INSIGHT: A Closer Look at the OECD’s Draft Guidance on Financial Transactions

The OECD project on the transfer pricing aspects of financial transactions has been challenging because of different views among countries and the difficulty to find consensus on fundamental complex issues. One of those issues is whether there is a role for the arm’s length principle to evaluate the capital structure of a related borrowing entity. The other issue regards whether applying a group credit rating as default rule, rather than a derived credit rating of the borrower including implicit support, is essentially arm’s-length.

The OECD released its discussion draft on the transfer pricing aspects of financial transactions for public comments on 03 July 2018. The discussion draft was not a consensus draft but represented a ‘‘majority consensus’’ document. It seeks to clarify the application of the ‘‘accurate delineation’’ analysis on financial transactions. It also deals with specific issues relating to the pricing of loans, cash pooling, financial guarantees, and captive insurance.

The OECD received comments from 78 organizations on the discussion draft, consisting of 965 pages in total. This illustrates how important multinational enterprises (MNEs) consider this issue. Taxpayers are rightfully concerned about the contents of the guidance, because previous updates of the OECD Transfer Pricing Guidelines (‘‘OECD Guidelines’’ or ‘‘Guidelines’’) foreshadow that they will need to substantiate and document their intra-group financial transactions currently in the master file and local file consistent with new guidance, although the financial transactions discussion draft is not yet finalized. Updates of the OECD Guidelines usually do not get a future effective date. They generally are deemed to only include clarifications and apply retroactively. In addition, intra-group financial transactions are often scrutinised in tax audits. It is therefore absolutely appropriate that the OECD seeks as broad consensus as possible on the new guidance, which can greatly contribute to consistency in the application of transfer pricing approaches and help avoid transfer pricing disputes and double taxation.

As indicated, there appear to be two substantive issues to be tackled:

• should the arm’s-length principle play a role in evaluating the capital structure of an MNE group entity, and
• should the MNE group credit rating be the default rating for pricing intra-group loans, financial guarantees, and other financial transactions.

The OECD has succeeded in decreasing the number of non-consensus issues from a list of about 25 to these
two core issues. The OECD’s meeting of the first week of April 2019 served to achieve consensus on these two issues with the goal to complete the new guidance at the end of this year.

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