Tax Articles

The 2022 OECD Transfer Pricing Guidelines (2ⁿᵈ of 2 Parts)

By: Atty. Jomel N. Manaig

After giving a glimpse on the guidelines on the Transactional Profit Split Method and on hard-to-value intangibles, the second part of this article would walk us through the guidelines involving financial transactions. Considering the significant and extensive reach of financial transactions between related parties, the Organization for Economic Cooperation and Development (“OECD”) saw it fit to provide a set of guidance to enable consistency in the transfer pricing of financial transactions.

Generally, the guidance puts premium on the accurate delineation of transactions. To this end, consideration must be placed on key economically relevant characteristics such as the contractual terms, functional analysis, characteristics of financial instruments, economic circumstances, and business strategies.

In crafting the specific guidance on financial transactions, the 2022 OECD Transfer Pricing Guidelines (“TPG”) laid down recommended approaches to certain financial transactions like treasury activities, financial guarantees, and captive insurance companies.

Treasury function or activity is part of the process of making the financing of the commercial business of the group as efficient as possible. The treasury may perform several functions such as acting as a contact point to centralize external borrowing or even more complex functions. Consequently, the treasury function will usually be a support service to the main value-creating operation. Depending on the facts and circumstances of each case, such activities may be services in which case the pricing guidance on intra-group services applies.

When evaluating the transfer pricing issues related to treasury activities, the OECD maintains the need to accurately delineate the actual transactions and determine exactly what functions an entity is carrying on rather than to rely to any extent upon a general description such as “treasury activities”. The 2022 OECD TPG laid down extensive discussions relating to transfer pricing considerations involving treasury transactions like intra-group loans, cash pooling, and hedging. Depending on the facts and circumstances, such treasury activities may be services in which case the pricing guidance on intra-group applies. At times, more complex functions may be attributed to distinct treasury functions which would ultimately require a commensurate compensation.

Financial guarantee, on the other hand, requires the guarantor to meet specified financial obligations in the event of a failure to do so by the guaranteed party. Tackling financial guarantees in the transfer pricing context, it would first require a keen understanding as to the nature and extent of the obligations guaranteed and the consequences for all parties.

In determining the arm’s length price of guarantees, a number of pricing approaches may be explored, such as: (1) the Comparable Uncontrolled Price (“CUP”) Method; (2) the Yield Approach; (3) the Cost Approach; (4) the Valuation of Expected Loss Approach; and (5) the Capital Support Method. However, when the accurate delineation of the actual transaction indicates that the purported guarantee is not a guarantee, other pricing approaches should be considered.

Lastly, the provisions of the 2022 OECD TPG on financial transactions dealt with captive insurance, as well as reinsurance. The term captive insurance is intended to refer to an insurance undertaking or entity substantially all of whose insurance business is to provide insurance policies for risks of entities of the group to which it belongs.

As with other financial transactions, accurate delineation is key for captive insurance and reinsurance. It is necessary to identify the commercial or financial relations between the associated enterprises and the conditions and economically relevant circumstances attaching to those relations. In relation to the pricing of intra-group transactions involving captive insurance and reinsurance, the most appropriate method should be selected following existing guidelines. Various methods may be determined as the most appropriate, such as: (1) the CUP Method; (2) a combined approach which takes into account profitability of claims and return of capital; (3) an analysis of the group synergy benefit; and (4) an analysis on the profit from agency sales.

With the revisions in the 2022 OECD TPG, we move a step closer to ensure that the taxable profits are not artificially shifted out of a country’s jurisdiction and that the tax base reported in the country reflects the economic activity undertaken therein. It also gives taxpayers a clear guidance on the proper application of the arm’s length principle. Hopefully, both Philippine taxpayers and the BIR would be able to bring the entirety of the 2022 OECD TPG to bear.