by François Masquelier, Head of Corporate Finance and Treasury, RTL Group, and Honorary Chairman of the European Association of Corporate Treasurers
I find it astonishing that a subject as important as BEPS (base erosion and profit shifting) and the new transfer pricing rules has not caused much more of a stir in the world of treasury. It is as if BEPS did not exist. It is, however, essential to review transfer pricing strategies for treasury transactions to ensure we comply. Whether we like it or not, it is a reality that treasurers will have to live with, and they will need to adapt to become a profit centre.
The story is only just beginning
BEPS recently became a reality with the first European Directive adopted by the Commission on 12 April 2016. The rest will soon follow with transposition of most of the OECD’s actions. From a taxes point of view, the ‘Country by Country’ report seems to us to be of only minor interest. Conversely, the impending fiscal measures as a whole, in combination with each other, will create a real headache for tax managers. People are talking about a tax paradigm, of the revolution of the century and of total upheaval. The much sought-after fairness in tax will come at the price of unending difficulties. To point the finger at just one difficulty, we could start with the restriction on deducting interest (see BEPS action # 4). Interest will be deductible only if it is below 30% of EBITDA (with a de minimis threshold of €1m). This might create situations in which entities that are struggling or loss-making will no longer be able to deduct interest, and will therefore be even harder hit. We could also cite the ‘Exit Taxation’, the ‘switch-over clause’, the ‘General Anti-Abuse Rule’, hybrid mismatch (see BEPS action #2), the revision of the AEOI Directive (mandatory automatic exchange of information for taxes + disclosures), and finally and perhaps the worst, the wholesale extension of the German CFC (Controlled Foreign Company) rules (see BEPS action # 2). This last measure will, right from the outset, generate a whole raft of demands and attempts to tax anything that may not have been taxed.
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Table 1 – Transfer pricing principles applicable to treasury activities
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Finding out where you stand and what your taxes are in this can of worms of tax correctives will be an almost impossible task for tax managers. The aim is to move from preventing double taxation to rooting out double non-taxation. The crisis in public finances requires this new global framework to ensure fairness in tax. Every country is trying to claim its fair share of the tax cake. The main idea of BEPS is to align the taxable base with value creation. It has three main watchwords: Consistency, Substance and Transparency. Against which, you could argue that transfer pricing rules already existed long before BEPS. It is just a matter of applying them in the future. Some countries have already started to ask ever more searching questions to justify the fair transfer price. A major principle of taxation, that of choosing the option that costs the least in tax, has now been called into question. To summarise, BEPS will involve much more complexity, and will make it essential for operational personnel and tax people to get together to align and agree on their strategies. Finally, one of the most important points in our view, BEPS and transfer pricing will involve much more documentation and a review of prices charged between subsidiaries.[[[PAGE]]]
The five key transfer pricing questions
Five key questions need to be asked if treasury management is handled centrally: what, how, why, where, and who?
1. WHAT types of treasury activity does the group treasury (GT) handle centrally and recharge to affiliates?
2. HOW is GT organised to serve its affiliates and how can treasury management add value?
3. WHY are treasury activities handled centrally?
4. WHERE is the GT function located?
5. WHO takes and bears the financial risks?
The last question is crucial: who, ultimately, will end up bearing the risk(s)? For instance, who bears the loss if the borrower subsidiary goes bust? Who is responsible if the guarantee issued by central treasury is called? And so on. Based on this question, you can work out the margins to be applied.
Figure 1 – Treasury centralisation today
No more free lunches with TP
In transfer pricing, one principle comes to the fore: ‘Everything has its price’ (its transfer price). The problem arises when you try to set this price and to calculate it. Everything has to have a price, but that price must be fair. Will the CBS The Price is Right become the treasurers’ television show? This is no game, sadly, but a reality, BEPS or no BEPS.
This principle also means that loans can no longer be granted without interest, without documentation and that loans cannot be waived without due justification, and that finally asymmetrical loans can no longer be granted (for example 100% loans by one single shareholder, unless again the margin on this can be justified). The transfer pricing rules must henceforth be applied more fully and more punctiliously. From the basic principle set out above, we can derive two sub-principles: ‘Nothing is free in terms of transfer pricing between two entities of the same group’ (even if they are sister companies). The concept of family counts for nothing in tax. The second principle is that taking things to extremes undermines the transfer and is no longer acceptable. If the group’s internal bank issues a guarantee in favour of a subsidiary, it cannot be issued without charge. But neither can it be charged at 500 basis points, which would be right for making it as tax efficient as possible. The fair price for the specific case must be applied. This brings us to a major rule: the ‘case-by-case’ rule. And to round it off, the final principle is that everything needs to be documented to justify what has been charged, and why. Paradoxically, therefore, it is more complicated to trade goods and services between the subsidiaries of the same group than with third parties. The ten basic principles set out in Table 1 are decisive in ensuring that you comply with transfer pricing rules.
Central treasury management - structure
Treasurers never think of their treasury management centre as a profit centre. For ‘traditional’ treasurers, profit centres are centres intended to generate profit by trading financial products without necessarily having underlying risks. In practice, no or few centres operate in this form. The aim is to hedge the actual risks and to mitigate them (see Table 1). However, when it comes to tax and transfer pricing, things work differently. A treasury centre, or a group in-house bank (IHB), must apply a margin to all financial services or transactions, especially if it bears the ultimate underlying risk (in the event of default by the counterparty). A central treasury or IHB therefore has more than one role (advisory, agency and in-house bank), it is often centralised or partially centralised, and employs a high level of skill and expertise. That makes it a profit centre and not a service centre as some treasurers see it. That changes the approach, and is the reason why treasurers can no longer operate without charge, or (obviously) overcharge, when invoicing for services.
