The OECD’s much-anticipated Transfer Pricing Guidance on Financial Transactions will form a new Chapter X of the Transfer Pricing Guidelines (TPG) and will add a new section to Chapter I on risk-free and risk-adjusted rates of return.
The OECD intends for the guidance, which applies the arm’s length principle to financial transactions of associated enterprises, to aid consistency in the application of transfer pricing which will reduce transfer pricing disputes and double taxation.
This is the first time that such guidance has been provided and it has proved quite challenging for the OECD to get consensus on some aspects. Some compromises have inevitably been made along the way, such as not seeking to mandate delineation under Chapter I of the TPG as the only approach for determining whether purported debt should be respected as debt; and clarifying that the guidance does not prevent countries from using domestic legislation to address issues of capital structure and interest deductibility.
There is plenty to think about in the guidance. I have highlighted three areas below.
Credit rating and implicit support
The 2018 discussion draft explored whether there should be a rebuttable presumption that the group's credit rating should apply to every member of the group. The final guidance recognises, quite sensibly, that although in some circumstances it might be appropriate to apply the group’s credit rating to an individual MNE, in others it will be more appropriate to use the MNE’s stand-alone credit rating and adjust for implicit support.
Implicit support (the incidental benefit an MNE is assumed to receive solely by virtue of group affiliation) raises tricky issues. When considering whether adjustments should be made to a stand-alone credit rating for implicit support, the guidance suggests taking into account the relative importance of the entity to the MNE group as a whole and the linkages between the entity and the rest of the MNE group. The guidance notes that the impact of an assessment of implicit support is a matter of judgment and that the information on which the MNE group would base a decision whether to provide support to an entity in particular circumstances may not be available. Indeed, there may be no decision by the MNE group itself until the eventuality for such support arises.
The guidance notes that cash pooling (either physically or notionally bringing together the balances on a number of separate bank accounts) is popular among MNEs and brings a number of advantages to the group. There is no “one size fits all” approach and the accurate delineation of cash pooling transactions will depend on the facts and circumstances of each case. It is essential to examine, under Chapter I guidance, the economically significant risks associated to the cash pooling arrangement (including liquidity risk and credit risk), taking into account the short-term nature of the credit and debit positions within the cash pool arrangement.
The concern with captive insurance is whether the captive is just a dressed-up cashbox or whether it is undertaking a genuine insurance business. The 2018 discussion draft provided that a captive which does not diversify by insuring non-group risk, or by reinsuring out of the group, may not be found to undertake a genuine insurance business. The final guidance, however, recognises the possibility of internal risk diversification, although it notes this may generate lower capital efficiencies than those achieved through external risk diversification.
This guidance is significant because it is the first time the Guidelines will be updated to include guidance on the transfer pricing aspects of financial transactions, which should contribute to consistency in the application of transfer pricing and help avoid transfer pricing disputes and double taxation.