example, be market price risk, counterparty credit risk, liquidity risk and settlement risk).

Step 4 involves an analysis of whether the conduct of the parties to the transaction is in line with the contract. If this is not the case, the conduct of parties will prevail over the contract. In a second step (i.e. once the party assuming the risk has been identified), one must determine whether the party assuming the risk does in fact exercise control over the risk and has the financial capacity to assume the risk. If so, the transfer pricing analysis can move directly to Step 6 (pricing). If not, an additional Step 5 is required. 

Action 13 

On 5 October 2015, the OECD published its final report under Action 13 on transfer pricing documentation and country-by country reporting (the Action 13 Final Report). Many countries have already adopted a number of the new requirements in various forms, and other countries have drafted legislation or have the intention to draft legislation. 

Country-by-country reporting encompasses a three-tiered approach to transfer pricing documentation that should consist of:

–a master transfer pricing file containing standardized information relevant for all MNE group members. The master transfer pricing file should provide among others the MNE’s intercompany financial activities. This means that, in short, a general description of how the group is financed should be provided. In addition, the members of the MNE group that provide a central financing function should be identified and a general description of the MNE’s general transfer pricing policies related to financing arrangements between associated enterprises should be provided;

–a local transfer pricing file referring specifically to material transactions of the local taxpayer. The local transfer pricing file should provide more detailed information relating to specific intercompany transactions. The specific information is listed in Annex 2 of the country-by-country report; and

–a country-by-country report containing certain information relating to the global allocation of the MNE’s income and taxes paid, together with certain indicators of the location of economic activity within the MNE group. This applies only for MNEs with a global turnover over EUR 750 million.

It is important that the information provided in the master file, local files and country-by-country file is aligned. Tax authorities may ask questions when information provided in a local file deviates from the information in the country-by-country report or another file. Legal agreements should also be part of the documentation related to intra-group financing transactions. However, it is essential that the risks laid down in these agreements, the division of the risks, the assumption of the risks, the control over the risks and the financial capacity to assume the risks reflect the actual intent and conduct of parties. 

Conclusion

MNEs not only need to keep track of the transfer pricing rules when dealing with intra-group financing transactions. As we have seen, countries make use of other rules when determining the consequences of intra-group finance transactions. When it comes to Actions 9 and 13, it is important for MNEs to, among others:

–develop or review their transfer pricing policy for intra-group financing transactions to ensure a global and consistent transfer pricing approach and pricing across jurisdictions; 

–prepare and/or update legal agreements; and 

–cover intra-group financing transactions in transfer pricing documentation, both in the master file and local files.