Taxpayers’ challenges with financial transactions

The panel was asked whether complexity is still an issue. Thomas Hürlimann, group tax manager for Nystar (a commodities trading firm) in Switzerland, said applying the arm’s-length price to interest and debt is very complex.

“The focus of tax authorities was on profit level,” added Daniele Troisi, the general manager for tax and customs affairs at Nissan. “But now they’re looking at below operating profit as well.”

Often, financial transactions are related to strategic decisions of investment allocation.

“Then the tax and legislation need to define a stable effective tax rate,” said Paolo De Salvia, EMEA tax director for Bunge Group, Switzerland.

The panel said that, in the case of financial transactions, absent of any specific tax rules, companies have incentives to maximise interest expenses and reduce overall effective tax rates but analyses, by tax authorities, typically start by assuming the financial instrument will be recognised as debt.

But, Anthony Clark, of HM Revenue & Customs (HMRC) who deals with financial transactions on a daily basis, said: “We’re tax inspectors. We’re inherently suspicious.”

The issue of advance agreements between taxpayers and authorities was also raised and Chris Raybould, of Baker & McKenzie, Canada, said the Canada Revenue Agency is working on a special team to build this up: “I don’t see companies trying a lot of advance agreements, but it would be a welcome development in my view.”

Hybrid financing

Hybrid financing can be defined as a combined face of equity and debt. This means that the characteristics of both equity and bond can be found in the approach.

The concept usually triggers a tax advantage because it has been developed to enjoy the positive factors of both the equities and debt instruments and it takes its form in a number of ways, such as preference shares (characteristics of debt and equity), convertible debentures (convertible partially or fully into equity shares) and innovative hybrids (which have a different qualification depending on the country, for example, Dutch participating loans or US promissory notes).

“The problem is whether the hybrid instrument is being used for genuine commercial reasons or as the main reason,” said Clark. “If business can provide that the tax advantage is incidental... what we always want is for tax to follow commercial reason.”

Next steps

The panel said the next steps in clarifying the transfer pricing aspects of financial transactions should be through the development and implementation of a sound policy on intercompany transactions. Caroline Silberztein, ex-head of the OECD’s transfer pricing unit, hinted this could be the next transfer pricing project to come out of the OECD, following the transfer pricing aspects of intangibles.

The panel wants any development and implementation to focus and document all conditions, not just the price, and warned taxpayers to beware of interaction between anti-abuse provisions and the arm’s-length principle, and vice-versa.