by Julie Martin
Draft OECD transfer pricing guidelines on related-party financial transactions, slated for release this summer, will include important guidance for multinationals on intercompany loans, cash pooling, and reinsurance, though reaching consensus among countries on some fundamental issues is proving difficult, tax officials said at the 2017 OECD International Tax Conference, held in Washington DC last week.
Officials also discussed other OECD transfer pricing guidance projects in the pipeline including a project dealing with hard-to-value intangibles at the June 5–6 conference, sponsored jointly by the OECD, USCIB, and BIAC.
Jefferson VanderWolk, who heads the Tax Treaty, Transfer Pricing & Financial Transactions Division at the OECD Centre for Tax Policy and Administration, said that he still expects that draft transfer pricing guidelines on financial transactions will be released this summer. The goal is finalize the guidance by year-end, he said.
The aim of the project is twofold, VanderWolk said. The work is part of an ongoing effort to fill in gaps in the OECD transfer pricing guidelines by providing guidance for ordinary course transactions. It is also an OECD/G20 base erosion profit shifting (BEPS) plan project, he said, and thus focuses on financial transactions used by multinationals to shift profits to low tax jurisdictions and erode a country’s tax base.
Accurate delineation/intercompany loans
VanderWolk said that an important aspect of the guidance will be a discussion of the accurate delineation of financial transactions. Financial transactions are sometimes given labels that do not necessarily describe what is actually happening, he said.
He said that the OECD Committee on Fiscal Affairs Working Party No. 6 (WP6), responsible for drafting the guidelines, may address simple loans between cross-border affiliates. This is not a easy task, said VanderWolk, noting that in the recent Chevron Australia decision the Court’s transfer pricing analysis of a loan took up 85 pages.
He said that in Chevron, a core question was whether one should analyze an intercompany loan by viewing the borrower as a stand alone company or as part of the Chevron group.
A question is whether and to what extent the credit rating of the parent is attributed to the subsidiary, VanderWolk said, adding that he did not think it is possible to write one-size-fits-all guidance in this area.
VanderWolk said that WP6 intends to produce extensive guidance addressing guarantees.
“On guarantees, we will be looking at both financial and performance guarantees, implicit and explicit, downstream, upstream, cross . . . trying to be as comprehensive as we can and as clear as we can about what we are talking about and how it should be priced,” he said.
The financial transactions guidance will likely also cover hedging arrangements where affiliates help other affiliates reduce risks and address comparables that are relevant to financial transactions. He said he was unsure whether WP6 will produce specific guidance dealing with capital contributions and interest free loans.
Risk adjusted rate of return
Brian Jenn, Attorney Advisor, US Treasury, said that WP6 is still trying to resolve an important disagreement among countries regarding how much return is properly allocable to group members that bear economic risk by funding activities.
Jenn said that Chapters 1 and 6 of the OECD transfer pricing guidelines mask a fundamental dispute among countries. While the guidelines provide that funders that exercise control over an investment risk should receive a “risk adjusted rate of return,” they do not go on to define what that means, he said.
Some countries take the view that a funder that bears risk but that does not contribute any value-adding activities should be limited to a debt-like return. The US’s view is that such funders could be entitled to a higher return than that, reflecting an undertaking of upside and downside risk, Jenn said.
Chris Faiferlick, Principal, EY, noted that Pepperdine University’s annual capital market survey shows that investment returns have recently reached as high as 30–40 percent for venture capital. This provides an idea of what the return could be, at least in the US, if an entity is deemed an investor entitled to upside and downside risk, Faiferlick said.
Cash pooling & captive insurance
WP6 is trying to reach consensus on how to allocate the synergy benefit among group members in a cash pooling arrangement, VanderWolk said.
The cash pool leader provides a service, which needs to be compensated, and, after that, the synergy benefit must be divided. VanderWolk said that while some argue that benefit should only be divided among the net contributors to the pool, others argue that net borrowers should also get a share using an appropriate allocation key because the group would not receive the full savings from the bank accommodating the pool without the participation of both.
Faiferlick commented that European tax authorities seem to have an animosity toward cash pools and that guidance would thus be welcome. Tax authorities go too far by not allowing a return for capital risk in structures where risk is born by the cash pool leader but there is no abuse, he said.
Similar issues are being debated by WP6 regarding captive insurance. Allocating the synergy benefit appropriately will be the goal of that guidance, VanderWolk said.
The draft will also include guidance of general application for captive insurance, following the principles of Chapter 1 of the OECD transfer pricing guidelines, and will look at the special aspects of these transactions to make sure that the guidance is appropriate to the industry, he said.
VanderWolk said that Chapter 1 provided of an example of a commercially irrational captive insurance transaction that spooked the industry. He assured that the example was not meant to imply that all captive insurance involves tax avoidance.
“There has been quite a lot of fear in the industry that we are going to demonize all captive insurance; that’s not the goal, the goal is to address the transfer pricing of captive insurance dealings,” VanderWolk said.
Jenn said WP6 is focused on identifying the circumstances under which risk assumption by a related party would be respected.
“[T]he real pressure point in the discussion, I think, is how much really does the related party reinsurer have to be doing in order to get the return that the unrelated party could,” Jenn said.
VanderWolk said that WP6 is also working on a revised discussion draft on the attribution of profits to PEs, which should be released very soon. WP6 released a non-consensus draft on the topic one year ago. The goal to finalize this guidance by the end of 2017, he said.
During a separate panel, Michael McDonald, a Financial Economist at the US Treasury, said that there are no developments to report regarding the draft on profit splits, which was released the same day as the PE draft.
McDonald said that comments are sought on four aspects of a May 23 OECD discussion draft on the implementation of rules for transfers of hard-to-value intangibles (HTVIs) to assist the drafters finalizing the document.
McDonald said that the draft HTVI guidance basically modifies the form of payment notwithstanding the accurate delineation of the transaction. He said that this topic warrants further consideration and comments.
Comments are also requested on how to handle closed tax years. Should the recovery be limited to open years or should recovery in open years cover the full amount? he asked.
The OECD would also like views on whether HTVIs should be based on what taxpayers would have done as opposed to or in conjunction with the rational of information asymmetry.
Finally, a very difficult area in need of input is how to straddle the line between what is viewed as real impediment to getting the right transfer pricing result and the avoidance of hindsight, McDonald said.
The deadline for comments on the HTVI guidance is June 30.