Transfer pricing for Irish securitisation companies

Ireland introduced a new more expansive set of transfer pricing rules under Finance Act 2019. Previously, transfer pricing in Ireland applied only to trading transactions and, in particular, only where trading profits were artificially understated because of a non-arm's length transaction between associated entities. Even in these circumstances, small or medium enterprises ("SMEs") were exempted from the rules and grandfathering applied for any transactions which were agreed before 1 July 2010 and not materially altered since then.

The new rules are part of Ireland's commitment to implement the global standards agreed during the OECD BEPS process and the new legislation, at Part 35A of the Taxes Consolidation Act 1997 ("the TCA"),¹ includes direct references to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations published by the OECD on 10 July 2017 (the "2017 OECD Transfer Pricing Guidelines").

Now², the Irish transfer pricing regime extends to certain non-trading transactions, including capital transactions where the market value of the asset exceeds €25m. It also extends to transactions which were agreed before 1 July 2010 and not materially altered since then. Thirdly, it extends to transactions entered into by SMEs³ and fourthly, it applies to transactions carried out by qualifying companies for the purposes of Section 110 TCA ie Irish Securitisation Companies (referred to in this article as "Section 110 Companies").

Section 110 Companies

The profits of a Section 110 Company are taxable at 25%, the rate of tax which applies for non-trade profits in Ireland. However, the legislation provides that Section 110 Companies can take deductions for trading expenses such as interest payments. The real magic of a Section 110 Company lies in its ability to achieve tax neutrality by taking interest deductions on profit dependent loans or notes ("PPLs" or "PPNs"). The same interest would not be a deductible expense for a trading company by virtue of the deemed distribution rules in Section 130 TCA. Subject to certain conditions and anti-avoidance provisions, these rules are disapplied for Section 110 Companies under Section 110 (4) TCA⁴.

Helpfully for Section 110 Companies, interest or any other distributions paid by a Section 110 Company in respect of PPLs or PPNs ie "excessive interest" under Section 130(2)(d)(iii)(II) TCA is expressly carved-out of the new transfer pricing rules.

In all other respects, Section 110 Companies were already required to enter into all of their transactions and arrangements on an arm's length basis⁵. Accordingly, the biggest impact of the new transfer pricing rules on Section 110 Companies is the requirement to document their related party transactions, from a transfer pricing perspective, in accordance with OECD guidelines.

Related Party Transactions

The Irish transfer pricing rules (and accordingly the requirement to document transactions in accordance with the OECD guidelines) apply to transactions between "associated persons". Section 835B TCA states that two persons are associated if at any time:

1. one person is participating in the management, control or capital of the other person and that other person is a company; or

2. the same person is participating in the management, control or capital of each of the two persons and those persons are companies.

The Section 11 TCA definition of "control" is applied for the purposes of this definition. Section 11 TCA provides that "control" in relation to a company means the power of a person to secure:

1. by means of the holding of shares or the possession of voting power in or in relation to that or any other company; or

2. by virtue of any powers conferred by the constitution, articles of association or other document regulating that or any other company,

that the affairs of the first-mentioned company are conducted in accordance with the wishes of that person.

So, who are the related parties for a Section 110 Company?

It would appear from the Section 11 TCA definition that a PPN holder would not be considered to be "participating in the...control" of the Section 110 Company so long as the relevant PPN holder (a) does not hold shares or voting power in the Section 110 Company, and (b) is not in a position to secure that the affairs of the Section 110 Company are conducted in accordance with that PPN holder's wishes by virtue of powers conferred on the PPN holder through a document regulating the Section 110 Company. It seems unlikely that such a scenario would arise unless the PPN holder owns shares in the Section 110 Company.

However, there is a possibility that a PPN holder might be considered to be "associated" with a Section 110 Company if an interpretation is taken that the PPN holder participates in the capital of the Section 110 Company. Accordingly, we can't rule out the possibility that Section 110 Companies which are orphaned, or held on trust for charitable purposes, might be subject to the new transfer pricing rules and, as a result, may be required to document their transactions, from a transfer pricing perspective, in accordance with OECD guidelines.

For Section 110 Companies entering into transactions with parent companies, or other companies in a position of control, the new transfer pricing documentation requirements will definitely apply.

