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Transfer Pricing and Covid-19: What consequences on intragroup financings?

Application of the arm’s length principle for intragroup financing during the crisis


In the context of the Covid-19 crisis, multinational enterprises (“MNEs”) must finance their subsidiaries to ensure the continuity (and above all the recovery) of their activity. Even though markets are facing a major economic downturn, the arm’s length principle still prevails and MNEs have to manage their intragroup financings accordingly.

The current crisis will inevitably lead to an increase of financing needs. Since MNEs are generally structured through an entity performing central financing functions (so-called “Central Financing entity”) and acting as an intermediary between independent financial institutions and affiliated enterprises, intragroup financing is expected to also increase.

The challenge for MNEs is to ensure, in the current economic downturn, that the conditions applied to intragroup financial transactions, and particularly the interest rates, comply with the arm’s length principle, notably in the case where the borrowing entity is located in France and where, whatever the nationality of the lender, the provisions of Article 212 I a. of the French Tax Code (“FTC”) apply and thus where the burden of proof of arm’s length conditions is on the taxpayer. More specially, it is important for MNEs to consider whether it is necessary to review current intragroup financial transactions concluded before the crisis and how to apply the arm’s length principle to new intragroup financial transactions concluded during the crisis.

1. Impact of the Covid-19 crisis on current intragroup financial transactions

For ongoing financial transactions, the OECD indicates that an independent borrower considers the potential impact of changes in economic conditions, notably the risk of not being able to make timely payments of interest and principal on the loan[1]. Therefore, it may be appropriate for a borrower to renegotiate the conditions initially set in its existing intragroup financial transactions, and specifically the amounts of the debts and/or the repayment terms.

Further to these issues related to the renegotiation of the intragroup loans, accurate attention must be paid to financial covenants provided in the intragroup loan agreements and to any potential intragroup guarantees that may apply.

2. Challenges in determining an arm's lenght interest for new intragroup financial transactions

Considering the financing needs of their operating subsidiaries, MNEs will have to search for new sources of financing through their Central Financing entity which is then responsible for allocating funds among the group’s affiliates and thus determining an arm’s length interest rate.

To do so, the Comparable Uncontrolled Price method (“CUP method”) is largely used since this method is considered as the most direct and reliable way to apply the arm’s length principle and as such is preferable over all other methods.

With regards to financial transactions, the CUP method consists in comparing the interest rate applied in an intragroup transaction with the interest rate applied under comparable conditions between independent enterprises using publicly available data on other borrowers with the same credit rating.

However, due to the current economic environment, MNEs are likely to face some issues for a proper application of the CUP method, and specifically the following:

  • Regarding the determination of the borrower’s credit risk: the credit risk (i.e. creditworthiness) of a borrower is generally determined based on its historical financial data at the time of the analysis. Since the Covid19 crisis is expected to have a significant impact on the financial performance and ratios of borrowing entities, analyzing a borrower's creditworthiness and defining its credit rating based on its historical financial data may not reflect the current economic circumstances it faces and thus could lead to overestimate its repayment capabilities.
  • Regarding the identification of comparable transactions: in the same way as during the 2008 crisis, MNEs are likely to face a significant decrease in the number of comparable transactions on the market, particularly in the context of risky investments (i.e. noninvestment grade).
  • Regarding the particular circumstances related to French Stateguaranteed loans: the question whether the guarantee granted by the French State may indirectly benefit the foreign group’s affiliates financed by a French Central Financing entity (i.e. by applying to the foreign intragroup borrowers the same interest rate as the rate that the lender obtained from the Stateguaranteed bank loan) may arise.


The current crisis will create more complexity for the application of the arm’s length principle for both ongoing and new intragroup financial transactions, which will require specific attention on case-by-case basis. Any decision taken during the current crisis will have to be well-documented and appropriately justified to anticipate a potential tax audit.

Finally, the Covid-19 crisis will inevitably impact the affiliates’ financial and debt ratios, with potential consequences on the limit for deducting net financial expenses and the risk of being subject to thin capitalization rules. The use of debt to finance group’s affiliates will therefore have to be the subject of an overall analysis of the group's situation in order to ensure the full deductibility of the financial expenses.

[1] §10.59 - OECD (2020), Transfer Pricing Guidance on Financial Transactions: Inclusive Framework on BEPS Actions 4, 8-10, OECD, Paris (hereinafter “OECD Guidance on FT”).

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