Interested in Interest: Financial Transactions in Transfer Pricing DLA Piper 2019 Transfer Pricing Masterclass Series Presenters

Randall Fox Rachit Agarwal Partner, London Director, London Co-Head Transfer Pricing [email protected] [email protected]

Background & Experience Background & Experience • Economist • Economist • APA Team Leader at US IRS • Practiced in India, Netherlands and UK with DLA Piper, Baker • Led all US/Swiss APA negotiations on intangibles issues McKenzie and Indian professional services firm • World Bank transfer pricing technical training to developing • Financial transaction transfer pricing specialist countries worldwide • IBFD and Maastricht University transfer pricing lecturer • Independent expert witness in Transfer Pricing Arbitration

Monia Volpato Economist, London [email protected]

Background & Experience • Economist • Prior experience with Bloomberg as a financial analyst • Financial transaction transfer pricing specialist • Expertise in financial modelling

www.dlapiper.com 2 Agenda

• Setting the Scene • Types of Financial Transactions • Recent Developments • Focus of the session • Intra-group Loans • Cash Pools • Guarantees • Case study and Wrap-Up

www.dlapiper.com 3 Setting the Scene

www.dlapiper.com 4 Types of Financial Transactions

Back-to- Intra-group Cash Financial Captive Financial Factoring Back Loans Pooling Guarantees Insurance Derivatives Financing

www.dlapiper.com 5 Recent Developments

Landmark UN Draft court Chapter cases

Tax authorities guidance Recent End of Developments LIBOR

BEPS

OECD Discussion Draft

www.dlapiper.com 6 Intra-group Loans

www.dlapiper.com 7 Two Main Considerations!

Thin Cap – Arm's Length Debt

Cost of Financing – Arm's Length Interest Rates

www.dlapiper.com 8 Arm's Length Debt

Elements to Consider

What a lender would What a borrower acting have lent and what a in the best interests of borrower could have their own business borrowed? would have borrowed? "Could" "Would"

www.dlapiper.com 9 Arm's Length Debt - Determination

• EBIT/Interest Liquidity • EBITDA/Interest Ratios • CFO/Interest • FCF/Interest

Solvency • Structure of loan (maturity, amortizing or bullet) • Debt/EBITDA Ratios • Debt/Equity

Covenants • Would any financial covenant be breached?

• Capital structure of similar companies in the Industry industry

www.dlapiper.com 10 Arm's Length Interest Rate

Building Blocks

Interest Rate

Credit Terms and Conditions Worthiness

www.dlapiper.com 11 Arm's Length Interest Rate - Creditworthiness

Creditworthiness

Is the borrower separately rated by a major credit rating agency?

Terms and Conditions

Is the parent of the borrower rated by a major credit rating agency?

Consider whether implicit support Need to determine standalone needs to be credit rating of the borrower? accounted for

Adjust it for implicit support (if appropriate)

www.dlapiper.com 12 Creditworthiness – Implicit Support

Parent's Credit Rating : A-

Borrower's Standalone Credit Rating: BBB

No implicit support Some implicit support Full implicit support

Lender Lender Lender

Interest Interest Interest Loan Loan Loan Payments Payments Payments

Borrower Borrower Borrower

Borrower's credit rating: BBB Borrower's credit rating: BBB+ Borrower's credit rating: A-

www.dlapiper.com 13 Arm's Length Interest Rates – Terms & Conditions Creditworthiness

Impact Terms and on Conditions interest rate

Higher Debt Pre- Non - Higher risk Non - Some terms and Higher Amount payment guaranteed Long term Mezzanine At maturity Unsecured currency Convertible conditions can have a significant

possible impact on Junior the interest rate!

Low Debt Demand Guaranteed Short term Senior Quarterly Secured Lower risk Convertible Lower Amount (regular) currency

www.dlapiper.com 14 Cash Pools

www.dlapiper.com 15 Types of Cash Pool

• Cash Pool Leader physically sweeps excess cash out of the individual bank accounts on a periodic basis

Physical • Ownership of the cash changes Cash Pool • Cash Pool Leader can be somewhere within the full spectrum of a service provider to an in-house bank

• Cash is not physically transferred and Cash Pool Participants operate accounts directly with the bank

Notional • Allows the multinational to net off balances of different accounts across Cash Pool jurisdictions • Cash Pool Leader, typically, is a service provider

www.dlapiper.com 16 Benefits of Cash Pools

Centralize cash management

Centralize Create decision making synergies

Obtain Manage foreign favourable exchange interest rates exposures with banks

Cost savings on banking transactions

www.dlapiper.com 17 Typical Structure and Intra-group Transactions

Parent Company (US)

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Money Market Funds EExxcceessss ffuunnddss IInntteerreesstt eexxppeennssee

Cash Pool leader Third party bank IInntteerreesstt iinnccoommee FFuunnddiinngg

EExxcceessss ffuunnddss Third party bank

DDeeppoossiittss @@ IIBBOORR ++ 2255 LLooaannss @@ IIBBOORR ++ 7755 bbppss

Cash Pool participants

www.dlapiper.com 18 Transfer Pricing Aspects to Consider

Intra-group Loans

Remuneration for Cash Pool Leader

Guarantees

Cash Pool Benefit

Legal Agreements

Transfer Pricing Documentation

Cash Pool Policy

www.dlapiper.com 19 Guarantees

www.dlapiper.com 20 Benefits of Guarantees

Lower Financing Cost

Increase in Debt Capacity

Access to Untapped Markets

www.dlapiper.com 21 Guarantee Fee – Applicability

Account for implicit Benefit Applicable support

Guarantee

No Benefit Not Applicable Take into account both perspectives

Benefit No Benefit Prepare robust analysis

Lower Financing Cost Moral Hazard

Increase in Debt Capacity Capital Contribution

Both

www.dlapiper.com 22 Methods to Determine Guarantee Fee

Cost CUP Contingent Benefit Method Put Option Analysis

Price of the Cost for the Letter of credit lender's right guarantor - fees to sell the loan Floor to a guarantor

Benefit for the Commitment borrower - fees Ceiling

Guarantee fee Credit default based on swap bargaining power

www.dlapiper.com 23 DLA Piper is a global law firm operating through various separate and distinct legal entities. Further details of these entities can be found at www.dlapiper.com.

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