Treasurers who want to keep things simple, and who think that not invoicing will ensure that they do not charge a price that would be seen as not being fair, are kidding themselves. All services must be invoiced. Not invoicing will be seen as giving an unfair advantage to a subsidiary, which would be re-categorised as taxable. Here again a price must be charged, but it must be appropriate. Treasurers must get used to the idea that they are operating a profit centre, whether they like it or not. Psychologically, this is a real revolution for all self-respecting treasurers. Treasurers will render in-house bank services and invoice for them, even if incidentally they render other services in the form of advice or act as agent on behalf of a subsidiary. It may not sound much, but it is something of a revolution for the world of treasury.[[[PAGE]]]
Table 2 – Examples of margins/spreads applied to affiliates for treasury operations
Click image to enlarge
The fair price for TP: the trickiest exercise of all
The trick consists in deciding on and justifying (documenting) the margin applied or the fees charged. A case-by-case analysis needs to be carried out by assessing the finances of the counterparty entity (either in-house or using a service such as Standard & Poor’s or Moody’s, which in addition offers specially designed documentation). The counterparty risk of each subsidiary, the country risk and finally the sector risk all need to be taken into account. The final factor is the existence of any implicit parent company guarantee (which might be rock-solid or not so rock-solid). These four factors make the exercise relatively difficult. That is why treasurers often subcontract this part of the analysis.
It is essential to document the relationship with the subsidiary by means of a Master Agreement covering all dealings and by means of Service Level Agreements (SLAs). Such documentation usually exists, but is often inadequate or out of date. This is a good time to revisit it and make sure it is complete. These documents must be comprehensive and accurate. The examples in Table 2 explain the margins taken but these margins are determined by the implicit group counterparty rating (i.e., that of the subsidiary). The advisory content is not the highest in terms of cost, but more difficult to assess in terms of price. For example, the GT performs reporting and accountancy work (e.g., IFRS, EMIR, FATCA, CRS, MiFID, and others) on behalf of the subsidiary. Everything should be properly laid down to satisfy foreign tax authorities asking questions (such as whether there is an APA - Advance Pricing Agreement - in place or not).
Prices and margins must be at arm’s length, justifiable and properly documented. Based on a stand-alone price, an appropriate margin must be added (or deducted, as the case may be). Ideally, the benefit should be shared between central treasury and the subsidiary.
Figure 2 – Centralisation in practice
Margins to be applied in conditions of negative interest rates
We need to tackle the subject of negative interest rates, which complicate the task of deciding on the margins to apply to loans made to subsidiaries, and to subsidiaries’ deposits. In the above examples, we have seen where these abnormal market conditions might lead us. For example, with deposits, we might apply a reverse spread if we wanted to guarantee at least the zero interest rate that each subsidiary can still obtain on a current account (for how long, that is the question).[[[PAGE]]]
Reviewing TP - a tax optimisation opportunity?
For treasurers, BEPS essentially boils down to Action numbers 4, 8, 10 and 13. It imposes a sort of tax health check, which is always salutary, even in the treasury function. Central treasuries often apply constant margins, or apply varying margins using unsophisticated methods, or charge fixed fees that are completely inflexible for everyone. By calculating margins and other fees individually, we could probably increase them, particularly if the risk is left with central treasury. That would allow us to maximise deductibility of these margins, particularly if the GT is under a more favourable tax regime than the subsidiary. BEPS is a golden opportunity to revise your transfer pricing strategy from top to bottom. It may be the spur to improving consistency of approach, to being closer to substance in some cases, and undoubtedly to improving transparency. Since all transactions must be invoiced properly, GT becomes a profit centre (modest, and obviously not excessive, profits). For some activities such as advice, administration, dealing with banks, etc., we are talking about reasonable fees. For financial transactions, we would apply a reasonable margin and for providing information systems, we would apply the traditional cost plus principle (a margin of 5% to 6%). Are you sure you have all the documentation in place and that you can justify everything? If not, hurry up and make sure you’re ready by 2017. Don’t rely on a bank to set your benchmark and find the reference material for documenting your treasury TP to ensure it is in shipshape order. To conclude, I quote this French proverb: “If you want to know the value of money, try to borrow some”. But more ironically, we might quote another saying: “In business, the lower the price, the bigger the sticker” (even between subsidiaries of the same group).
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François Masquelier has been Head of Corporate Finance and Treasury with RTL Group since November 1997. Before joining RTL Group he worked for Mitsui Talyo Kobe Bank (Sakura Bank) in Brussels, Eridania Béghin-Say Coordination Center in Brussels and ABN AMRO Bank in Belgium and Luxembourg. He is Doctor in Law, Fiscal Law and Economy & Administration from the University of Liège, and has a degree from the Business School of Brussels. François is the President of the Association of Corporate Treasurers in Luxembourg (ATEL), and the Honorary Chairman of the European Association of Corporate Treasurers (EACT). |
François Masquelier
