Implications of Transfer Pricing on Financial Transactions

The implications of transfer pricing on financial transactions between associated enterprises is a key challenge that multinational enterprises (MNEs) need to navigate. Transfer pricing involves setting the prices of transactions when products, services or IP are transferred between the associated enterprises of an MNE located in different tax jurisdictions.

These prices should be at arm’s length range, meaning the MNEs must ensure that transactions are priced as if they were conducted between unrelated parties in an open market.

However, the conditions governing the financial transactions between independent enterprises are the result of a wide range of commercial considerations. On the other hand, an MNE group has the option to decide upon those conditions within the MNE group.

In an intra-group situation like this, other considerations such as tax consequences become relevant. Transfer pricing consultants in Dubai can guide you on these considerations.

This blog will provide you with more insights on the implications of Transfer Pricing on financial transactions:

Determine whether a Purported Loan should be Treated as a Loan

The OECD Guidelines state that the balance of debt and equity funding of a borrowing entity in an MNE group will differ from that which would exist if it were an independent entity operating under the same or similar circumstances. This will affect the amount of interest payable by the borrowing entity and so may affect the profits accruing in a given jurisdiction.

The approach of accurate delineation can be used before pricing a loan to determine whether the purported loan is regarded correctly or should be recharacterized as equity for tax purposes.

Furthermore, the recharacterization as equity of a purported loan is not limited to an all-or-nothing consideration. However, a bifurcation of a purported loan between debt and equity as part of the accurate delineation analysis can be used.

The Guidelines state the following factors that can be used to distinguish intercompany debt from other forms of funding such as equity:

• The presence or absence of a fixed repayment date
• The obligation to pay interest; the right to enforce payment of principal and interest
• The status of the funder in comparison to regular corporate creditors
• The existence of financial covenants and security
• The source of interest payments
• The ability of the recipient of the funds to obtain loans from unrelated lending institutions
• The extent to which the advance is used to acquire capital assets
• Failure of the purported debtor to repay on the due date or to seek a postponement

Identifying the commercial or financial relations

For the accurate delineation of financial transactions, the factors affecting the performance of businesses in the industry sector in which the MNE group operates must be analysed. This analysis will consider the fact that MNE groups operating in different sectors may require, for example, different amounts and types of financing due to different capital intensity levels between industries, or may require different levels of short-term cash balances.

The economically relevant characteristics of actual financial transactions

The following economically relevant characteristics must be considered for analysing the terms and conditions of a financial transaction as part of the accurate delineation of the actual transaction:

• Contractual Terms
• Functional analysis
• Characteristics of financial instruments
• Economic circumstances
• Business strategies

Treasury Function

The organisation of the treasury is dependent on the structure of the MNE group and the complexity of its operations. Different treasury structures have different degrees of centralisation. In a decentralised treasury, each entity within an MNE group will have full autonomy over its financial transactions.

On the other hand, a centralised treasury has full control over the financial transactions of the MNE group, with entities within the MNE group responsible for operational but not financial matters. The OECD sets out transfer pricing considerations related to treasury activities such as the following:

Intragroup Loans

In determining an arm’s length interest rate on intragroup loans, the essential factors include the lender’s and borrower’s perspectives; the borrower’s credit rating and credit rating of a specific debt issuance; the effects of group membership (and associated implicit support); incurrence and maintenance covenants; guarantees; and loan fees and charges associated with the transaction.

Cash Pooling

Cash pooling brings together, either physically or notionally, the balances on a number of separate bank accounts. Cash pooling arrangements are complex contracts involving controlled and uncontrolled transactions. The OECD describes two pricing schemes for cash pooling transactions: rewarding the cash pool leader and rewarding the cash pool members. The appropriate basis on which to reward the cash pool leader depends on the specific facts and circumstances of the arrangement. Transfer pricing advisers in Dubai can advise you in this regard.

Guarantees

a financial guarantee provides for the guarantor to meet specified financial obligations in the event of a failure to do so by the guaranteed party. OECD recommends five pricing approaches for circumstances in which a guarantee is appropriate. They are:

• The CUP method
• The yield approach
• The cost approach
• The valuation of the expected loss approach
• The capital support method

Captive insurance

MNE groups may opt to consolidate certain risks through “captive” insurance, which refers to an insurance undertaking or entity substantially all of whose insurance business is to provide insurance policies for risks of entities of the MNE group to which it belongs.

In order to consider the transfer pricing implications of a transaction with captive insurance, it is first necessary to identify the commercial or financial relations between the associated enterprises and the conditions and economically relevant circumstances. Consult with the best transfer pricing experts in Dubai for more insights.

Hire the Best Transfer Pricing Consultants in Dubai, UAE

Determining the arm’s length compensation for financial transactions can be complex for MNEs, However, transfer pricing consultants in Dubai such as Tax Gian can help you. We are one of the leading transfer pricing advisers in Dubai with more than two decades of experience.

Tax Gian is a brand of Jitendra Tax Consultants (JTC) consisting of a team of highly experienced tax experts. Since 2001, Jitendra Chartered Accountants, an associate of JTC, has been providing end-to-end advisory services to its clients. Call us today to avail yourself of comprehensive transfer pricing advisory services in Dubai, UAE.