Documentation Requirements

Section 835G TCA now takes accounts of OECD BEPS Action 13 which proposed a three tiered approach to transfer pricing documentation as follows:

• Master File - described by the OECD as a single document to contain common standardised information about the global business of a multinational company, providing a high-level overview of the business, including the nature of its global operations and general transfer pricing policies and widely implemented transactions;

• Local File - described by the OECD as a set of various standardised documents containing country-specific information containing related party transactions undertaken in the country and information relating to specific intra-group transactions related to taxpayers in a specific jurisdiction;

• Country by Country reporting⁶.

In an effort to make the transfer pricing documentation requirements proportionate, the legislation provides that the Master File and Local File obligations apply only where turnover exceeds €250m per annum in the case of the Master File and €50m per annum in the case of the Local File with each test applied on a global consolidated group basis.

The information to be included in a Master File and a Local File, as per the 2017 OECD Transfer Pricing Guidelines, are set out below.

Deadline and Penalties

The deadline for preparation of the relevant documentation requirements is no later than the date on which the annual tax return for the relevant chargeable period is due to be filed. Accordingly, if an Irish company has a 31 December year end, the legislation requires it to prepare and finalise its transfer pricing documentation for the 2020 financial year by 23 September 2021. Whilst there is no requirement to file the transfer pricing documentation with Revenue unless the taxpayer receives a written request, the taxpayer must provide the documentation within 30 days if it receives a written request from Revenue.

The penalty for failing to provide the required documentation when requested is either €4,000 or €25,000 depending on the taxpayers turnover. Larger taxpayers will also be subject to a daily penalty of €100 per day for each day on which the documentation remains outstanding.

Of course a failure to ensure that the arm's length price adopted meets the transfer pricing standards would be a much a more serious issue for the Section 110 Company⁷. Any required transfer pricing adjustment in a Section 110 Company would represent unexpected taxable profits, for which no deduction would be available ie a tax cost would arise for the company at 25% of the adjustment amount. Section 110 Companies don't have any reserves, or wriggle room, to pay unexpected taxes as all of their profits (save for a small amount ie €2,000 to €5,000) are swept out of the company under the PPL or PPN. Accordingly, it is imperative that they apply the arm's length principle correctly and meet the requirements of the transfer pricing rules.

Further, by virtue of Section 110 (1) TCA, if a Section 110 Company enters into a transaction or arrangement otherwise than by way of a bargain made at arm's length, it will lose it status as a Section 110 Company giving rise to significant taxes in the company - taxes which the company would not be in a position to pay!

Transfer Pricing Documentation - Master File⁸

The following information should be included in the master file:

Organisational structure

Chart illustrating the multi-national enterprise's ("MNE's") legal and ownership structure and geographical location of operating entities.

Description of MNE's business(es)

General written description of the MNE's business including:

• Important drivers of business profit;

  • A description of the supply chain for the group's five largest products and/or service offerings by turnover plus any other products and/or services amounting to more than 5% of group turnover. The required description could take the form of a chart or a diagram;

  • A list and brief description of important service arrangements between members of the MNE group, other than research and development (R&D) services, including a description of the capabilities of the principal locations providing important services and transfer pricing policies for allocating services costs and determining prices to be paid for intra-group services;

  • A description of the main geographic markets for the group's products and services that are referred to in the second bullet point above;

  • A brief written functional analysis describing the principal contributions to value creation by individual entities within the group, ie key functions performed, important risks assumed, and important assets used;

  • A description of important business restructuring transactions, acquisitions and divestitures occurring during the fiscal year.

MNE's intangibles

• A general description of the MNE's overall strategy for the development, ownership and exploitation of intangibles, including location of principal R&D facilities and location of R&D management.

• A list of intangibles or groups of intangibles of the MNE group that are important for transfer pricing purposes and which entities legally own them.

• A list of important agreements among identified associated enterprises related to intangibles, including cost contribution arrangements, principal research service agreements and licence agreements.

• A general description of the group's transfer pricing policies related to R&D and intangibles.

• A general description of any important transfers of interests in intangibles among associated enterprises during the fiscal year concerned, including the entities, countries, and compensation involved.

MNE's intercompany financial activities

• A general description of how the group is financed, including important financing arrangements with unrelated lenders.

