![]() ![]() Profit participating loans, which bear higher risks for the lender if the borrower makes poor investments, but also provide higher returns if the borrower makes very profitable investments or.Plain vanilla interest-bearing loans, for which the borrower pays a fixed interest rate over the principal at fixed dates.The market features numerous types of financial instruments adapted to the borrowers’ needs and the lenders’ expectations. The involved parties are basically free to agree on any terms and conditions while respecting the arm’s length principle. It is also essential to determine the financial instrument’s terms and conditions before entering into the transaction. To demonstrate this, a debt capacity analysis is recommended, aiming to determine the maximum amount of debt that the borrower would obtain in a third-party context, given the financial instrument’s agreed terms and conditions. Therefore, for tax and transfer pricing purposes, it may be relevant to demonstrate that the (full amount of the) loan should be regarded as a loan and not as a form of contribution to equity. If neither of the three agencies has published a credit rating, transfer pricing practitioners typically try to assess a rating based on qualitative and quantitative figures, by either (i) using a designated tool provided by one of the rating agencies, or (ii) relying on rating methodologies published by rating agencies for numerous industries.Ī unique feature of related party financial transactions is that the lender often has either control over the borrower, or both entities are controlled directly or indirectly by one entity. This is typically done based on the strategic importance of a single entity to the group. However, in some cases, it is appropriate to deviate from the corporate family rating when assigning a credit rating to the borrowing entity. Rating agencies assign credit ratings to multinational enterprises as a whole (“corporate family rating”). ![]() Transfer pricing practitioners typically rely, if available, on credit ratings published by one of the three credit rating agencies: Moody’s, Standard & Poor’s, and Fitch. Since creditworthiness is one of the main factors to be considered when determining an appropriate interest rate, Chapter X provides extensive guidance on the use of credit ratings. As part of this process, the lender assesses the borrower’s creditworthiness, often expressed as a credit rating. The lender should also thoroughly evaluate the investment before providing funds to the borrower. Regarding flexibility, different terms like convertibility or early-repayment may be beneficial. Given the funding needs, a rational borrower would compare different offers and choose the most cost-efficient and flexible one. ![]() įrom a borrower’s perspective, this means being clear about the amount needed, the flexibility required and the cost limits. In a third-party context, both the borrower and the lender should perform a careful evaluation of the options realistically available to borrow and lend money, respectively. Chapter X emphasizes the importance that the lender’s and the borrower’s perspectives on the transaction are aligned. The transaction’s purpose should be clear and objective, meaning that a neutral, well-informed person would recognize the need for funding. The planning phase is essential thoroughly documenting the discussions and decisions taken upfront may help the taxpayer sustain the arm’s length nature of the transaction for tax authorities’ potential inquiries. ![]() Various elements must be considered before entering into a related party financial transaction. This article discusses the key transfer pricing aspects that may become relevant during a related party financial instrument’s lifespan before entering into the transaction ( birth), after having entered into the transaction ( life) and when terminating the transaction ( demise). Tax authorities are increasingly requesting taxpayers to provide financial information and transfer pricing documentation for financial transactions involving related parties. While financial transactions were often ignored once put in place, administrative practice, case law, interaction with interest limitation rules and new guidance have elevated them to the same level as other intercompany transactions. Two years on since Chapter X of the OECD Transfer Pricing Guidelines ( Chapter X) was published in February 2020, the practical transfer pricing aspects of financial transactions are due another look. ![]()
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