Financial Services Transfer Pricing
Financial services transfer pricing constitutes one of the most complex areas, as it involves management of debt and cash between the group entities. Therefore, applying an appropriate analysis for calculation of the arm’s length quantum of debt, is important. At Taxand Cyprus we can assess this fully, along with interest rates and interest deductibility, through corporate interest restriction (CIR) and we can also prepare documentation and applications to support related party debt position and advanced thin capitalisation agreement (ATCA).
- At Taxand Cyprus we employ economic analyses which determine the arm’s length pricing for intercompany financial services and transactions. The specific industry markets and regulatory environment the related entities operate in are considered in our analyses. Our comprehensive databases and understanding of these factors enable us to manage the transfer pricing risk of our clients.
- We can advise in all areas of transfer pricing for financial services including asset and equity related valuations, structuring of service flows and capital, cost allocation arrangements, as well as Intra-Group Financing Transactions. In addition, we pay particular attention in understanding the value creation process of the businesses within different industries in the financial sector including insurance, banking and capital markets, investment and wealth management, real estate and private equity.
- Establishing an arm’s length return for the transactions by considering returns from any ancillary services or use of intangible assets to the value creation process.
- Determining based on economic and financial analyses the return to be paid to key functions within the value chain stemming from the intercompany cross-border transactions.
- Providing advice on the overall cross-border intra-group pricing system adopted.
- Designing tailored transfer pricing policies for the business based on its operations, group structure, looking at the value creation chain based on the entities’ functions, assets and risks.
- Advising business restructuring by undertaking the relevant pricing and valuations of equity and intangibles.
- Preparing transfer pricing documentation and providing clients with help in communicating this documentation both internally (e.g. to the Board of Directors) or externally (e.g. to tax authorities).
- Assisting taxpayers to discuss and negotiate with tax authorities for compliance with transfer pricing requirements.
Intra-Group Debt, Treasury Services and Financial Intermediation
Taxand Cyprus has an expertise in the area of financial arrangements that can effectively increase access to liquidity and reduce the cost of capital for a borrower. This includes the following:
- Advising on transfer pricing issues that relate to financial engineering of structured financial instruments.
- Application of major financial databases used for economically sound loan pricing techniques.
- Pricing of the embedded options in structured financial instruments applying the most suited pricing models or model combinations.
Determination of shadow credit ratings where an explicit credit rating is not available and confirmation of existing credit ratings.
It is crucial that taxpayers have robust policies and processes in place to ensure firstly that intercompany financial transactions are carried out at arm’s length, and secondly to demonstrate this in an appropriate and convincing manner to the tax authorities.
Taxand Cyprus experts provide treasury support services in the following areas:
- Pricing financial transactions for cash pooling, loans, structured finance, guarantees, leasing, commodity and currency hedging.
- Analysing controlled parties’ capital structure, defending against allegations of thin capitalisation, assisting clients in obtaining APAs, advance rulings, and supporting filing positions.
- Advising on how to implement transfer pricing models with tailor made designs for our clients’ particular needs that correspond to different treasury service models.
- Preparation and analysis of risk assessments by providing recommendations on best practices in transfer pricing for treasury services.
- Preparation of transfer pricing documentation that are in line with country-specific regulations and OECD Guidelines.
- Assisting clients with audited financial statements that are required by tax authorities for the preparation of required transfer pricing analysis and/or documentation. Providing experts specialising in financial economics and transfer pricing to support a taxpayer’s position in controversy and negotiations with tax authorities.
In some tax jurisdictions, perspective rules of controlled entity capitalisation may apply while many other entities apply the arm’s length principle to determine the related debt of controlled entities that expect to bear and the levels of interest cover that should be maintained.
Tax authorities frequently question and examine the thin capitalisation by requesting advance pricing agreements (APAs), tax audits and challenges faced by taxpayers that are compounded by the effects of financial crisis. Due to the ongoing economic changes, banks are hesitant to provide lending services and the tax authorities in some jurisdictions demand greater levels of interest cover and lower leverage for entities belonging in a group.
With the use of sophisticated financial modelling to derive an objective, market-based test of capacity to bear debt and meet interest expense, Taxand Cyprus uses the approach of a basic benchmarking analysis. This approach provides clients with economically robust answers and tax authorities with acceptable analyses.
One of the most contentious issues in transfer pricing is the pricing of intercompany guarantees. Taxand Cyprus’s has an expertise in calculating shadow credit ratings, or confirming actual ratings where they already exist. This has been developed through extensive work on assignments involving intercompany loans and guarantees. Taxand Cyprus’s capabilities in this area includes the use of the following methods:
- Credit default swap (CDS) benchmarking: Market data available on CDS are taken into account when establishing an arm’s length range for a guarantee fee. The necessary adjustments are made to reflect the scope, terms and economic conditions of the specific nature of the guarantee provided. If no data is available in the CDS market, then the latest CDS pricing models is used to calculate an arm’s length estimate of the guarantee fee.
- Counterfactual debt pricing: determining the interest rates or bond premiums related parties would be charged in the absence of a parental guarantee, as well as conducting profit split analyses to determine what proportion of interest savings should be paid to the guarantor as a fee.
- Expected loss: in order to determine the expected loss, the value of a guarantee is taken by multiplying the nominal amount guaranteed by the probability of default and making adjustments to account for the expected rate of recovery. Various methods can be used to determine the premium that should be applied to this figure to compensate the guarantor for its cost of capital and risk, including the Capital Asset Pricing Model (CAPM).
Capital infusion: determination of capital infusion that is necessary to bring a related party’s credit rating in line with that of the guarantors. A calculation is performed of the cost of capital that is associated with this infusion.
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