• The identification of any members of the MNE group that provide a central financing function for the group, including the country under whose laws the entity is organised and the place of effective management of such entities.

• A general description of the MNE's general transfer pricing policies related to financing arrangements between associated enterprises.

MNE's financial and tax positions

• The MNE's annual consolidated financial statement for the fiscal year concerned if otherwise prepared for financial reporting, regulatory, internal management, tax or other purposes.

• A list and brief description of the MNE group's existing unilateral advance pricing agreements (APAs) and other tax rulings relating to the allocation of income among countries.

Transfer Pricing Documentation - Local file⁹

The following information should be included in the local file:

Local entity

• A description of the management structure of the local entity, a local organisation chart, and a description of the individuals to whom local management reports and the country(ies) in which such individuals maintain their principal offices.

• A detailed description of the business and business strategy pursued by the local entity including an indication whether the local entity has been involved in or affected by business restructurings or intangibles transfers in the present or immediately past year and an explanation of those aspects of such transactions affecting the local entity.

• Key competitors.

Controlled transactions

• For each material category of controlled¹⁰

• A description of the material controlled transactions (e.g. procurement of manufacturing services, purchase of goods, provision of services, loans, financial and performance guarantees, licences of intangibles, etc.) and the context in which such transactions take place.

• The amount of intra-group payments and receipts for each category of controlled transactions involving the local entity (i.e. payments and receipts for products, services, royalties, interest, etc.) broken down by tax jurisdiction of the foreign payor or recipient.

• An identification of associated enterprises involved in each category of controlled transactions, and the relationship amongst them.

• Copies of all material intercompany agreements concluded by the local entity.

• A detailed comparability and functional analysis of the taxpayer and relevant associated enterprises with respect to each documented category of controlled transactions, including any changes compared to prior years¹⁰.

• An indication of the most appropriate transfer pricing method with regard to the category of transaction and the reasons for selecting that method.

• An indication of which associated enterprise is selected as the tested party, if applicable, and an explanation of the reasons for this selection.

• A summary of the important assumptions made in applying the transfer pricing methodology.

• If relevant, an explanation of the reasons for performing a multi-year analysis.

• A list and description of selected comparable uncontrolled transactions (internal or external), if any, and information on relevant financial indicators for independent enterprises relied on in the transfer pricing analysis, including a description of the comparable search methodology and the source of such information.

• A description of any comparability adjustments performed, and an indication of whether adjustments have been made to the results of the tested party, the comparable uncontrolled transactions, or both.

• A description of the reasons for concluding that relevant transactions were priced on an arm's length

• A summary of financial information used in applying the transfer pricing methodology.

• A copy of existing unilateral and bilateral/multilateral APAs and other tax rulings to which the local tax jurisdiction is not a party and which are related to controlled transactions described above.

Financial information

• Annual local entity financial accounts for the fiscal year concerned. If audited statements exist they should be supplied and if not, existing unaudited statements should be supplied.

• Information and allocation schedules showing how the financial data used in applying the transfer pricing method may be tied to the annual financial statements.

• Summary schedules of relevant financial data for comparables used in the analysis and the sources from which that data was obtained.

¹Sections 835A to 835HB TCA
²The new transfer pricing regime applies for chargeable periods commencing on or after 1 January 2020.
³However, this is still subject to the commencement of the new Section 835F TCA by order of the Minister for Finance.
⁴Typically a Section 110 Company will use a PPL or PPN to extract all of its profits, leaving behind only €2,000 to €5,000 in the company. It pays tax at 25% on the amount of profits which are left behind in the company ie it pays tax of approximately €500 to €1,250 each year.
⁵See Section 110(1) TCA - definition of "qualifying company".
⁶Irish legislation implementing the Country by Country reporting requirement was enacted in Finance Act 2016.
⁷It is also worth noting that the exclusion for domestic non-trading transactions does not apply to Section 110 Companies.
⁸As per the OECD Transfer Pricing Guidelines 2017.
⁹As per the OECD Transfer Pricing Guidelines 2017.
¹⁰OECD 2017 guidelines defined a controlled transactions as a transaction between associated enterprises.
¹¹To the extent this functional analysis duplicates information in the master file, a cross-reference to the master file is sufficient.