The Organisation for Economic Co-operation and Development (OECD) released its final report with transfer pricing guidance on financial transactions on 11 February 2020. The report discusses the application of the principles included in the 2017 edition of the OECD Transfer Pricing Guidelines (TPG).
This is the first time that guidance on financial transactions is included in the TPG and it should help to reduce transfer pricing disputes and double taxation.
Key Takeaways from the Finnish perspective
- The report discusses the delineation of financial transactions, and potential re-characterisation of debt into equity. The relevance of this section is limited in Finland due to the scope of the current TP adjustment provision and case law from Supreme Administrative Court.
- The report highlights that implicit support from being part of a group should be considered in an MNE’s credit rating. This may change the way finance transactions have been priced in Finland.
- The use of holding entities in financing structures is under pressure, potentially also in M&A transactions. For example, entities without functional substance and the ability to control the risk over lending may not be entitled to the respective interest income.
Summary of the report
The report focuses, among other things, on the accurate delineation of financial transactions and specific issues related to the pricing of financial transactions, such as intra-group loans, cash pooling, and guarantees for example. Furthermore, it provides guidance on the determination of risk-free rates of return and risk-adjusted rates of return where an associated enterprise is entitled to such return under the TPG’s guidance. The report also includes a number of examples to illustrate the principles discussed. The now published guidance on financial transactions will form a new Chapter X of the TPG and will add a new section to Chapter I on the risk-free and risk-adjusted rates of return.
According to the Finnish Tax Administration, it will take the new guidance into account and will provide its views on the effects of the report during the spring 2020.
We have highlighted some of the key considerations below.
- Accurate delineation of actual intra-group transactions is in the centre of the report. The pricing of the controlled financial transactions will be considered after the accurate delineation analysis of the financial transactions. Attention is paid, for example, to accurate delineation of financial guarantees and guaranteed loans. As the accurate delineation analysis is related to the terms of funding in general, companies should pay attention to the terms of their intra-group funding as well as the documentation of the arm’s length terms and conditions. At the moment, the section of the report discussing the characterisation of an investment as a loan or equity is not relevant in Finland due to the current case law.
- The decision-making functions and related capabilities to control the risk associated with financing activities determines the level of returns the funder is entitled to. Based on the report, intra-group lenders without any functional substance (the people functions needed to manage and control the financial risks) would be entitled to no more than a risk-free return, but the funded party would still be entitled to a deduction up to an arm’s length amount in respect of the funding. The remainder would be allocable to the party exercising control over the investment risk.
- The report discusses extensively on how to determine group companies’ credit rating. Guidance is provided on how to determine the group companies’ stand-alone rating and how to take into account the benefit of group membership. The report states that the effect of group membership is relevant for the terms of the loans from third parties. Thus, it should also be taken into account in intra-group financing transactions. The report also highlight that when analysing the role of group membership, it is important to consider what is the role of the borrowing group company and whether it would receive support from the rest of the group in the event it gets into financial difficulties.
- Cash pooling is popular among the multinational groups and may provide several advantages. The report notes that there is no one solution for every group, but, in general, the cash pool leader should first receive a compensation for the functions it provides. Furthermore, the cash pool leader may perform no more than a coordination or agency function, and the cash pool leader’s remuneration as a service provider should be determined accordingly. However, the report states that there may be cash pool leaders with more functionalities as well. Correspondingly, a proper documentation for the cash pool is recommended.
Borenius’ lawyers are available to assist in addressing any questions you may have regarding these new guidelines.