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Ian Farmer |
Taxation authorities have significantly increased their focus on intra-group financial transactions, including related-party loans, credit guarantees and other forms of financing and credit risk transfer arrangements. With the global financial crisis limiting the availability of once plentiful and relatively inexpensive external funding, many taxpayers, in their hunt for cash, have seen their intra-group financial transactions increase significantly.
Financial transactions are increasingly a key source of tax controversy, with the transfer pricing aspects of intra-group financial transactions becoming contentious.
One key reason is that the pricing of financial transactions, as with many other areas of transfer pricing, is inherently subjective. Even if the parties setting prices possess the knowledge and judgment to accurately estimate an arm's-length price for a transaction, the reviewer of the price (such as a taxation authority) might not possess the requisite expertise.
Another important source of controversy for some borrowers is impact on operating profits of high-yield loans provided by private equity firms. This has led in some cases to the introduction of specific earning stripping rules to limit the amount of interest that can be deducted from operating profits.
Furthermore, the financial crisis has demonstrated to taxation authorities that financial markets are a complex area, particularly once the transfer pricing implications of these transactions are considered. As such, it has raised their awareness and focus on intra-group financial transactions.
Estimating arm's-length terms for an intra-group financial transaction is further complicated by the fact that little concrete guidance exists from taxation authorities regarding how taxpayers should price these transactions.
The lack of guidance from the OECD increases the possibility that taxation authorities will take significantly different approaches toward evaluating intra-group financing. Hence, financial transactions represent may be acceptable to taxation authorities in one jurisdiction but not in another.
Some taxation authorities also are beginning to challenge the pricing of financial transactions using a combination of transfer pricing and tax-related arguments. As an example, the Australian Taxation Office has indicated that multiple provisions of the tax act may impact whether a taxpayer receives a deduction on a loan, including the general deductibility provisions, the debt/equity rules, the thin capitalisation legislation, and the transfer pricing rules.
The presence of overlapping (and potentially conflicting) rules in a single jurisdiction further complicates the process of pricing and structuring intra-group debt, and differences across jurisdictions could increase the difficulty of mitigating the risk of relatively simple transactions.
The subjectivity associated with pricing intra-group financial transactions, combined with differing taxation authority views on how these transactions should be priced, has significantly increased their tax risk in recent years. This is even more so in the financial markets at the moment, in which taxpayers are forced to use their cash in the most optimal way, in many cases resulting in an increase of intra-group financial transactions.
However, while intra-group financial transactions can give rise to potential tax risk, if given appropriate attention and with the appropriate documentation in place, they remain a potential source of opportunity, particularly in light of the recent dramatic changes in the financial markets.
Ian Farmer (ian.farmer@au.pwc.com), Sydney
