The importance of benchmarking quality in financial transactions

Intra-group loan

Intra-group loans, like other related party transactions, should be made on an arm’s length basis.

In order to verify loan transactions to comply with the arm’s length principle, the comparable uncontrolled price method is most often used in the external variant. Data for this analysis is obtained from external specialized databases.

Tax authorities can verify the validity of the analysis at every stage: from the establishment of comparability criteria to the statistical measures used to determine the market level of remuneration.

An example is a loan granted to finance investments on the Norwegian continental shelf. COPSAS (the borrower, the company) entered into a loan agreement with its related party ConocoPhillips, where the interest rate was specified as NIBOR 6M + 125 bps. The authority determined that the margin should be lower in this case.

Rating calculation

The Norwegian court said that the rating used in the analysis was miscalculated and should have been A-.

In contrast, a benchmark compiled by an independent advisory firm indicated that the borrower’s rating was BBB+.

The irregularities in the rating calculation highlighted included the fact that the debt was counted twice. The court also pointed out that there is a relationship between credit rating and interest rate levels, as better creditworthiness results in lower interest rates in the market. The authorities therefore examine in detail all the assumptions and variables used in the comparative analysis.

Authorities verify comparability of contracts

The lender pointed out that the court did not take into account the examples it presented of comparable loans made to other companies with oil operations on the Norwegian continental shelf. The borrower presented 14 such loans with different terms and in different currencies. The loans were granted at different times to oil companies operating in the indicated industry.

However, the court found that these are pipeline transportation companies that are engaged in different activities than the company (exploration), even if they operate on the Norwegian continental shelf and are companies subject to special tax. The court also said that if the loans relate to activities in a different market and have a different risk picture than that applicable to the company’s operations, they cannot be directly compared to the transaction under review. In addition, it pointed out that two of the companies were start-ups, which could have affected the assessment of loan risks. Thus, the court rejected the possibility of including in the study the loan rates indicated by the taxpayer, and the market range study was conducted on the basis of the Bloomberg database.

Quality of analysis also key in financial transactions

A careful analysis of each criterion adopted in a transfer pricing analysis indicates a growing awareness among tax authorities of the technical and substantive aspects of preparing comparative analyses.

Particular attention should therefore be paid to the quality of the analysis prepared and the benchmarking criteria adopted to conduct it.

Tax authorities verify not only the market interest rate, but also other conditions, such as whether the loan is repaid and the actual ability to service the debt.