The recent global financial crisis brought on by the COVID-19 pandemic has emphasised the importance of cash and financial risk management for all businesses. In light of the current uncertainty, more multinational enterprises (MNEs) are turning to treasury management functions to reduce financing costs while still meeting the liquidity needs of their businesses. To cushion some of the impact from the volatility in the global financial markets and benefit from effective cash management across the group, both globally and regionally, many MNEs are making the move to centralise their group treasury operations.
Singapore is one of the more popular destinations for such centralised operations in Asia due to its location, role as a global financial centre and established infrastructure. It is important for MNEs with group treasury centres in Singapore to ensure that they are clear on the role of these centres and the related transfer pricing implications to ensure compliance with the laws set by the Inland Revenue Authority of Singapore (IRAS), Singapore’s tax authority.
Centralisation of group treasury operations into a single treasury centre, often run as a profit centre, provides significant advantages such as minimising group borrowing costs, enhancing liquidity, reducing compliance costs and increasing oversight of the group’s transfer pricing policies across entities in multiple jurisdictions to ensure alignment.
Group treasury centres can perform a broad spectrum of treasury activities, ranging from centralised cash handling/administration for the group to a full-fledged treasury centre involved in the planning and implementation of group financial transaction policies, and bearing and managing the associated risks.
This article focuses on the two most common related party financing activities undertaken by group treasury centres - intra-group loans and cash pooling arrangements - and some practical considerations that treasury centres need to be mindful of from a Singapore transfer pricing perspective.
Intra-group loans effectively channel surplus funds, available within the MNE group, to entities in need of short, medium, or long-term financing. This eliminates the need to borrow funds from external financial institutions, thereby reducing interest payments to third parties and enhancing liquidity within the group. Moreover, given that external borrowings are minimised, the MNE group’s overall credit standing remains stable, which in turn leads to other financial benefits.
As set out in the OECD 2017 Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD TP Guidelines) Chapter X (ten), for intra-group loan transactions, MNEs should consider:
Given that Singapore’s Transfer Pricing Guidelines (SGTPG) are largely consistent with the OECD TP Guidelines, though not specifically stated under the current SGTPG, IRAS may still require taxpayers to evaluate both the above while setting up intra-group loan transactions. Failure to consider these points may result in risk of tax adjustments by IRAS on the interest expense and/or income for the borrower/lender.
The arm’s length debt amount usually varies depending on the industry within which the borrower operates. An analysis of the key debt ratios (such as debt to equity, interest coverage and debt coverage) of independent parties operating within the specific industry may guide taxpayers to determine the arm’s length debt amount. However, interplay of other factors like credit quality, economic conditions and financial regulations of the borrower’s local market, for example, may also need to be considered.
Once the arm’s length debt amount has been established, taxpayers need to determine the arm’s length interest rate that should be charged on this debt amount. As set out in the OECD TP Guidelines and the SGTPG, the Comparable Uncontrolled Price (CUP) method is typically the most appropriate method for determining the arm’s length interest rates for intra-group financing transactions. The CUP method is applied in two ways:
When pricing intra-group loans, treasury centres should regard the following:
Cash pooling arrangements
Cash pools are a popular way for businesses to manage their short-term liquidity across the group by bringing together the balances of a number of different accounts. Treasury centres may be involved in the implementation and operation of a cash pool for the group. Cash pooling arrangements are usually complex agreements involving both third party banks (who provides the pooling platform/system) and a number of related parties. They can also raise substantial challenges from a transfer pricing perspective as they are not typically undertaken between non-related parties.
A treasury centre entity may be involved in a cash pool arrangement as a ‘header’ or as a participant. The header holds the account into which the excess cash balances of the group entities participating in the cash pool arrangement are swept in. Participants are those entities that deposit into or borrow cash on an overnight/short term basis from the header account. This is usually undertaken on a daily basis via the platform operated by the third party bank.
Cash pooling arrangements can be ‘physical’, meaning that there is an actual daily transfer of cash between participants, and header accounts or ‘notional’, where the daily balances are not physically transferred but notionally pooled at the end of each day. These arrangements could be based on a ‘zero balance’ or ‘target balance’ mechanism, which means that all participant entities at the end of each day either have a zero or the targeted bank balance. The economic benefits from any cash pooling arrangement are mainly ‘netting’ and ‘volume’. Netting benefit results from the netting of surplus and deficit positions of all participants, thereby significantly reducing reliance on third party funds and minimising interest payments to third parties outside the MNE group. Volume benefit emanates from savings in interest payments or increased interest earnings given the greater bargaining power from the consolidated cash position of the group at the header entity level and usually accrues at the header account level.
A cash pool header may perform a wide spectrum of tasks, ranging from acting as no more than a low risk cash administration or handling entity, to performing the role of an internal bank and bearing all associated liquidity, credit, interest and investment risks inherent to the arrangement. In the former role, the treasury centre would typically be entitled to no more than a service fee, based on a cost-plus remuneration model. Any surplus profits in the header account should then be allocated back to the other participants. In the latter scenario, the treasury centre may retain all surplus profits from the arrangement after paying arm’s length interest on deposits and collecting arm’s length interest from borrowers such that all participants in the pooling arrangement are economically better off participating in the pool compared to transacting individually with third parties.
