Intercompany loans (Q&A 21 to 41)
Currency of the loan
The first salient point is that the TPQ&A discusses cases in which an intercompany loan can be denominated in a foreign currency. While the OECD does not specifically cover this topic, it could be related to the analysis of other options realistically available. For instance, chapter X of the OECDTPG makes provisions aimed at ensuring that the intra-group transaction has a commercial rationality and is at least as favorable to both parties as their best next alternatives. However, the SFTA goes beyond the OECDTPG by giving practical examples of acceptable cases where an intercompany loan could be granted in a foreign currency, namely if such currency is the company’s functional currency; if it allows the company to benefit from more favorable terms by taking into account the costs associated with protection against foreign exchange risks; or if said currency corresponds to the currency in which most revenues are generated by the asset financed by such loan.
Credit rating analysis
With respect to credit rating analysis, although the TPQ&A generally follows the OECDTPG, the SFTA’s point of view regarding the use of group credit ratings is noteworthy. Indeed, the TPQ&A goes beyond the OECDTPG by indicating that a group’s credit rating should only be used to determine a subsidiary’s credit rating in exceptional cases, which must be appropriately justified in light of all the facts and circumstances.
While the OECDTPG indicate that the top-down approach (i.e., use of the group credit rating as the starting point of the analysis) is appropriate if there is a close link between the rated entity and the parent company of the group for which the credit rating has been assigned, the TPQ&A is less strict in its application. The OECDTPG notably acknowledge that the top-down approach could be preferred given some of the limitations of the bottom-up approach (i.e., use of the standalone credit rating of the borrower as starting point of the analysis). This can lead to difficulties surrounding the use of financial tools for standalone credit rating and the implicit support analysis, difficulties in accounting for controlled transactions reliably and information asymmetry, etc. In fact, the TPQ&A goes even further and highlights that an issue rating (i.e., for the particular financial instrument) rather than the borrower’s rating would be recommended as the basis for a TP analysis.
In practice, we have seen many groups using the credit rating of the group as a starting point for the rating analysis (potentially with adjustments), mainly for simplicity. In this context, in case of multiple loan transactions or cash pooling, we note that it can get cumbersome for groups having to compute the standalone credit rating of each subsidiary based on their financial statements and subsequently adjust it, if necessary, in consideration of potential group support. Therefore, it could be helpful to get more information from the SFTA on the appropriate justifications they expect from the taxpayer in order to accept the use of the top-down approach, especially considering that such top-down approach also appears to be endorsed by credit rating agencies such as Standard & Poor’s.
Definition of intra-group interest rates
A further slight difference between the OECDTPG and the TPQ&A lies in the treatment of banks’ opinions. Although neither the SFTA nor the OECD recommend these as they are considered insufficient for demonstrating compliance with the arm’s length principle, the SFTA shows more flexibility by indicating that banks’ opinions could potentially be accepted as a starting point in exceptional cases.
It is also interesting to note that, among the main comparability factors to be analyzed in the context of an intercompany loan, the TPQ&A focuses on the importance of the issuance/start dates of comparable transactions, noting that only third-party transactions occurring at or close to the issue date of the transaction under review should be considered as reliably comparable.
In addition, acknowledging the difficulty of finding comparable data for loans Swiss denominated in francs, the SFTA mentions the possibility to use comparable loans in other currencies as long as appropriate adjustments are performed (with EUR loans being preferred given the proximity and interdependence between the economies of the European Union and Switzerland). This recommendation is a welcome clarification and aligns with the OECDTPG’s provisions allowing comparability adjustments to improve the reliability of a comparison and acknowledging that adjustments based on quantitative factors for which good quality data is easily available (e.g., on currency differences) are more likely to be achieved.
Prepayment clauses
While the OECDTPG require analysis of all the characteristics of the loan (for instance based on the concept of the accurate delineation of financial transactions1, including a detailed analysis of the surrounding economic circumstances of the transaction and characteristics of the financial instruments), the TPQ&A provides more details and specifically discusses the treatment, and even acceptance, of early payment clauses in intercompany loan agreements, along with concrete examples.
End of LIBOR
As chapter X of OECDTPG was published before the LIBOR transition, it does not contain specific guidance on this subject. Therefore, practical views on this topic from the SFTA are gladly received.
The TPQ&A allows the use of variable interest rates as long as the arm’s length principle is observed. For instance, the TPQ&A recommends the use of the SARON compound rate and most recent option for intercompany loans in CHF.
Aligned with the OECDTPG, which allow appropriate adjustments to achieve comparability under economic circumstances, the TPQ&A also recognizes the need for adjustments to derive long-term base rates from daily base rates as necessary.
Regarding intercompany loans concluded prior to the end of LIBOR and still in force, the TPQ&A specifically indicates that changes to the terms and conditions of loan agreements are only allowed if they follow the arm’s length principle. Accordingly, it is specified that the end of LIBOR should not be used as an opportunity for updating other unrelated loan conditions without justification.
Furthermore, the TPQ&A indicates that base rates to be used to replace LIBOR should be aligned with market standards and should be established by reference to the following: new base rate for each currency, initial duration of LIBOR rate used to derive variable interest rate, appropriate adjustment to derive long-term base rate and spreads computed by the International Swaps and Derivatives Association whose purpose is to ensure that new reference rates are equivalent to LIBOR in terms of risk.2
Finally, the TPQ&A provides three concrete examples of whether modification of the characteristics of an intercompany loan following the end of LIBOR is acceptable to the SFTA or not.
