Intercompany Financial Transactions and Services
Drawing on combined expertise from NERA's Global Transfer Pricing and Securities and Finance Practices, NERA's economists use advanced analytical techniques to provide robust solutions that help taxpayers in determining arm’s length pricing for financial transactions. Our capabilities in this field uniquely position us to manage transfer pricing risk and deliver value to our clients. NERA’s capabilities span all areas of intercompany finance, including loan and guarantee pricing, structured finance and leasing, thin capitalization and treasury services, private equity, and asset and fund management.
Asset and Fund Management
NERA economists have a deep understanding of the fund industry and its value creation process and can provide sound advice on remuneration of the various entities included in the value chain. Our experts support clients by:
- Establishing an arm's length basis for rewarding fund management activities, taking into account any provision of ancillary services and the contribution of intangible assets to the value creation process.
- Providing economic and financial analyses of the net compensation paid to a fund manager as part of a series of cross-border transactions.
- Analyzing and providing economic advice on the overall system of transfer pricing adopted by an investment fund and designing the transfer pricing policy of the fund in the context of establishing on-shore investment management activities.
- Drafting or assisting in drafting contemporaneous transfer pricing documentation.
- Providing experts specializing in financial economics and transfer pricing to support a taxpayer's position in controversy and negotiations with tax authorities.
Loans Guarantees
Pricing of intercompany guarantees is becoming one of the most contentious issues in transfer pricing. NERA's expertise in calculating shadow credit ratings, or confirming actual ratings where they already exist, has been developed through extensive work on assignments involving intercompany loans and guarantees. NERA's capabilities in this area include the use of the following methods:
- Capital infusion—determine the capital infusion needed to bring a related party’s credit rating in line with that of the guarantor's, and then calculating the cost of capital associated with this infusion.
- Expected loss—calculate the value of a guarantee by multiplying the nominal amount guaranteed by the probability of default and making adjustments to account for the expected rate of recovery. There are a variety of methods that 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).
- Credit default swap (CDS) benchmarking—establish an arm's length range for a guarantee fee by reference to available market data on CDS, making adjustments as necessary to reflect economic conditions, and the scope, terms, and conditions of the specific nature of the guarantee provided. If CDS market data are not available, the latest CDS pricing models can be used to generate an arm’s length estimate of the guarantee fee.
- Counterfactual debt pricing—determine the interest rates or bond premiums related parties would be charged in the absence of a parental guarantee, as well as conduct profit split analyses to determine what proportion of interest savings should be paid to the guarantor as a fee.
Structured Finance
Structured finance refers to financial arrangements that effectively increase access to liquidity and reduce the cost of capital for a borrower. NERA's relevant expertise in this area includes:
- Advice on transfer pricing issues related to the financial engineering of structured financial instruments.
- Application of economically sound loan pricing techniques using major financial databases.
- Pricing of the embedded options in structured financial instruments using the most appropriate pricing models or model combination (e.g., Black Scholes, Cox-Rubinstein Binomial Model, Garman Kohlhagen model).
- Confirmation of existing credit ratings, or determination of shadow credit ratings where an explicit credit rating is not available.
Thin Capitalization
While safe harbors and prescriptive rules of controlled entity capitalization may apply in some tax jurisdictions, many others adhere to the arm’s length principle of determining how much related debt controlled companies can be expected to bear, and what levels of interest cover should be maintained.
The "thin capitalization" questions are frequently examined by tax authorities in the context of requests for advance pricing agreements (APAs) and tax audits, and the challenges faced by taxpayers are compounded by the effects of the financial crisis. Indeed, the drying up of bank lending has prompted tax authorities in some jurisdictions to demand higher levels of interest cover and lower leverage for companies belonging to an affiliated group.
NERA's approach in this area complements basic benchmarking with the use of sophisticated financial modeling to derive an objective, market-based test of capacity to bear debt and meet interest expense. This approach provides clients with economically robust answers and its use has been accepted by tax authorities.
Treasury Services
Recent court cases such as GE Capital Canada v. HMQ in Canada and DSG Retail and others vs. HMRC in the UK have highlighted the relevance of transfer pricing for corporate treasury functions.
It is important that taxpayers have robust policies and processes in place to ensure not only that intercompany financial transactions are carried out at arm’s length, but also that this fact can be convincingly demonstrated to tax authorities. NERA experts provide treasury support services in the following areas:
- Pricing financial transactions, including those in relation to cash pooling, loans and structured finance, guarantees, leasing, and commodity and currency hedging.
- Providing analysis of controlled parties' capital structure including defense against allegations of thin capitalization and assisting clients in obtaining APAs, advance rulings, and support for filing positions.
- Advice on the design and implementation of transfer pricing models that correspond to different treasury service models (e.g., in-house banking and conduit arrangements).
- Conducting risk assessments and providing recommendations on best practices in transfer pricing for treasury services.
- Preparation of transfer pricing documentation in line with country-specific regulations and OECD Guidelines.
- Assisting clients audited by tax authorities in preparing required transfer pricing analyses and/or documentation.
- Providing experts specializing in financial economics and transfer pricing to support a taxpayer's position in controversy and negotiations with tax authorities.
