Key Takeaways: - Significance and Arm's Length Nature - Delineation and Comparability Analysis - Potential Transfer Pricing Methods - Application of Arm's length Principle

1. Chapter B.9 of UN TP Manual: Intra-Group
Financial Transactions - Part I
CA Jugal Gala

2. Research Credits
Gracelin Lita

3. Legends used in the Presentation
AE Associated Enterprises
ALP Arm’s Length Prince
BEPS Base Erosion and Profit Shifting
ITA Income Tax Act
MNE Multi National Enterprise
OECD Organization for Economic Cooperation and
Development
TP Transfer Pricing
TNMM Transactional Net Margin Method
UN United Nations

4. Presentation Schema
Overview
Practical Importance of
Intra-Group Financial
Transactions
Arm’s length nature of
Intra-group Financial
Transaction
Delineation and
Comparability Analysis
Potential Transfer Pricing
Methods
Application of Arm’s
Length Principle to Intra-
group Loans
Way Forward

5. Overview

6. Overview
It is common practice for MNEs to finance part of their operations through loans, or to reduce cost
for external funding of their associated operating companies by issuing intercompany guarantees or
through cash pooling activities.
As for any other intragroup arrangement, the application of the arm's length’ principle requires
the accurate delineation of the actual transaction (assessing how the actual behaviour of the
parties to a transaction stacks up against what is provided in the written contract)
Chapter B9 of the UN TP Manual sets out guidance for non-financial MNE Groups that engage in
financial transactions.
In today’s session we would be discussing on general principles for intra-group financial transactions
and intra-group loan. Guidance for intra-group financial guarantees will be discussed in further
sessions

7. Concerns Regarding Intra-group Financial Transactions
Several factors of concern relating to intra-group financial arrangements have contributed towards the introduction
of tax measures aimed at reducing the tax advantages of debt financing. Some of them are as follows:
The significance of financial transactions for MNE Groups (in terms of
amount involved and frequency)
• This reduces taxable profits in the jurisdiction of the borrower, and can, depending on the
situation of the group lender, reduce the MNE Group’s overall tax liability
The ease that an MNE Group has in shifting debt to group companies and
claim an interest deduction.
• Concerns of Hybrid mismatch arrangements – OECD BEPS Action Plan 2
The difficulty that tax administrations face in determining the true
character and characteristics of certain financial instruments
• Concerns of Thin Capitalization – OECD BEPS Action Plan 4 (Section 94B of ITA)
The concern that excessive interest deductions provide opportunity for
tax base erosion

8. Practical Importance of Intra-
Group Financial Transactions

9. Common Types of Intra-Group Financial Transactions
• A financial transaction might consist of an equity instrument, a contractual right or obligation to receive
cash or another financial asset or to exchange financial assets or liabilities, or a derivative.
• Typical examples are Equity instruments (eg. common stocks), debt instruments (eg. Loans, bonds, CP,
debentures, etc.) and financial derivatives (eg. Forex transactions, stock options, futures, forwards and
other hybrids)
In an intra-group context, more common intra-group financial transactions include the following:
• Intra-group loans
• Financial guarantees by parent for third-party loans taken by subsidiaries
• Cash pooling
• Hybrid financing
• Derivatives
• Treasury services (e.g. factoring and forfeiting, netting arrangements, payment factories, commodity
risk management, captive insurance, asset management, carbon trading)
Note: The scope of Chapter B9 of UN TP Manual is limited to analysis of intra-group loans and intra-group financial
guarantees, since they are most commonly seen financial transactions in practice

10. Centralised Treasury of a MNE Group
Unlike in a decentralized form, a centralised treasury has full control over the financial resources of the group
which offers scale benefits and financing cost savings for an MNE group
Treasury department/entities operate in different types:
• Cost centres: They assist group companies with routine services and arrange transactions on their behalf
but do not assume any risk of capital.
• Value-added centres: These are cost-saving centres and more risk tolerant than their cost centre
counterparts.
• Profit centres: They may seek profits by deliberately creating market positions, as well as actively managing
operational exposures. They may operate as in-house banks, maximize the profits of their own operations,
and assume the risk of capital.
Treasury departments/entities operating as service centres are typically remunerated by applying the CUP
method, the cost-plus method, or the TNMM based on cost, whereas, in profit centres the ‘spread’ between
costs of funding and return on cash invested will be mainly allocated to that treasury department/entity.
The substance of these centralized activities has to be carefully reviewed for accurate delineation of the actual
transaction to determine arm’s length remuneration of services rendered

