Transfer pricing precautions you need to take if the euro breaks up

This year is being viewed as make or break for the currency, with a number of countries (including France, Greece and Italy) having their credit rating downgraded and the real risk that either the currency could break-up entirely or some countries, at least, could exit altogether. This will impact multinational entities’ (MNE) transfer pricing arrangements with affected countries.

Interest rates

If the Euro is fragmented, the arm’s length on interest on intra-group loans could be affected. This can be expanded to companies based outside the European economic area (EEA) but with subsidiaries inside it.

“If a member state was to leave the Euro it is likely that its new currency would depreciate quickly and its new nominal interest rates rise,” said Danny Beeton, head of transfer pricing economics at Freshfields Bruckhaus Deringer in London. “This could create short to medium term problems for achieving a company's target transfer pricing margins in that jurisdiction.”

Beeton said, in the longer term, the operation of the transfer pricing policy, and the fundamental impact of the devaluation on the subsidiary's profitability, may additionally affect its standalone creditworthiness and therefore its arm's-length interest rate.

“The case for continuing to do business in the jurisdiction could even by called in to question, at least through the present form of business and broad commercial arrangements, in which case the company would have to consider the tax implications of a business restructuring,” Beeton added.

Companies with operations in the vulnerable or weaker European states would be well-advised to put in place a contingency plan for this eventuality.

The contingency plan

Increasingly, tax authorities are focusing on the interest rates for intra-group loans, so this is an important area to tighten up.

Rupery Macey-Dare, another economist in Freshfield’s transfer pricing team, said companies should review their intra-group pricing policies: “Review profit margin targets for production, sales and service subsidiaries in, or transacting with, a subsidiary in an exiting jurisdiction.”

“Also review intra-group interest rates and guarantee fees in light of the depreciating new currency with any attendant increasing inflation, nominal interest rates, credit default swap rates and risk and the declining creditworthiness of the subsidiary there,” he added.

Taxpayers should also look at their commercial intra-group arrangements.

“Consider whether existing intra-group transactions would still continue at arm's length, including goods sales, licences and guarantees if no longer profitable or not as profitable as the next best alternative and calculate break fees for the amendment or termination of existing intra-group agreements,” said Beeton.

Additionally, in terms of an evolving economic situation, taxpayers should:

· Amend intra-group agreements and prepare new ones to reflect any new commercial arrangements; and

· Prepare transfer pricing documentation reports to explain why the old and new intra-group pricing policies and commercial arrangements are both consistent with the arm's-length principle, why the changes were necessary and the approach to calculating arm's-length break fees.

However, Andrea Bonzano, head of tax for Fiat said he does not have any contingencies in place: “We still strongly believe in the Euro and we see the actual turbulence as a temporary issue.”

The EC declined to comment because, according to a press contact “speculation as to what could happen would go against the Commission's political agenda and work to ensure that this scenario absolutely does not happen”.