TRANSFER PRICING OF INTERCOMPANY LOANS AND CASH POOLING

Two hot areas of transfer pricing for consideration are intercompany loans and cash pooling. These two intercompany financing transactions are used by most multinational entities (MNEs) and are being targeted by the IRS and global tax authorities. Yet, most intercompany loans remain undocumented and have commercial terms that would not meet the required transfer pricing standards.

On July 3, 2018, the Organization of Economic Cooperation and Development (OECD) released a discussion draft on the transfer pricing aspects of financial transactions. The discussion is part of Action 8 - 10 of the base erosion and profit shifting (BEPS) initiatives.

With the increased transparency provided by the BEPS initiatives, intercompany financing is attracting more attention than ever before. The release of this OECD discussion draft is another attempt at assuring MNEs are complying with global transfer pricing guidelines. The IRS and other global tax authorities are becoming more sophisticated and thorough in their audits, and will be paying more attention to intercompany financing transactions.

One of the major issues addressed is how to analyze financial transactions. In particular, the identification of debt versus equity in related party financial transactions. Some items to consider include the following:

• Presence or absence of a fixed repayment date;
• Obligation to pay interest;
• Right to enforce payment of principal and interest;
• Existence of intercompany agreement;
• The ability of the borrower to obtain loans form an unrelated lending institution; and
• The evaluation of an arm's length interest payment considering the credit rating to measure the creditworthiness of the borrower in order to identify comparable.

  Intercompany loans must be structured with consideration of the items listed in the table above in order to be respected as an arm's length transaction for transfer pricing purposes. Otherwise, the IRS or foreign taxing authorities may characterize all or some of the transaction as equity. The terms and conditions of the loan between the related parties are critical in analyzing the intercompany transaction. 

  Cash pooling arrangements are also included and should have the formalities of an intercompany agreement, provide clear benefits to participants and reward the cash pool leader for its assets employed and risks assumed. Keeping in mind that short-term versus long term balances in a cash pooling arrangement should be respected, as well as special attention to excessive outstanding balances.

  Intercompany loans and cash pooling arrangements are present in many, if not all, MNEs. Governments all over the world are watching these unpopular intercompany transactions and more global audits are predicted. Also, financial statement auditors and tax compliance service providers are now asking for support, transfer pricing documentation on tax provisions or tax returns from a transfer pricing specialist.

  Please be sure your intercompany financing meets not just the US requirements but global expectations as well. For more information contact us in one of our many locations.