You may also be interested in:

Articles

Treasury Alert: Regulatory Effort to Impact Intercompany Lending

  • By Andrew Deichler
  • Published: 5/15/2015

Treasury and finance executives of multinational corporations need to pay attention to a regulatory initiative that could dramatically alter international lending and taxation.

A project by the Organization for Economic Co-operation and Development (OECD) seeks to address concerns about the potential for multinational corporations to reduce their tax liabilities through shifting of income to no-tax or low-tax jurisdictions.

OECD’s Base Erosion and Profit Shifting project has been endorsed by the Group of 20, the world’s 20 largest economies, and they have committed to additional action on a country-by-country basis. Additionally, there are some non-G20 countries that are also participating in the process.

Why it matters for treasury

Fundamentally, many aspects of BEPS will touch intercompany financing. “As we all know, the way intercompany financing is structured has a huge tax element to it,” said Lee Holt, partner, International Tax Services—Capital Markets with Ernst & Young, in a session at the EuroFinance International Cash & Treasury Management conference in Miami. “At its core, debt financing is usually deductible by the borrower. So it’s a tax-efficient mechanism to fund companies that need money.”

BEPS will have a particularly significant impact on cross-border financing. At its core, internal, cross-border debt financing is one of the hallmarks of international tax planning. “It is by far the most common mechanism to achieve a tax beneficial result,” Holt said. “You have a low-tax country lending to a high-tax country. It’s easier to move profits. Through debt financing, I lend, I get an interest deduction in the high-tax jurisdiction, and it’s taxed at a negligible rate in the lending jurisdiction. I don’t have to move people, I don’t have to move capital assets.”

Years ago, as tax laws developed, it was decided that interest expense would be tax deductible, whereas payments on equity generally would not. “Broadly speaking, you get tax benefits for somebody lending with a loan, because of the deductibility of the interest,” Holt said.

A key role for treasury is determining how to move money around the organization in the most efficient way possible, and that’s largely through debt financing. BEPS could make that process harder. BEPS could:

  • Prevent the use of hybrid financing. Hybrid financing is a very tax-centric type of financing that may no longer be achievable in the future. “We’re seeing countries adopting their own domestic law today to prevent the benefit of these structures—basically denying the interest expense if the return isn’t taxable,” Holt said.
  • Limit interest deductibility. This could touch long-term and medium-term intercompany financing. It could even hit cash pooling, as some pooling structures are viewed as intercompany loans.
  • Require additional/new transfer pricing documentation. This is another area where the OECD is trying to apply a consistent approach. Many countries have their own approach to making sure that transactions between related parties are structured in the same way as transactions between unrelated parties.
  • Limit the benefits of treasury centers. Treasury centers typically achieve tax benefits such as having profits in fairly tax-efficient locations. “Some of the tax benefits of those treasury structures may no longer be possible,” Holt said.

“Many countries are already taking action without waiting for the OECD recommendations,” explained Holt. “Ultimately, the process is guidance by the OECD to its member countries. It’s up to the individual countries to implement it as they see fit in their own domestic law.”

Having this many countries working together on tackling tax is unusual, noted Holt. “At its core, much of international tax planning relies on arbitrage or differences between many jurisdictions around the world,” he said. “It’s those differences that enables a lot of international tax plan. So the basic purpose of this is to bring harmony and consistency to how particular transactions are taxed or looked at, to eliminate those arbitrage possibilities.”

What to do

Intercompany financing is an area historically that tax and treasury have worked together very closely on, and that needs to continue. “I think if anything, there’s a need to work even more closely to monitor the BEPS developments and perhaps influence the process,” Holt said. “We’re still in a ‘comments and influence’ period.”

Additionally, treasurers should monitor individual countries’ unilateral tax law changes. Something could happen tomorrow, even though the BEPS process still has time to play out. “A country could say, ‘I’m going to go ahead and change my law,’ and that will influence how a company structures their intercompany financing,” Holt added.

The Call for Speakers is OPEN
Think you have what it takes to lead an educational session at FinNext 2019? We KNOW you do. Just pick a topic you're passionate about and share it with your FP&A peers. This is your time to shine. 
Submit your Proposal

Copyright © 2018 Association for Financial Professionals, Inc.
All rights reserved.