11. Arm’s length nature of Intra-group
Financial Transaction

12. Analysis
Considering the different facets of debt financing (such as the issue of excessive of interest deductions, ROI not at
arm’s length and whether prima facie loan can be regarded as a loan or contribution to capital), the analysis of
arm’s length nature of financial transactions can arguably be conducted from several perspectives:
First, it could be undertaken by (initially) accepting the
transaction as an intercompany loan at face value,
until the facts and circumstances of the transaction that
are available for review (and possibly additional
available evidence or conduct of the parties) leads to
the decision that the transaction is commercially
irrational.
Alternatively, a second scenario is that the analysis
could be conducted from the perspective of
determining whether the economically significant
characteristics of the transaction lead to the
conclusion that the financial transaction sufficiently
resembles an intercompany loan (or more resembles
something other than an intercompany loan)
If commercially irrational
Financial transaction to be disregarded as intercompany loan for transfer pricing purposes

13. Contd…
In a third scenario, it is also examined whether it is possible to conclude that the intercompany transaction in its
entirety is not a loan, but (arguably only) part of it could be treated as an intercompany loan.
Relevant evidence might for example include a debt capacity analysis of the borrower.
Inter-company financial
transaction
Partly inter-company loan
Financial transaction for TP purposes would be
treated partly as loan and partly as something
other than a loan such as contribution to equity
Commercially irrational
The financial transaction may be disregarded as
an intercompany loan for transfer pricing
purposes.
 In all three scenarios mentioned above, the treatment of the transaction as something other than a loan
would for tax purposes, lead to a limitation in the deductibility of interest expense (entirely or partially) and
not necessarily imply a characterization of the transaction as something else (e.g. and equity instrument)
 The conclusion and decision to characterize a transaction between associated enterprises that is presented as
an intercompany loan (in its entirety or partly) as something other than an intercompany loan requires
careful analysis and should be based on adequate information, as a conclusion like this is likely to lead to
double taxation

14. Delineation and Comparability
Analysis

15. Economically Significant Characteristics for TP and
Benchmarking Purposes
Contractual arrangements between AEs of an MNE may be less explicit. Hence, other
documents and information may need to be consulted to determine the veracity of
the transaction
Contractual terms
Debt capacity of the borrower, credit risk of lender, consideration of functions relating
to source of funds for repayment, intended use of funds and purpose of the financial
transaction in the context of the parties’ businesses, needs to be considered
Functional analysis
To accurately delineate the actual transaction, it is material that the characteristics of
the specific financial transactions (or financial services) under review are clearly
defined and supported by the conduct of the parties and other facts
Characteristics of Financial
Products or Services
The intent of the parties with respect to the funding provided, participation in
management and voting power by the party extending the financing all may be
relevant considerations in this respect
MNE Group’s global
financing policy
Specific business sector or industry in which the parties operate, geographic
jurisdictions, macro-economic trends and timing of the transaction, currency of the
financial transaction
Economic circumstances of
the parties

16. Consideration of the Creditworthiness of AEs
To obtain reliable comparables, the creditworthiness of the AEs involved in the intra-group financial transactions
may need to be considered
• Credit risk may be measured by assigning a credit rating to the tested party derived from independent
commercial credit rating agencies)
The impact of implicit support (benefits of group membership) in credit rating of a borrower is also to be considered.
• An improved credit rating for an AE based merely on so-called passive association does not merit a return or
payment, at arm’s length (an implicit support is not an explicit guarantee and unenforceable by the lender)
• Where there are significant difficulties in determining the extent and effect of any implicit support, the credit
rating of the MNE group may also be used for pricing the accurately delineated loan (this is where borrower’s
credit rating does not differ much with that of MNE’s)
Also, in most cases, the situation after the new financing transaction takes place must be considered for the credit
rating of the AE
It may also be relevant to consider the risk of an entity operating in a particularly risky country to the extent that
this is not already reflected in the credit rating of that entity
Note: In some developing countries the government may have official prescribed interest rates in place and no use
is made of international commercial credit rating approaches (Eg: Credit rating rules applicable in Mexico and China)

17. Consideration of Risks Embedded Into the
Financial Instrument
Consider the following example:
AE Co.A AE Co.BInter-company Loan
If lender Co.A will only be entitled to claim repayment from Co.B in case of Co.B’s bankruptcy after the latter has
repaid the other three different loans, it holds a subordinated loan instrument with a higher risk
Thus, the credit rating of a specific financial instrument is also linked to the specific features of that particular
financial instrument and not only to the risk profile of the borrower (accordingly, credit rating of the borrower has
to be adjusted)
For example, if it is the practice of the credit rating agency to apply a one-notch credit rating downgrade to reflect
the subordinated nature of this financial instrument, the credit rating of this financial instrument would BBB- now
Loan 1
Loan 2
Loan 3
Loan 4
Credit rating of BBB
The “status” of the loan 4 between Co.A and Co.B in essence
is lower than that of the other three loans

18. Delineation of the Financial Transaction
Consider the arm’s
length nature of the
transaction as
structured by the
AE
Examine the
conduct of the
parties and base
the analysis of the
financial
transaction
If pricing of the
transaction is not at
arm’s length or the
transaction is to be
characterized
differently, arm’s
length principle to
be applied
After accurate
delineation of the
transaction, the
most appropriate
transfer pricing
method can be
selected and
applied.
Within this process, potentially comparable financial transactions can be identified, and comparability
adjustments might be applicable, to determine the arm’s length price or profit (or range of prices or profits)
for the financial transaction(s) under review.

