The OECD Releases The Base Erosion And Profit Shifting (BEPS) Public Discussion Draft On BEPS Actions 8-10: Financial Transactions

On 3 July 2018, the OECD launched a consultation on the transfer pricing of financial transactions by publishing the first draft of a new chapter of the OECD Transfer Pricing Guidelines for Tax Administrations and Multinational Enterprises. The consultation comments are invited until the end of the consultation period on 7 September 2018.

This new chapter on financial transactions can help to fill a large gap in the Transfer Pricing Guidelines, which has resulted in high profile disputes in this area having to be settled by courts around the world on the basis of expert evidence on how independent parties approach such transactions. The issues covered by the new chapter are especially relevant to Luxembourg, given its attractiveness to financial institutions and as a location for non-financial companies to place their group treasury centres.

The draft proposes some controversial approaches and whatever form the final guidance takes, it is clear that all businesses with related party financial transactions will need to review how they price them, that the agreements are properly worded, that both parties are able to perform their roles in the transaction and that they actually do so in practice.

The first part of the discussion draft provides guidance on the situations in which loans can be recharacterised as debt, while the second part provides guidance on the pricing of financial transactions such as treasury services, loans, cash pooling, hedging, financial guarantees and captive insurance.

Identifying what should be treated as debt for tax purposes

The draft guidance suggests that debt should be treated as equity (i.e., with no interest tax deduction) if the borrower cannot service the full amount of the debt. It is even suggested that the whole of a loan could be treated as equity even if only a small part of the loan could not be serviced. In addition, the agreement for the funding should have the features of a loan, and it should be operated as a loan (thus, failure to demand an instalment of interest when due could lead to the whole loan being treated as equity).

It should also be asked whether the provider of the funds could have used them more profitably in another investment opportunity and whether the borrower has a business need for the funds.

The guidance also suggests that whether funding should be respected as a loan or not should be influenced by the extent to which the provider of the funds performs the usual functions of a...