Transfer pricing: should treasurers take tax developments on the chin?

The OECD recently issued proposals around transfer pricing in respect to intra-group financial transactions look set to significantly impact multinational corporates. This is precisely why treasurers must get involved in shaping this latest tax guidance, while there is still time.

On 3 July 2018, the Organisation for Economic Co-operation and Development (OECD) released the first public non-consensus discussion draft on the transfer pricing aspects of intra-group financial transactions (Discussion Draft). This long-awaited document covers transfer pricing considerations around the treasury function, credit ratings of subsidiaries, intra-group loans, guarantees, cash pools / current accounts, and captive insurance set-ups. Further work in this area will continue and is expected to be finalised in 2019. The proposals presented in the Discussion Draft, if adopted by the OECD as formal guidance, will definitely have significant impact on treasury operations of multinational companies.

In recent years the number of challenges and transfer pricing audits around intra-group financial transactions have intensified, often resulting in double taxation. While few of these disputes end up in litigation, one prominent example of a financial transactions transfer pricing case reaching the courts relates to Chevron. In 2017 the company lost a landmark tax case in Australia, resulting in the assessment of AUD 340m in tax, penalties and interest. In a nutshell, the Australian Tax Office was successful in re-assessing the level of interest rates not by merely challenging the pricing (i.e., interest rate benchmark) itself, but rather first reconstructing the contractual terms and conditions of the loan agreement, and subsequently arriving at the lower arms length interest rate.

The Discussion Draft also follows the aforementioned logic, which is consistent with the prior OECD Base Erosion and Profit Shifting (BEPS) work. The document reiterates that a transfer pricing analysis of intra-group financial transactions requires a two-step test:

1. First, accurate delineation of a transaction, which is focused on commercial rationality of the transaction and its terms and conditions. This means that the terms and conditions of the deal are open to challenge and ultimately may deviate from those included in the underlying legal agreements. In this respect, the Discussion Draft also refers to behaviours encountered in a third-party context, as well as industry-specific trends and practices; and
   
   
2. Second, assessing an arms length price, based on the arms length terms and conditions of the deal, as established in the first step.

Having worked for many years with both the tax and the treasury professionals within multinational companies and witnessing multiple tax disputes around financial transactions, I often observe that some of the best practices followed by corporate treasurers with respect to cash management, intra-group loans, FX deals, and other types of transactions do not necessarily withstand the arms length test. This is driven by the fact that the concepts of commercial rationality and third-party behaviour are subjective and prone to various interpretations in practice. In this respect, it is somewhat worrying that the Discussion Draft seems to create room for even broader interpretations and potential conflicting views. However, the main lesson learnt from day-to-day practice is that having the right evidence in place is crucial, as ultimately it can mitigate potential tax controversy.

Although the Discussion Draft is a non-consensus document, it provides insights into the direction of travel by the OECD. Multinational companies and business associations can still influence the current (draft) proposals included in the Discussion Draft and contribute to the development of final guidance. Companies and associations of corporate treasurers are therefore encouraged to submit their comments, including responses to the specific questions in the Discussion Draft, before the deadline of 7 September 2018.

The Discussion Draft can be accessed at: http://www.oecd.org/tax/beps/oecd-releases-beps-discussion-draft-on-the-transfer-pricing-aspects-of-financial-transactions.htm.