In an increasingly interconnected global economy, multinational enterprises (MNEs) routinely engage in intercompany financial transactions such as loans, cash pooling, guarantees, and other funding arrangements. These transactions have become central to the scrutiny of tax authorities around the world.
The shift in the regulatory environment is significant. Financial transactions have become a fertile ground for challenge on the premise of potential base erosion and profit shifting. As such, they are subject to increasingly rigorous tax audits and documentation requirements.
This trend has been amplified by the release of Chapter X of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations in 2022 (the Guidelines), which has led tax authorities to create specialised teams within the financial administrations and to adjust their practices accordingly.
This article provides an in-depth examination of the current landscape surrounding the transfer pricing (TP) of financial transactions. It highlights the growing scrutiny by tax authorities, explores areas of subjectivity, and concludes with suggestions on how to mitigate risk in an evolving compliance environment.
Background
Traditionally, financial transactions in TP were not prioritised in the same way as tangible goods, services, or intellectual property. However, as intercompany financing has grown in volume and complexity, regulators have become increasingly concerned over the past few decades about whether these arrangements reflect arm’s-length conditions.
The Guidelines were expanded to include Chapter X, which addresses financial transactions in a detailed and systematic way. The guidance emphasises the importance of accurately delineating financial transactions and understanding the commercial rationale behind them.
The core concepts include:
Substance over form – merely labelling a transaction as a loan or guarantee is insufficient. The terms, risks, and actual behaviour of the parties involved must align with what would occur between independent entities.
Risk control and capacity – a legal entity must have the capacity to control the financial risks it assumes. If not, it may not be entitled to the returns associated with those risks.
Functional analysis – the return on financial transactions must align with the functions performed, assets used, and risks assumed by each party in the transaction.
These principles signal that financial transactions are no longer exempt from detailed scrutiny and must withstand the same analytical assessment applied to other related-party transactions.
Key financial transactions under review
Several types of financial transactions are now under active scrutiny. These are elaborated below.
Loans between related parties must be evaluated based on a range of factors, including the interest rate, loan term and repayment schedule, currency denomination, security and guarantees, credit rating of the borrower, and economic conditions at the time of the loan. Where an interest rate deviates from what independent parties would have agreed to, tax authorities may adjust the terms or recharacterise the transaction entirely. For instance, a high-risk borrower with no collateral receiving a long-term, low-interest loan from a group entity may face adjustments.
Cash pooling structures, which are centralised cash management systems, are commonly utilised by multinational groups. However, tax authorities are now scrutinising whether the returns attributed to pool leaders and participants accurately reflect their contributions and risks. Key considerations include the functions of the cash pool leader, whether they act merely as a coordinator or as a risk-bearing intermediary, and the treatment of overdrafts and surplus balances. The allocation of interest spreads and the implicit or explicit support provided by the group are also under examination. Tax authorities are sceptical of cash pools that result in one-sided benefits for certain group members or where pooling advantages are not clearly supported by documentation.
When one group entity guarantees the debt of another, it may charge a guarantee fee; however, determining the arm’s-length fee is complex and involves an assessment of several factors. These include:
The nature and extent of the guarantee;
The resulting benefit to the borrower, such as a lower interest rate;
The creditworthiness of the guarantor; and
The alternative arrangements available in the open market.
In many cases, tax authorities question whether a guarantee exists at all, especially when no fee is charged, or whether the benefit derived is accurately measured.
Increased scrutiny by tax authorities
Tax authorities worldwide are adopting more aggressive approaches to financial transactions. While the Guidelines have set a framework, the interpretation of those principles remains jurisdiction-dependent, creating significant uncertainty for taxpayers.
The key trends include:
Increased audit activity – financial transactions are now standard items in TP audits, especially in industries with heavy intercompany financing. Tax authorities are increasingly challenging the TP of intragroup financing arrangements, particularly where a local entity places excess cash with a group treasury centre under deposit-like terms. These adjustments often disregard the limited functional and risk profile of the depositing entity and the short-term, highly flexible nature of the arrangements.
