In February 2020, the OECD issued the long-anticipated transfer pricing (TP) guidance on financial transactions, to supplement Chapter 10 of the OECD Transfer Pricing Guidelines (OECD TP Guidelines), covering issues relating to the inter-company pricing of loans, cash poolings, financial guarantees and captive insurance.
While it was welcomed by the TP community as a means to contribute to the consistent application of TP and help reduce relevant disputes, it is generally acknowledged that there may be different views on various topics and that the process of fully implementing the new principles and reaching a consistent approach within the OECD countries, may involve several stages.
Greek law explicitly stipulates that national TP provisions are to be applied and interpreted in accordance with the general principles and guidelines of the OECD TP Guidelines.
One would consider this to provide sufficient comfort in case of a tax audit. However, post-February 2020 experience from TP audits on intra-group loans shows that, in practice, a different interpretation of the new guidelines by the tax authorities could lead to increased controversy.
Although every case should be examined on its own merits, the most frequent area of dispute appears to broadly relate to the identification of the characteristics of the transaction materially affecting the price and, thus, accounted for in the search for comparables.
For the purpose of determining the arm’s-length interest rate of an intra-group loan, the OECD TP Guidelines – without overlooking potential internal comparable uncontrolled prices (CUPs) – acknowledge that the widespread availability of information and analysis of loan markets, facilitates the use of the external CUP method.
Thus, the interest rate may be benchmarked against publicly-available data on loans or realistic alternative transactions (such as bonds), for other borrowers with the same credit rating and with sufficiently similar characteristics affecting the pricing.
To this end, the most important factors, among others, are considered to be: the amount of the loan, its maturity, the schedule of repayment, the nature or purpose of the loan, the level of seniority and subordination, the location of the borrower, the currency, the collateral provided, the presence and quality of any guarantee, and whether the interest rate is fixed or floating.
Hence, a level of subjectivity on the selection of the most important comparability criteria, prioritisation in the search strategy, and the extent of comparability adjustments required in order to produce accurate results, is necessary.
These practical considerations appear to be the key drivers of dispute.
Tax authorities tend to reject the TP analysis performed by taxpayers, usually on insufficient comparability grounds, and adopt the approach of examining the arm’s-length nature of the inter-company interest rate, by reference to the interest rate indexes on euro-denominated loans, provided by domestic credit institutions, as published on a monthly basis by the Bank of Greece.
This monthly index is constructed based on interest rate quotes from all credit institutions operating in Greece and represents the weighted average for said quotes; the weights being the respective shares of the credit institutions in the total outstanding balance at the end of the reference month. Data by the central bank provides some level of analysis by term or principal amount.
The tax authorities’ main argument for this position is that these rates are indicative of the market conditions in the respective jurisdiction and demonstrate the option realistically available for the borrower, should the borrower decide to raise funds from a credit institution instead.
Taking a closer look, although this approach appears to account for some of the characteristics of an intra-group loan (e.g. location of the borrower, currency and by approximation duration of the loan or principal amount), it fails to account for other factors determinant of the pricing of an intra-group loan, as explicitly identified in the OECD TP Guidelines – most importantly, the creditworthiness of the borrower/issuance.
Furthermore, the use of indexes which represent an average price without any further analysis of the underlying data, does not leave room for any comparability adjustments that could potentially remediate any comparability deficiencies.
It is yet to be seen what the final ruling will be on these cases. What is certain, though, is that the position of the tax authorities has created great uncertainty to multinational groups with intra-group financial transactions.
Practical recommendations for a smoother tax audit would be:
- Re-evaluate the existing TP documentation and supplement where necessary, in order to present all arguments supporting the methodology followed and the choices made relating to the comparability criteria, the documentation approach or the database selection; and
- Ensure that consistency can be demonstrated in the documentation approach used over the years and/or for transactions of the same nature, and adequately support the reasoning behind any possible deviations.
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