On 8 April 2019 the UN released draft updates to the United Nations Practical Manual on Transfer Pricing for Developing Countries. The updates include an important chapter relating to financial transactions.

This release occurred in advance of the Eighteenth Session of the Committee of Experts on International Cooperation in Tax Matters on April 23–26.

Financial transactions

The new chapter of the transfer pricing manual relating to financial transactions looks at measures to combat base erosion; the delineation of the arm’s length nature of a loan; the treatment of intragroup guarantees; how to apply the most appropriate transfer pricing method; the treatment of cash pooling; issues around captive insurance; and various other issues.

Four-step analysis

The proposed chapter sets out a four-step analysis to determine the arm’s length nature of intra-group financial transactions involving analysis of the economically significant characteristics; accurate delineation of the entire transaction undertaken; selection of the most appropriate transfer pricing method; and the application of that transfer pricing method.

Economically significant characteristics of the financial transaction

The chapter outlines the economically significant characteristics of a financial transaction that need to be taken into account to establish the arm’s length nature of the transactions. These factors to consider are the contractual terms and actual conduct of the parties; the functional profile of both parties including debt capacity and credit risk of the borrower; the characteristics of the financial products or services; the economic circumstances of the parties and of the industries in which they operate; the business strategies of both parties including financing policies and debt targets; and interaction with other intragroup transactions.

Delineation of the transaction

In delineating the financial transaction it is necessary to consider whether the applicable interest rate is at arm’s length and to consider if the loan should actually be treated instead as a contribution to capital.

Transfer pricing methods

The draft chapter notes that the comparable uncontrolled price (CUP) method is the most commonly used method but a cost-based method could also be applicable in certain treasury service transactions such as transfer o funds by a group lender or cost centre to other members of the group. A transactional profit split method could sometimes be possible in certain limited circumstances. The manual also notes that Brazil applies a “sixth method” for certain transactions.

Other proposed additions to the manual

The new material in the updated transfer pricing manual also included proposed revisions to the guidance on the transactional profit split method, together with some changes to the sections on establishing transfer pricing capability in developing countries; risk assessment; and transfer pricing audits. These proposed updates would be included in a 2021 update of the UN transfer pricing manual.