Transfer Pricing in financial services industry
RoyaltyRange
Transfer Pricing raises serious challenges in the financial services industry. Tax authorities acknowledge that these service providers focus on managing and shifting risks, presenting both distinct challenges and advantageous opportunities in Transfer Pricing.
Transfer Pricing in the financial industry refers to the pricing of transactions between different divisions or entities within a financial institution, particularly across different jurisdictions. This practice is important for ensuring that transactions are conducted at arm’s length, meaning they reflect the fair market value that would be agreed upon by unrelated parties.
Transfer Pricing in this sector is significant due to the complex nature of financial transactions, the involvement of multiple entities operating in different countries, and the potential for tax implications. Financial institutions often have various subsidiaries, branches, or affiliates operating in different countries, each engaged in transactions such as loans, derivatives trading, asset management, and other financial services.
The financial services industry has a wide variety of companies and operations. The Transfer Pricing issues of companies of different segments may unavoidably reflect the main aspects under which these companies operate.
Financial services firms offer funding, payment processing, insurance, investment management products, and hedging services to participants in supply chains. However, banks, insurers, and investment managers are often perceived as separate from production supply chains. In the financial services sector, these firms typically describe their business activities in the context of value chains rather than supply chains.
A value chain encompasses the series of actions undertaken by a company within a particular industry to provide a valuable product or service to its customers. Unlike a supply chain, which primarily focuses on the physical flow of goods from raw materials to the end product, the value chain is a strategic concept or decision-making tool designed to optimize the creation of value for customers.
In the realm of international taxation, the value chain concept is featured in sections of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, as well as the OECD Guidance on Permanent Establishments. This supports endeavors to utilize the value chain concept for structuring and tackling Transfer Pricing management challenges.
At the core of a financial services firm’s value chain are its capital resources, human expertise, and intangible assets like licenses, brands, and technology. These value chains depict the sequence of decisions, financing activities, operational functions, risk mitigation efforts, and service provision, often spanning across borders and involving related entities. These value chains are undergoing rapid transformations influenced by factors such as the COVID-19 pandemic, digitalization, evolving work structures, emerging competitors, and market dynamics. Many of these changes are expected to endure in the long term.
In the last few years, the financial services industry has been heavily impacted by two main Transfer Pricing challenges: the COVID-19 pandemic and the Interbank Offered Rates (IBORs) transition.
The transition from Interbank Offered Rates (IBORs) refers to the global financial industry’s shift from using benchmarks such as the London Interbank Offered Rate (LIBOR) to alternative reference rates. IBORs have historically served as key benchmarks for various financial transactions, including loans, derivatives, and other financial contracts. However, concerns about the reliability and sustainability of IBORs, particularly in the wake of manipulation scandals and a decline in interbank lending activity, have prompted regulatory authorities to advocate for their replacement with more robust reference rates.
The COVID-19 crisis, which surged dramatically during the fiscal year 2020, rapidly spread and heightened uncertainty on a global scale. The crisis has led to elevated financing expenses stemming from heightened credit risk, as well as significant losses incurred by many taxpayers due to unforeseen expenses related to credit, foreign exchange, interest rate, and investment risks becoming a reality. Also important, is that A review of intercompany agreements became essential as the COVID-19 outbreak underscored the inability to meet numerous contractual obligations within intra-group contexts.
Transfer Pricing in the financial industry is a complex and highly regulated area that requires careful consideration of various factors, including tax implications, regulatory requirements, and risk management considerations. Effective Transfer Pricing practices are essential for ensuring compliance, managing risks, and optimizing the tax position of financial institutions operating in a global context.
Sources:
https://www.ey.com/en_lu/tax/latest-transfer-pricing-challenges-in-the-financial-services-ind
https://www.pwc.com/m1/en/blogs/pdf/transfer-pricing-the-rise-and-rise-of-digital-banking.pdf