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. Consultation comments were invited until the end of the consultation period on 7 September 2018. On 11 February 2020, the OECD published the final conclusions of its project in the form of a new chapter X of its Transfer Pricing Guidelines for Tax Administrations and Multinational Enterprises1 (except for certain text on the risk-free and risk-adjusted rate of return which will be added to Section D.1.2.1 in Chapter I, immediately following paragraph 1.106).

This new chapter 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 in which to place their group treasury centres.

The chapter recommends some controversial approaches and 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, that they actually do so in practice, and that the quantum of the transactions is not excessive.

The first part of the chapter provides guidance on the application of the arm's length principle to financial transactions, while the remainder provides guidance on the pricing of financial transactions such as loans, cash pooling, hedging, financial guarantees and captive insurance.

The key elements of the new guidance may be summarised as follows.

1. Application of the arm's length principle to financial transactions

1.1. Identifying what should be treated as debt for tax purposes

The new guidance states that one of its main purposes is to clarify the accurate delineation analysis under Chapter I of the Transfer Pricing Guidelines in the context of financial transactions. In this respect, it considers that the following economically relevant characteristics may be useful indicators depending on the facts and circumstances:

  • 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; and
  • the failure of the purported debtor to repay on the due date or to seek a postponement.

As an example, it considers that part of a debt should be treated as equity (with no interest tax deduction) if in light of all good-faith financial projections at the time of granting, it is clear the borrower will not be able to service the full amount of the debt upon maturity.

1.2. Identifying the commercial or financial relations

The new guidelines reiterate the need to accurately delineate financial transactions by analysing the factors affecting the performance of the business in the relevant industry sector. The accurate delineation of a transaction should begin with the identification of the economically relevant characteristics of the transaction, i.e. the commercial and financial relations between the parties, and the conditions and economically relevant circumstances attaching to those relations, including:

  • an examination of the contractual terms of the transaction;
  • the functions performed, assets used and risks assumed;
  • the characteristics of the financial instruments;
  • the economic circumstances of the parties and of the market; and
  • the business strategies pursued by the parties.

Based on the above, the new guidelines consider that if, for example, a group as a whole has targeted a particular credit rating, then this could be a reason to deny an interest deduction for any part of a related party loan to a group member which would reduce its standalone rating below that level. Also, interest could be disallowed if the lender could have found a more profitable use for the funds, or if the borrower did not actually need all of the funds, or if borrowing so much would damage its credit rating, its market reputation and its access to the capital markets.

1.3. Economically relevant characteristics

According to the new guidelines, the following economically relevant characteristics should be considered to analyse the terms and conditions of the financial transaction or to price said transaction:

  • contractual terms: written agreements but also the actual conduct of the parties and the economic principles that generally govern relationships between independent parties in comparable circumstances have to be analysed;
  • functional analysis: the functions performed, the assets used and the risks assumed need to be identified. In this respect the guidelines remind that if a group company other than the lender manages the risks of a loan and has the financial capacity to bear those risks, then the lender should only be credited with the risk-free return element of the interest income;
  • characteristics of the financial instruments: e.g. amount, maturity, schedule of repayment, nature and purpose of the loan, level of seniority and subordination, geographical location of the borrower, currency, collateral, guarantee, fixed or floating interest;
  • economic circumstances: e.g. currencies, geographic locations, local regulation, business sector, timing of the transaction; and
  • business strategies: e.g. related parties should be allowed to enter into loans where the initial financial ratios would be poor if the borrower's business plans and forecasts show that when it reaches its steady state, its ratios will be strong enough.


1. http://www.oecd.org/tax/beps/transfer-pricing-guidance-on-financial-transactions-inclusive-framework-on-bepsactions-4-8-10.pdf.

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