Navigating intercompany financing in 2024

April 2024
6 min read

An update on the new transfer pricing regulations


In January 2022, the OECD incorporated Chapter X to the latest edition of their Transfer Pricing Guidelines, a pivotal step in regulating financial transactions globally. This addition aimed to set a global standard for transfer pricing of intercompany financial transactions, an area long scrutinized for its potential for profit shifting and tax avoidance. In the years since, we have seen various jurisdictions explicitly incorporating these principles and providing further guidance in this area. Notably, in the last year, we saw new guidance in South Africa, Germany, and the United Arab Emirates (UAE), while the Swiss and American tax authorities offered more explanations on this topic. In this article we will take you through the most important updates for the coming years.

Finding the right comparable

The arm's length principle established in the OECD Transfer Pricing Guidelines stipulates that the price applied in any intra-group transaction should be as if the parties were independent.1 This principle applies equally to financial transactions: every intra-group loan, guarantee, and cash pool should be priced in a manner that would be reasonable for independent market participants. Chapter X of the OECD Guidelines provided for the first time a detailed guidance on applying the arm's length principle to financial transactions. Since its publication, achieving arm's length pricing for financial transactions has become a significant regulatory challenge for many multinational corporations. At the same time the increased interest rates have encouraged tax authorities to pay increased attention to the topic – strengthened with the guidelines from Chapter X. 

To determine the arm’s length price of an intra-group financial transaction, the most common methodology is to search for comparable market transactions that share the characteristics of the internal transaction under analysis. For example, in terms of credit risk, maturity, currency or the presence of embedded options. In the case of financial transactions, these comparable market transactions are often loans, traded bonds, or publicly available deposit facilities. Using these comparable observations, an estimate is made on the appropriate price of a transaction as a compensation for the risk taken by either party in a transaction. The risk-adjusted rate of return incorporates the impact of the borrower’s credit rating, any security present, the time to maturity of the transaction, and any other features that are deemed relevant. This methodology has been explicitly incorporated in many publications including in the guidance from the South African Revenue Service (SARS)2 and the Administrative Principles 2023 from the German Federal Ministry of Finance.3

The recently published Corporate Tax Guide of the UAE also implements OECD Chapter X, but does not explicitly mention a preference for market instruments. Instead, the tax guide prefers the use of “comparable debt instruments” without offering examples of appropriate instruments. This nuance requires taxpayers to describe and defend their selection of instruments for each type of transaction. Although the regulation allows for comparability adjustments for differences in terms and conditions, the added complexity poses an additional challenge for many taxpayers. 

A special case of financial transaction for transfer pricing are cash pooling structures. Due to the multilateral nature of cash pools, a single benchmark study might be insufficient. OECD Chapter X introduced the principle of synergy allocation in a cash pool, where the benefits of the pool are shared between its leader and the participants of the pool based on the functions performed and risks assumed. This synergy allocation approach is also found in the recent guidance of SARS, but not in the German Administrative Principles. Instead, the German authorities suggest a cost-plus compensation for a leader of a cash pool with limited risks and functionality. Surprisingly, approaches for complex cash pooling structures such as an in-house bank are not described by the new German Administrative Principles.  

Moving towards new credit rating analyses

Before pricing an intra-group financial transaction, it is paramount to determine the credit risks attached to the transaction under analysis. This can be a challenging exercise, as the borrowing entity is rarely a stand-alone entity which has public debt outstanding or a public credit rating. As a result, corporates typically rely on a top-down or bottom-up rating analysis to estimate the appropriate credit risk in a transaction. In a top-down analysis, the credit rating is largely based on the strength of the group: the subsidiary credit rating is derived by downgrading the group rating by one or two notches. An alternative approach is the bottom-up analysis, where the stand-alone creditworthiness of the borrower is first assessed through its financial statements. Afterwards, the stand-alone credit rating is adjusted with the group’s credit rating based on the level of support that the subsidiary can derive from the group. 

The group support assessment is an important consideration in the credit rating assessment of subsidiaries. Although explicit guarantees or formal support between an entity and the group are often absent, it should still be assessed whether the entity benefits from association with the group: implicit group support. Authorities in the United States, Switzerland, and Germany have provided more insight into their views on the role of the implicit group support, all of them recognizing it as a significant factor that needs to be considered in the credit rating analysis. For instance, the American Internal Revenue Service emphasized the impact of passive association of an entity with the group in the memorandum issued in December 2023.4

The Swiss tax authorities have also stressed the importance of implicit support for rating analyses in the Q&A released in February 2024.5 In this guidance, the authorities did not only emphasize the importance of factoring the implicit group support, but also expressed a preference for the bottom-up approach. This contrasts with the top-down approach followed by many multinationals in the past, which are now encouraged to adopt a more comprehensive method aligned with the bottom-up approach.

Standardization for success

Although the standards set by the OECD have been explicitly adopted by numerous jurisdictions, the additional guidance further develops the requirements in complex transfer pricing areas. Navigating such a complex and demanding environment under increasing interest rates is a challenge for many multinational corporations. Perhaps the best advice is found in the German publication: in its Administrative Principles, it is stressed that the transfer price determination should occur before completion of the transaction and the guidelines prefer a standardized methodology. To get a head start, it is important to put in place an easy to execute process for intra-group financial transactions with comprehensive transfer pricing documentation.  

Despite the complexity of the topic involved, such a standardized method will always be easier to defend. One thing is for certain: the details of transfer pricing studies for financial transactions, such as the analysis of ratings and the debt market, will continue to be a part of every transfer pricing and tax manager agenda for 2024.

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  1. Chapter X, transfer pricing guidance on financial transactions, was published in February 2020 and incorporated in the 2022 edition of the OECD TP Guidelines. ↩︎
  2. Interpretation Note 127 issued in 17 January 2023 by the South African Revenue Service.  ↩︎
  3. Administrative Principles on Transfer Pricing issued by the German Ministry of Finance, published on 6 June 2023.  ↩︎
  4. Memorandum (AM 2023-008) issued on 19 December 2023 by the US Internal Revenue Service (IRS) Deputy Associate Chief Counsel on Effect of Group membership on Financial Transactions under Section 482 and Treas. Reg. § 1.482-2(a). ↩︎
  5. Practical Q&A Guidance published on 23 February 2024 by the Swiss Federal Tax Authorities.   ↩︎
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