In an important shift, the world has bid farewell to the era of near-zero short-term interest rates that persisted for over a decade. Short-term interest rates in the US were near zero from 2008 to 2016 and experienced a similar trend for a significant part of 2020 and 2021. During 2018 and 2019, the rates briefly surpassed 2%. With short-term U.S. Treasuries rates now surpassing 5%, a major change in the financial landscape has arrived, demanding immediate attention to the transfer pricing policies of multinational enterprises (MNEs) engaging in intercompany financial transactions.
Why It Matters: For years, business managers became used to foregoing a detailed assessment of market conditions when issuing intercompany loans. With rising interest rates, tax managers must pay close attention to current and proposed intercompany financing to ensure compliance with the arm’s length principle, minimize risk and seize potential opportunities.
The Challenge: One of the most pressing questions in this evolving financial ecosystem revolves around financial transactions and benchmarks. With a higher interest rate environment and short-term rates above the long-term ones comes the need to assess not only the risk profile of borrowers but also the market conditions more meticulously than at any point in the past years.
The Key Question: How does the arm’s length principle influence the nature of a loan? This determination hinges on a rigorous evaluation process akin to the criteria used by third-party lenders when deciding interest rates and related terms and conditions. This process entails assessing:
- The amount and currency of the loan;
- A comprehensive risk profile and debt-capacity analysis of the borrower;
- Maturity and schedule of repayment;
- Purpose of the loan (working capital, merger/acquisition, among others);
- Level of seniority and subordination;
- Geographical location of the borrower;
- Presence and quality of any guarantee;
- Whether the interest rate is fixed or floating;
- Collateral used to secure the loan, including the actual availability of pledged assets; and
- The liquidity position of the lender.
What to Do Next: It is important to evaluate current intercompany financing flows and where needed to prepare and renew benchmarks for intercompany loans. The transfer pricing policies for intercompany financial transactions that in the past were valid for years can now be obsolete after months of rising interest . Taxpayers should take concrete steps to minimize risk, including, but not limited to, evaluating intercompany loans’ floating rate, looking for alternative means of capitalizing subsidiaries, streamlining in-house cash processes, and selecting the appropriate financing horizon by balancing costs and repayment capacity.
Are you prepared for this new era of financial strategy? Contact us to stay compliant and plan your group financing strategy accordingly.
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Sol Assi – senior associate, BaseFirma USA – firstname.lastname@example.org
Andrés Stante – senior associate, BaseFirma Chile – email@example.com