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INTERNATIONAL
Intercompany Loans:
Observations from a Transfer Pricing Perspective
Michel E.P. van der Breggen1
1. INTRODUCTION
Over the years, transfer pricing has become a standard
item on the agenda of tax directors and controllers of
multinational enterprises (MNEs). The introduction of
transfer pricing documentation requirements in many
countries has been a contributing factor in this regard,
as has been the fact that transfer pricing is currently a
more or less recurring issue in tax audits. Until now,
the preparation of transfer pricing documentation and
discussions with tax authorities have typically centred
around transfer pricing within the context of the intercompany supply of goods, the provision of services
and intangible property (IP) transactions. Due, in part,
to their often complex nature and specific characteristics, intercompany financing transactions have had a
relatively low profile so far.
Judging from an increasing interest in intercompany
financial transactions from the business community
and tax authorities alike, this lack of attention seems to
be changing. In this regard reference is made to the
adjustments to the French thin capitalization rules that
are set to take effect on 1 January 2007 and which contain explicit requirements for the arms length nature
of interest on intercompany loans. Reference is also
made to the audit that the New Zealand tax authorities
have announced with respect to the intercompany
finance expenses of 50 multinationals.
Given this increasing interest in intercompany financial transactions, the present article will discuss some
observations with respect to the transfer pricing
aspects of intercompany loans.2
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What one group company will want to charge in interest may on occasion therefore be higher than what the
other group company will want to pay in interest. In
such a situation, in theory no group loan is expected to
be contracted because the parties are unable to agree
on a price. Nevertheless, in practice, loans will be contracted anyway, simply because on a group level it is
more cost effective to provide intercompany financing.
As the shareholding structure is apparently decisive in
this regard, the non-collecting tax authorities may take
the view that the companies have agreed on a nonarms length interest rate that needs to be adjusted.
4.3. Prepayment of intercompany loans
In practice, it is common, for example within the scope
of a major acquisition, that temporary intercompany
loans are used and that, after the course of time, mostly
after the acquisition structure has been fully implemented, loans are repaid and refinanced early. The
question of whether such a repayment is permitted
under the contractual terms of the loan and whether
this constitutes an arms length transaction, considering the terms of the repayable loan and of the new loan,
is often disregarded.
Assuming that the market interest rate has developed
in a certain direction in the time frame between the
contracting of the intercompany loan and the time of
early repayment, it will often be an interesting option
for one group company to repay the loan early,
although this will have adverse consequences for the
other. It is important in this regard to substantiate that
the entity taking the initiative for the repayment has an
economic interest in doing so (e.g. the debtor, because
a lower interest rate is available elsewhere) and that
this party also has the legal option under the contract to
terminate the loan early (and that not only the creditor
for instance, for whom early repayment will have
adverse consequences, may terminate the loan early).
In this process, regard must also be had to the costs that
might be associated with the early repayment of the
loan.
If the arms length nature of an early repayment is not
sufficiently substantiated and the refinancing effectively results in higher expenses or lower income in a
certain jurisdiction, the company involved might run
the risk of adjustments. In practice, this can usually be
avoided by proactively approaching the loan as a temporary form of financing when intercompany loans are
concluded.
5. OPTIMIZATION OF THE ARMS LENGTH
INTEREST RATE
Based on the OECD Guidelines and local transfer pricing requirements, the terms of an intercompany loan
13. See Sec. 7.13 OECD Guidelines (No service has been procured, for
example when an associated enterprise, merely based on its association, has
a higher credit rating than it would have had without any association).
14. If a formal guarantee is issued, a guarantee fee will in principle be due
to the issuer of the guarantee, as a result of which the finance costs for the
debtor are as high on balance as they would have been had the debtor contracted the loan on a stand-alone basis.
2006 IBFD
Exported / Printed on 31 Aug. 2016 by tailoredcourse2@ibfd.org.
NOVEMBER/DECEMBER 2006
ITPJ
299
2006 IBFD
Exported / Printed on 31 Aug. 2016 by tailoredcourse2@ibfd.org.