In practice, a treasury centre’s role in a cash pooling arrangement typically lies somewhere in between the above examples. From a transfer pricing perspective, it is important that all parties involved in the cash pooling arrangement share in the economic benefit of the cash pool. Therefore, when determining the remuneration for the treasury centre entity’s involvement in a cash pooling arrangement, it is important that an accurate delineation of the cash pooling arrangement is carried out so that parties involved are appropriately characterized and remunerated.
Documenting the arm’s length basis
Singapore requires taxpayers to maintain transfer pricing documentation of their related party transactions. In addition to avoiding compliance penalties, the documents serve as a first line of defence to support the taxpayer’s related party arrangements. Transfer pricing documentation is expected to include certain specific details about the group, local entity, analysis of the functions, asset and risk profile, along with an appropriate economic analysis.
Treasury centre entities should ensure that contemporaneous transfer pricing documentation is maintained for all its related party arrangements and local statutory filing requirements are met to avoid incurring penalties and surcharges.
Outside of the impact of COVID-19 on treasury centres, one of the key events will be the phasing out of London Inter-Bank Offer Rate (LIBOR) in 2021. Given that this is the most common reference rate for related party loans with floating rates, treasury centres should ensure that existing agreements are updated. It is also timely for taxpayers to review their transfer pricing benchmarking approaches to ascertain if pricing policies should also be updated.
The falling US treasury yields will likely place downward pressure on the arm’s length interest rates of new intra-group loan transactions. Businesses should review their existing transfer pricing policies and assess if they are appropriate.
With the Covid-19 situation where loans are due to be refinanced and credit quality downgrade is imminent for the group and/or its borrowing subsidiary, a revisit of the group’s pricing policy would also be helpful from a risk management perspective to examine if it remains supportable by the arm’s length range, and whether the loan terms need to be updated to reflect current conditions.
Given the backdrop of today’s challenging operating environment, it is uncertain how the global tax controversy environment will develop once the current pandemic situation eases. In order to support burgeoning government balances, the roll-out of fiscal policies to stimulate tax revenues would more likely than not include increased scrutiny by local tax authorities.
It is hence timely for corporate treasury entities to stay abreast of the technical and practical considerations when pricing their financial transactions and take a fresh look at their existing transfer pricing policies, as well as develop robust transfer pricing documentation as a first line of defence to facilitate future dispute resolution.
The writers are Avik Bose, Theppine Kyi and Michellin Choo, Deloitte Singapore transfer pricing partner, manager and assistant manager respectively. The above are their personal views and may not represent the views of the firm.
The views expressed in this column are the author's own and do not necessarily reflect this publication's view, and this article is not edited by Singapore Business Review. The author was not remunerated for this article.
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Avik is a Tax Partner at Deloitte Singapore. With over 16 years as a global transfer pricing professional with Big Four accounting firms, Avik has a wealth of experience in transfer pricing planning structures for various types of business models, supply/value chain realignments, intellectual property valuation, structuring and pricing intercompany financial transactions, corporate guarantees, cash pooling, debt factoring and leasing arrangements, thin-capitalisation analysis as well as planning and executing global documentation projects for multinational corporations (MNCs).
In his work with clients, Avik helps MNCs in industries spanning automotive, aerospace, financial services, shipping, IT, oil and gas, chemicals, pharmaceuticals, real estate, consumer goods and telecommunication, to develop and implement commercially viable transfer pricing policies to achieve tax efficiencies across jurisdictions. He has represented his clients before revenue authorities in several Mutual Agreement Procedure (MAP) and Advanced Pricing Agreement (APA) cases including representing before the Tax Courts.
Avik is also an active speaker at various transfer pricing discussion forums and authors articles in public domain. In the past, he had conducted training sessions on TP issues with revenue authorities in the region.
Before relocating to Singapore, Avik worked in Australia, India, the United Kingdom and the United States.
Avik is a Chartered Accountant by profession and holds a Master Degree in Commerce. He is also an Accredited Tax Professional with the Singapore Institute of Accredited Tax Practitioners.
Theppine is a transfer pricing manager with Deloitte Singapore, and has more than 9 years of tax experience in the Big Four firms across the UK and Singapore. He has served local / multinational / listed financial services companies in Singapore and the UK.
Theppine has extensive experience in assisting financial services clients with their transfer pricing requirements, including advising clients on transfer pricing planning and documentation of intercompany financial transactions and treasury functions, analysis and modelling of clients’ thin capitalisation positions and intercompany debt pricing. In addition, he has assisted clients in negotiating with tax authorities on APAs and transfer pricing audits.
Theppine graduated with a Bachelor of Science (Psychology) from the University of Bristol and holds a Masters in International Commercial Law from the University of Leicester. He is also a Chartered Accountant and an ICAS Tax Professional with The Institute of Chartered Accountants of Scotland.
Michellin is a Transfer Pricing Assistant Manager in Deloitte Singapore, with experience advising leading multinational clients in the Asia Pacific region from across the investment management, banking, insurance, securities brokerage, treasury and sovereign wealth fund sector.
Her experience includes the preparation of strategic local / global transfer pricing documentation and planning studies, restructuring solutions, and monitoring of global / local transfer pricing risk exposures. In addition, she has successfully supported her clients on negotiation with tax authorities involving APAs, MAPs, as well as audit defence solutions and support with a focus on intra-group loan transactions.
Michellin graduated with a Bachelors in Accountancy (Honours) from the Nanyang Technological University, Singapore, and earned CFA Level I.