What does OECD transfer pricing draft mean for treasurers?
18 Sep 18
The OECD’s recent draft on the transfer pricing of financial transactions may have major implications for treasurers, writes Martin Rybak
The Organisation for Economic Co-operation and Development (OECD) has recently published commentary on the transfer pricing of financial transactions. The commentary provides support for a wide range of potential outcomes.
However, it also introduces a number of concepts that may have a significant impact on how treasury teams interact with other parts of the business when implementing treasury policies.
The release of this public discussion draft on 3 July 2018 was originally mandated as a part of the OECD’s Base Erosion and Profit Shifting (BEPS) Action Plan initiated in 2013.
While final guidance is not expected until April 2019, this non-consensus discussion draft provides insight into the direction of the OECD’s thinking. Specifically, the discussion draft sets out commentary on a number of specific areas. Here, I’ll look at those areas that may represent a material change for treasurers.
Delineation of the transaction
The concept of accurate delineation for a transaction may be alien for corporate treasurers, as it considers whether a transaction should be priced in accordance with its legal form, or whether the legal form should be ignored such that the transaction is priced in accordance with its economic substance.
Typical examples of where a difference between the legal form and the substance of a transaction are likely to impact on its arm’s length price include:
- Where an intragroup loan should be regarded as equity (ie an accurate delineation as equity may render the identification of an interest rate as irrelevant and preclude an interest deduction for tax purposes); or
- Where a cash-pool deposit should be regarded as a loan, or as being part of a group netting arrangement (ie an accurate delineation as either alternative is likely to result in a different transfer pricing outcome).
Treasurers may therefore need to coordinate closely with transfer-pricing colleagues, in order to identify anomalies and ensure a consistency of methodology.
The discussion draft suggests that treasury functions are generally a support service and that strategic treasury decisions and the control of associated risks are usually undertaken at a group level, rather than being undertaken by the treasury function itself.
The inference of this is that a treasury function should only receive a limited level of remuneration.
In practice, many groups may have treated their treasury functions as controlling the risks associated with financial transactions and may therefore have provided their treasury functions with an entrepreneurial level of return (for example, the spread from intragroup lending and borrowing, or the netting benefits from pooling arrangements).
If final guidance is consistent with the discussion draft, such arrangements may attract an increased level of challenge from tax authorities across multiple territories.
Treasurers may, however, be able to proactively contribute to defending against such challenges by providing differential insight into their conduct in controlling relevant risks.
Treasury teams will be familiar with the idea of taking into account specific risk characteristics when pricing a loan (for example, credit risk, currency and tenor).
However, the discussion draft refers to pricing loans on the basis of the terms and conditions that would have been implemented at arm’s length, as opposed to simply pricing the terms in place.
An example may include pricing a loan by taking account of the security available to the borrower, as opposed to pricing the loan on an unsecured basis simply because that follows the legal form of the intragroup arrangement.
A further area of potential change for treasurers is the expectation that a borrower’s strategic importance within a group should be taken into account. The idea here is that a borrower of more strategic importance to a group will enjoy a greater level of support from its group.
The discussion draft suggests that treasury functions are generally a support service
As a consequence, even without any legally enforceable support (ie an explicit guarantee), a lender would recognise a perceived enhancement in risk profile by providing debt at a lower rate of interest.
The discussion draft also states that transactions should be considered from the perspective of the options realistically available to each of the relevant parties.
In the context of the options realistically available to group companies, these may in practice be restricted by group treasury policy. This may pose challenges in the context of each group company being treated as if it is operating at arm’s length.
For example, if an overseas subsidiary could earn a higher return by placing a deposit with a third party than it would by placing the deposit with the group’s treasury company, a local tax authority may challenge why the subsidiary is not receiving the higher rate of return available in the market.
Cash pooling and captive insurance arrangements
Cash pooling and captive insurance transactions are cited as examples of where arrangements should be looked at in their totality. Specifically, the discussion draft recognises that the benefits of such arrangements are only achieved by the coordinated action of group members.
In practice, the pricing of many such arrangements may have resulted in the majority of any benefits being allocated to the leader of the arrangements.
As such, the discussion draft infers that analysis may be needed to determine the extent to which the pricing of such arrangements should be revised to allocate the majority of any benefits between group participants.
The discussion draft recognises that the decision to hedge or not may be influenced by group policy and that situations arise where a multinational group is hedged on a consolidated basis but that, at a particular entity level, it is left unhedged. The OECD has sought feedback on how an entity in this position should be compensated.
The discussion draft introduces the concept that, where a guarantee enables a higher level of borrowing, the portion of the loan that has only been advanced as a result of the guarantee may be viewed as a loan from the lender to the guarantor and an equity contribution from the guarantor to the borrower.
The OECD has sought feedback on this concept and on the pricing of cross guarantees. As such arrangements may not have been given considered by existing treasury policies, further coordinated review may be required.
The OECD discussion draft has significant implications for the transfer pricing of intragroup financial transactions and for the remuneration supportable for the treasury functions of a wide range of multinational groups.
Given the complexity and variety of approaches that treasurers take to such transactions, the opportunity to influence the final output of the OECD may be welcomed.
However, to ensure that the pricing of financial transactions and the level of return for a treasury function are both supportable as being consistent with transfer pricing principles, treasurers should work with tax, legal, accounting and operational teams to:
- Monitor related developments from both the OECD and local tax authorities;
- By reference to the discussion draft, review existing arrangements to identify areas of potential inconsistency;
- Consider whether apparent inconsistencies can be rectified i) prospectively by making substantive changes in conduct with regard to the control of risks; or ii) retrospectively where existing arrangements simply need to be more rigorously documented;
- Design and implement practical treasury policies for intragroup financial transactions that are based on commercial reality and that related legal agreements capture this consistently;
- Ensure that transfer-pricing outcomes are aligned with the underlying policies and that robust empirical support for the pricing methodology is documented consistently; and
- Take steps to ensure that a coordinated strategy is in place to manage the risks posed by the types of challenges that may be anticipated from tax authorities in multiple territories.
About the author
Martin Rybak is an associate partner at EY, specialising in financial transactions transfer pricing