Background
On February 11 of this year, the Organization for Economic Cooperation and Development (OECD) published transfer pricing guidelines aimed at regulating financial transactions between related parties. The publication of these guidelines aligns with Actions 4 (limiting base erosion through interest deductions and other financial payments) and 8 to 10 (aligning transfer pricing with value creation) of the BEPS plan. The most relevant aspects of the guidelines are as follows:
Identification of Commercial and Financial Relationships, Proper Delineation of the Transaction
From the OECD’s perspective, the transfer pricing analysis for financial transactions should begin with a broad assessment of the internal and external factors affecting the transaction. This analysis should address the circumstances impacting the parties involved (considering their best available economic alternatives) and should be guided by the elements of the traditional comparability analysis proposed in Chapter III of the Guidelines. The expected outcome is a “characterization” of the transaction as a loan (or as any other financial instrument), rather than as a contribution to equity capital— which would ultimately affect the tax treatment of the transaction and, consequently, the tax base of the taxpayers involved.
Treasury Function
Following the emphasis on the proper delineation of the transaction, the transfer pricing guidelines address specific situations, beginning with the treasury function. The OECD notes that the treasury function is organized in consideration of the multinational group’s financial strategy, based on the macro/microeconomic context the group may face. In this regard, the new guidelines demand a precise analysis of the functions performed by the treasury, rather than a general description that would hinder appropriate remuneration.
For example, activities such as debt management (bond issuance, loans…), capital management, relationships with financial institutions and rating agencies, investment return monitoring, cash flow volatility reduction, and balance ratio maintenance should be evaluated on their own merits and eventually assigned remuneration corresponding to what independent third parties would have received in comparable transactions.
Regarding this point, it is necessary to clarify that the guidelines establish that the treasury function should generally be considered a service and therefore should be remunerated based on a market price for the activity performed or simply by considering the cost-plus approach with a market margin. This should always take into account the complexity of the activities assumed and the inherent risks associated with them.
Intercompany Loans
Within the treasury function, one of the main activities—if not the most important—is financing the activities of the group entities. The transfer pricing guidelines indicate that for the arm’s length analysis of these transactions, it is necessary to consider both the lender’s and the borrower’s perspectives.
Key considerations for the lender include when to grant the loan, for what amount, under what terms, what risks are involved, how these risks will be monitored, and what measures will be taken in case they materialize.
From the borrower’s perspective, the risks associated with acquiring financing should be evaluated, particularly the availability of alternatives to intercompany financing (e.g., debt issuance, loans from third parties, convertible obligations, commercial paper, etc.), their actual ability to meet credit terms in a timely manner, and their capacity to handle external factors that may affect their ability to pay.
Once the transaction is contextualized, and to confirm its arm’s length nature, the guidelines suggest using the comparable uncontrolled price (CUP) method, considering the frequent availability of financial information on uncontrolled financial transactions. Internal comparables—transactions of a similar nature conducted by the taxpayer with independent third parties—should also be considered.
The application of the CUP method presupposes the construction of an appropriate benchmark, meaning transactions carried out with independent third parties or transactions that independent third parties would have conducted under comparable circumstances. The determination of what is or is not comparable often involves assigning a credit risk rating to the debtor. Based on this rating, the interest rate assigned to the loan should be evaluated to determine whether it is set within normal statistical parameters.
The guidelines emphasize that, while credit ratings are useful tools, certain factors may distort the analysis. The different methodologies employed by rating agencies (and their varied consideration of qualitative and quantitative factors) may lead to inconsistent ratings.
Centralized Treasury (Cash Pooling)
The guidelines begin the analysis of cash pooling operations by emphasizing that such structures typically allow a group to manage short-term cash more effectively, reduce external borrowing, achieve better returns, and ultimately eliminate excessive financing costs. The guidelines distinguish between “physical cash pooling” and “notional cash pooling.”
In physical cash pooling, all members’ cash balances are transferred daily into a single account held by the central treasury leader, and any account deficit is covered by a transfer from the master account to the sub-account. Depending on whether there is a deficit or surplus, the treasury leader may either borrow funds or invest them.
In notional cash pooling, benefits are achieved without transferring balances—though banks may require additional guarantees. The bank will pay or charge interest based on the net balances reported by the centralized treasury entities, either to the treasury leader or to each member using pre-agreed formulas.
Since independent third parties do not typically engage in such transactions, defining the arm’s length nature of cash pooling can be complex. The guidelines emphasize that the analysis should go beyond simply assessing assigned interest rates. If participants in a cash pooling arrangement benefit from deliberate group actions, a functional analysis should clarify the nature of the advantage or disadvantage, the amount of benefits or losses generated, and how these are allocated among the group members.
Financial Guarantees
The new guidelines provide considerations on the use of guarantees in intragroup transactions. A guarantee is defined as a “legally binding commitment by the guarantor to assume a specific obligation of the debtor if the debtor defaults on that obligation.”
As with all related-party transactions, a proper delineation of the transaction’s characteristics is required. For guarantees, the first step is identifying the economic benefits obtained beyond mere passive group association. This includes comfort letters issued as attempts to ensure an obligation.
For the recipient of a guarantee, its existence may allow access to better financing conditions. The guidelines clarify that remuneration for a guarantee should only exist if the guarantee actually contributes to improving the financing conditions. Otherwise, the guarantee might be considered merely an administrative service with minimal compensation.
The transfer pricing guidelines suggest using the comparable uncontrolled price (CUP) method for determining the arm’s length nature of guarantees, considering the availability of internal and external comparables. The assessment should factor in the debtor’s credit profile, the guarantee’s terms and conditions, the guaranteed credit terms (amount, term, rate, currency, maturity), credit spread between the guarantor and debtor, market conditions, etc.
Risk-Free and Risk-Adjusted Rates
The last section of the transfer pricing guidelines addresses the arm’s length nature of risk-free rates and risk-adjusted rates. The guidelines state that when a creditor in a related-party financial transaction lacks the capacity or control over the risk associated with the investment, it should not earn a return higher than the risk-free rate.
Risk-free rates refer to the hypothetical return demanded on an asset that has no risk of loss. While no asset is truly risk-free, government bonds are commonly used as a close approximation. Depending on the circumstances, interbank rates, interest rate swaps, or government repurchase agreements may also be acceptable approximations.
When an entity controls only the financial risk of an investment but no other risks, its remuneration should consist of the risk-free rate plus a risk premium. The guidelines recommend using indicators derived from third-party transactions to determine appropriate risk-adjusted returns.
[1] Jesús Aldrin Rojas. Socio Líder. QCG Transfer Pricing Practice
[2] https://www.oecd.org/tax/beps/oecd-releases-transfer-pricing-guidance-on-financial-transactions.htm
[3] Aprecio la colaboración de José Chamorro y Esteban Ollervides en la discusión de las secciones de aseguramiento cautivo y tasas libres de riesgo.