Transaction recharacterisation – where a transaction lacks economic substance, tax authorities may delineate or recharacterise it partially or entirely (e.g., treating a loan as equity). In the context of cash pooling arrangements, tax authorities often argue a consistent surplus balance held by a participant over multiple years may indicate a disguised financing. In such cases, they consider market lending rates to be applicable, even in the absence of contractual repayment terms or any formal commitment to lock funds.
Retroactive adjustments – tax authorities often apply adjustments retroactively, creating unexpected liabilities and penalties for prior years; for example, in cases of historically low or negative rates, or in the event of disputes regarding economic analyses, when the relief may extend beyond previous fiscal years.
Documentation requirement – there is an expectation of thorough documentation demonstrating the commercial rationale, terms, pricing, and comparability of financial transactions. This is especially relevant in cases involving interest-free intercompany loans, which have attracted increasing attention. Although the tax courts have confirmed that the absence of interest is not inherently non-arm’s length in some cases, they require that such arrangements be justified by exceptional business circumstances – such as financial distress, strategic investment protection, or regulatory limitations – and are supported by robust evidence. The accurate documentation of the transaction remains a precondition.
As a result, MNEs must not only ensure their transactions are appropriately priced but also that they are well supported by proper TP documentation and defensible in the event of a dispute. Tax administrations increasingly expect not just methodologically sound benchmarking but also a comprehensive explanation of the business logic, economic context, and functional profiles that underpin each financial transaction.
Role of subjectivity in financial TP analysis
One of the most challenging aspects of financial transaction pricing is the inherent subjectivity involved. Unlike benchmarked service fees, financial instruments depend heavily on context-specific judgments.
Creditworthiness and implicit support
A central issue is how to evaluate the credit rating of a borrowing entity within a corporate group. Should it be assessed as a standalone entity, or should the lender assume that implicit support would be provided by the group in the event of financial distress? In practice, pricing often reflects some expectation of group backing, especially where strategic or reputational risks are at stake.
In many real-world scenarios, borrowers benefit, at least implicitly, from being part of a larger, financially stable group. This expectation often informs pricing decisions in intercompany settings, especially when reputational concerns, strategic interdependence, or historical patterns of support make group backing a rational assumption. However, tax authorities increasingly challenge this logic, insisting that only explicit guarantees justify favourable financing terms.
This divergence between taxpayer pricing behaviour and tax authority expectations becomes particularly problematic when pricing is based on an assumption of implicit support, while tax authorities impose a strict standalone credit risk assessment. For example, when external comparable uncontrolled prices are used without isolating borrower-specific credit profiles or without adjusting for geographic or maturity mismatches, authorities may argue that the analysis does not meet arm’s-length standards. At the same time, tax authorities are increasingly sceptical of pricing benefits that are not grounded in demonstrable functional or risk-bearing contributions.
The challenge for taxpayers is to delineate where group membership justifies pricing differentiation and where it simply inflates returns inappropriately. The line between legitimate benefit and unsupported advantage is not always clear.
In practice, this has led to several rejections of benchmarking studies where tax authorities disregarded project-based risk allocation or informal intragroup support mechanisms; instead imposing rigid filters based on credit ratings or macroeconomic comparability. Taxpayers are thus left to defend subjective assumptions about whether, and to what extent, an independent lender would rely on the implicit backing of the group. The lack of consensus on this issue, particularly where group strategies are not formally documented, creates a persistent source of dispute.
Functional substance v formal classification
Another key area of subjectivity lies in the determination of functional substance. A company may classify itself as a low-risk depositor or liquidity provider, but if it consistently maintains significant cash balances within a group cash pool, without demonstrating an active role in treasury decisions, tax authorities may view the behaviour as indicative of a long-term financing function. This may lead to a recharacterisation of the transaction, with corresponding pricing adjustments.
Similarly, group entities that act as financial intermediaries, such as intragroup lenders or pool leaders, must show more than formal contractual roles. Tax administrations increasingly demand proof that these entities have the personnel, systems, and authority to manage the risks they assume. Where such substance is lacking, the entity may be viewed as a mere conduit, and its returns may be allocated elsewhere in the group.