19. Potential Transfer Pricing Methods

20. Methods to Price Financial Transactions
Intra-group loan
CUP Method
Treasury services
for MNE group CPM or cost-based
TNMM Method
Global trading or
certain cash
pooling
transactions
Transactional Profit
Split Method
- In certain circumstances where the financing entity adds no
value, arm’s length remuneration would be at cost
- If a financing department/entity, however, provides financing
to group members and refinances these with deposits from
other group members or external sources and has, therefore,
a mismatch in timing and/or currencies as well as exposure in
creditworthiness, the CPM might not be the MAM for that
financing transaction
The CUP method may be employed when comparable
transactions exist between one party to the intra-group loan
transaction and an independent party (“internal comparable”)
or between two independent parties, neither of which is a
party to the intra-group loan transaction (“external
comparable”).

21. Safe Harbours
• To simplify the determination of the arm’s length price for intra-group financial transactions, a few countries
have been introducing safe harbours, most of which concern interest rates
• Official interest rates are issued annually that, if applied to the intra-group loans, extinguish the obligation
for the taxpayer to prove the arm’s length nature of the compensation related to those transactions, while
providing some assurance that the intercompany rate will not pose a risk of base erosion
Indian Safe Harbour Rules for Intra-group financial transactions applicable for AY 20-21 – Rule 10TD
S.No Eligible International
Transaction
Safe Harbour
1 Advancing of Intra-
group loan
denominated in INR
The interest rate declared is not less than the one-year marginal cost of funds lending
rate of SBI as on 1st April of the relevant previous year plus,-
Allowable Basis points CRISIL Credit rating of AE
175 AAA to A or its equivalent
325 BBB-, BBB or BBB+ or its equivalent
475 BB to B or its equivalent
625 C to D or its equivalent
425 Credit rating of AE not available and amount of loan
advanced to the AE and all AEs in INR does not exceed
Rs.100 crores in the aggregate as 31.03.2020

22. Contd..
S.No Eligible International
Transaction
Safe Harbour
2 Advancing of Intra-group
loan denominated in
foreign currency
The interest rate declared is not less than the 6-month LIBOR of the relevant
foreign currency as on 30th September of the relevant previous year plus
Allowable Basis
points
CRISIL Credit rating of AE
150 AAA to A or its equivalent
300 BBB-, BBB or BBB+ or its equivalent
450 BB to B or its equivalent
600 C to D or its equivalent
400 Credit rating of AE not available and amount of loan
advanced to the AE and all AEs in INR does not exceed
Rs.100 crores in the aggregate as 31.03.2020
3 Providing corporate
guarantee for amount not
exceeding Rs.100 crores
or where it exceeds, credit
rating of AE is of highest
safety as done by a SSEBI
registered agency
The commission or fee declared in relation to the financial transaction is at the
rate not less than one per cent per annum on the amount guaranteed.

23. Application of Arm’s Length
Principle to Intra-group Loans

24. Intra-group Loans
Types of Intra-group loans
Term loan Revolving loan or revolving credit facility
• When analysing an intra-group loan, relevant characteristics that may be considered include conversion
right, currency, guarantees, interest payments, options, repayment clauses, security provided, seniority
and terms of the loan
• Determination of arm’s length nature of intra-group loan would involve consideration of economically
significant characteristics of the intra-group loan as discussed preciously for any intra-group financial
transaction
• Internal CUP method or External CUP method can be used
• In cases of on-lending whereby an entity of a group obtains financing from an unrelated entity and
provides the resources obtained to a related entity, i.e. “pass- through” scenarios), Cost of funds approach
would be applicable
• While applying this method to price the intercompany loan, the lender’s cost of funds relative to other
lenders in the market may also need to be considered

25. Points for Consideration in Computing Arm’s Length
Interest Rate
Other relevant information in determining an arm’s length interest rate for intra-group
loans may include the use of Credit Default Swaps to reflect the credit risk linked to an
underlying financial asset, Economic Modelling by constructing an interest rate as a
proxy.
The arm’s length pricing of intra-group loans may also involve the evaluation of fees and
other charges in relation to intra-group loans.
It may need to be considered however, that associated enterprises may not incur charges
similar to those that independent lenders (i.e. banks) would in the process of raising
capital and satisfying regulatory requirements

26. Way Forward
It is to be noted that OCED under its mandate of BEPS Action Plan 4 and 8-10 released for
the first time “TP Guidance on Financial Transactions” in February 2020
The OECD Guidance encompass principles of delineation with respect to almost all intra-
group financial transactions including cash-pooling, hedging and captive insurance

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