The reliability of economic models’ outcomes depends upon the parameters factored into the specific model and the underlying assumptions adopted. In evaluating the reliability of economic models as an approach to pricing intra-group loans it is important to note that economic models’ outcomes do not represent actual transactions between independent parties and that, therefore, comparability adjustments would be likely required. However, in situations where reliable comparable uncontrolled transactions cannot be identified, economic models may represent tools that can be usefully applied in identifying an arm’s length price for intra-group loans, subject to the same constraints regarding market conditions discussed in paragraph 10.98.
TPG2022 Chapter X paragraph 10.106
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Category: OECD Transfer Pricing Guidelines (2022), TPG2022 Chapter X: Transfer Pricing Aspects of Financial Transactions | Tag: Comparability adjustments, Economic modelling, Financial transactions, Interest rate, Intra-group loan, Lack of comparables, Loan
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- TPG2022 Chapter X paragraph 10.105In their most common variation, economic models calculate an interest rate through a combination of a risk-free interest rate and a number of premiums associated with different aspects of the loan – e.g. default risk, liquidity risk, expected inflation or maturity. In some instances, economic models would also include elements...
- TPG2022 Chapter X paragraph 10.93Arm’s length interest rates can also be based on the return of realistic alternative transactions with comparable economic characteristics. Depending on the facts and circumstances, realistic alternatives to intra-group loans could be, for instance, bond issuances, loans which are uncontrolled transactions, deposits, convertible debentures, commercial papers, etc. In the evaluation...
- TPG2022 Chapter X paragraph 10.104Certain industries rely on economic models to price intra-group loans by constructing an interest rate as a proxy to an arm’s length interest rate....
- TPG2022 Chapter X paragraph 10.72Publicly available financial tools are designed to calculate credit ratings. Broadly, these tools depend on approaches such as calculating the probability of default and of the likely loss should default occur to arrive at an implied rating for the borrowing. This can then be compared to a market database in...
- TPG2022 Chapter X paragraph 10.179There are a number of possible models for estimating the expected loss and capital requirement. Popular pricing models for this approach work on the premise that financial guarantees are equivalent to another financial instrument and pricing the alternative, for example, treating the guarantee as a put option and using option...
- TPG2022 Chapter X paragraph 10.62The creditworthiness of the borrower is one of the main factors that independent investors take into account in determining an interest rate to charge. Credit ratings can serve as a useful measure of creditworthiness and therefore help to identify potential comparables or to apply economic models in the context of...
- TPG2022 Chapter X paragraph 10.74For these reasons, the reliability of credit rating results derived from the use of publicly available financial tools may be improved to the extent the analysis can reproducibly demonstrate consistency of ratings using such tools with those provided by independent credit rating agencies....
- TPG2022 Chapter X paragraph 10.65Information is readily available in many lending markets on the different rates of interest charged for differently rated enterprises and such information may usefully contribute to performing comparability analyses. Financing transactions that the borrowing MNE or another MNE within the group has with external lenders may also be reliable comparables...
- TPG2022 Chapter X paragraph 10.95Whereas it is unlikely that an MNE group’s average interest rate paid on its external debt meets the comparability requirements to be considered as an internal CUP, it may be possible to identify potential comparable loans within the borrower’s or its MNE group’s financing with an independent lender as the...
- TPG2022 Chapter X paragraph 10.81It is also important to note that although there are established approaches to estimate a credit rating for a particular group member or debt issuance, the considerations detailed above mean that a pricing approach based on the separate entity credit ratings that are derived from publicly available financial tools (see...