More than 18 months after the publication of its non-consensus discussion draft on Financial Transactions (BEPS Actions 8 – 10), the OECD released its ‘final’ report on the transfer pricing of financial transactions on Tuesday 11 February 2020. The original draft left some 25 areas of disagreement, representing a non-consensus position of the OECD’s Committee on Fiscal Affairs. While those areas are largely resolved by the guidance, there remain some issues that have not been definitively addressed.
The guidance is significant because it is the first time the OECD Transfer Pricing Guidelines will be updated to cover the transfer pricing aspects of financial transactions. The guidance addresses specific issues on:
The OECD’s new guidance is designed to improve international consistency in the transfer pricing of financial transactions by promoting a set of common standards and to reduce the risk of double taxation. It should certainly reduce risk in many areas and is to be hugely welcomed.
However, there also remain some contentious areas, leaving scope for controversy between countries, and leaving taxpayers with some difficult choices on their approach to pricing and structuring financing transactions. In addition, following the new guidance will require a higher level of documentation and analysis than some groups might historically have expected. We address some of these challenges below.
In addition to transfer pricing, many jurisdictions now use prescriptive (and often mechanical) tax rules reflecting BEPS Action 4, e.g. Corporate Interest Restriction and anti-hybrid mismatch provisions. These can potentially give rise to situations where a company in one country will be taxed on arm’s length interest income, but the borrower in another country will not be able to deduct interest due to a mechanical interest limit. Therefore, a holistic approach to the analysis of the characterisation and pricing of financing transactions is critical to map the impact on group profitability.
Many will regard the level of analysis set out for financial transactions under this new guidance as highly demanding. The emphasis it places on risk management within a finance structure and its economic rationale could also cause some practical challenges with establishing and supporting appropriate pricing. However, the expectations outlined by the guidelines set a clear standard for taxpayers and, for the first time, provide tax authorities with reasonably clear guidance on how to scrutinise the transfer pricing of financial transactions. As a result, we expect tax authorities will increasingly challenge groups’ financial arrangements.
Taxpayers should begin preparing for this increased scrutiny now to avoid the risk of tax adjustments and penalties, economic double taxation and accounting provisions for uncertain tax positions, not to mention the cost of deploying internal and external resource to handle associated tax enquiries. Failing to prepare will also expose the business to the reputational risks that can easily arise from major tax disputes and financial adjustments.
There are a wide range of factors to consider when dealing with policies and pricing of cross-border financing transactions. We can help you analyse your ‘facts and circumstances’ to find the right solution for your group.
BDO has deep experience and capability in this challenging area of transfer pricing. We can help you determine an appropriate supportable range of arm’s length pricing outcomes for related party debt, guarantee fees, cash pooling arrangements, factoring and other financial arrangements. We can also advise on appropriate structures for financing arrangements, prepare supportive ‘fit–for–purpose’ documentation, and advise on managing transfer pricing disputes.
We use a wide range of credit scoring capabilities and pricing tools to give best in class support for your transfer pricing of all financing transactions and can help you reconcile differing approaches taken by tax authorities globally.
Our financing transactions transfer pricing specialists around the world are also fully versed in the application of hybrid mismatch provisions, corporate interest limitation rules, withholding taxes and CFC and other anti-avoidance rules, so can provide you with the fully considered analysis, and solutions, you need.