This subjectivity is particularly evident in the evaluation of interest-free loans. In some cases, recent case law has held that such loans may be compliant with the arm’s-length principle under exceptional business conditions, giving significant weight to the economic rationale, the borrower’s financial position, and the overall coherence of the arrangement with group strategy. In this regard, the accurate delineation of the transaction, as debt or quasi-equity, is crucial, as is the taxpayer’s ability to explain why no interest was charged despite an expectation of remuneration under normal market conditions.
Across these situations, the consistent theme is that form alone is not sufficient. Taxpayers must demonstrate, with credible evidence, that the functions, assets, and risks attributed to each party reflect reality, not just on paper, but in economic substance and behaviour. The absence of clear guidance on how to weigh implicit support and substance introduces a layer of interpretive risk that taxpayers must address proactively.
Practical implications for MNEs
Given the increased focus on financial transactions from a TP perspective and the subjective elements involved, MNEs need to take proactive measures to mitigate risk, as follows.
Enhance documentation
Robust documentation is essential. Tax authorities are increasingly unwilling to accept TP outcomes that lack a clear articulation of the commercial logic, especially in atypical arrangements such as negative interest deposits, long-standing surplus cash pool balances, or interest-free loans. Taxpayers need to document that the pricing reflects the actual risk profile, market conditions, and functional capacity of each entity involved. This includes:
A detailed functional and risk analysis;
A clear description of the transaction purpose and structure;
Justification of selected TP methods that goes beyond mechanical application;
Benchmarking studies supported by consistent assumptions on maturity, currency, credit rating, and geographic comparability;
Economic modelling that addresses creditworthiness assumptions and implicit group support; and
A thorough explanation of why certain pricing deviations (e.g., negative or zero interest) are commercially rational under the relevant facts and circumstances.
Revisit internal governance and substance
Entities that are part of financial transactions should have clear decision-making authority and operational substance. This means:
Having appropriate personnel and systems;
Being involved in the origination and monitoring of financial arrangements; and
Demonstrating a clear value-creating role beyond paper-based functions.
Substance will be a key determinant of how tax authorities assess the legitimacy and pricing of financial transactions.
Consider advance agreements or rulings
In complex or highly subjective situations, such as intercompany loans without interest, implicit support pricing assumptions, or hybrid cash pooling structures, obtaining an advance pricing agreement (APA) or unilateral ruling may offer critical certainty. This is particularly relevant in jurisdictions that have shown a tendency towards aggressive delineation or the retroactive application of new benchmarking standards.
APAs can help validate assumptions around risk allocation, maturity, and credit support, and prevent disputes where tax authorities may otherwise reject the taxpayer's framework in favour of more formulaic or formalistic approaches.
Engage in internal training and coordination
Finance, treasury, legal, and tax departments must collaborate closely. Structures designed with purely financial efficiency in mind, such as excess cash placements or zero-interest intercompany funding, may inadvertently trigger tax exposures if they are not aligned with TP principles. Therefore, collaboration across departments and the evaluation and sharing of TP principles across departments is vital.
Final thoughts
Financial transactions have become one of the most dynamic and scrutinised areas in TP. What was once a peripheral topic – such as intragroup loans, deposits, cash pooling, and guarantees – is now at the forefront of audits and litigation. Tax authorities have become significantly more sophisticated in challenging intercompany financial arrangements, drawing on refined analytical tools and applying stricter interpretations of the Guidelines, particularly following the inclusion of Chapter X.
The regulatory focus has shifted decisively towards economic substance, functional contribution, and the actual allocation of risks and decision-making capacity within multinational groups. Tax authorities are no longer willing to accept formal labels or contractual definitions at face value. Instead, they demand that pricing outcomes reflect the real behaviour of the parties involved.
At the same time, disputes are becoming increasingly complex due to the subjective nature of key pricing elements, such as the role of implicit support, the influence of group affiliation, and the evaluation of standalone creditworthiness.
In this complex environment, companies must go beyond formal compliance. They must develop a nuanced understanding of the economic rationale behind each financial transaction, document it thoroughly, and align it with operational behaviour and functional substance.
Financial transactions TP is no longer a ‘check-the-box’ exercise; it is a strategic issue that requires rigorous analysis, interdepartmental coordination, and proactive risk management.
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