In the current economic situation, the importance of intragroup financial transactions has been growing. Companies are increasingly borrowing from a related party instead of financing from an external financial institution. This approach is triggered by lower creditworthiness of lenders or less activity of the banks. This approach was confirmed in a report prepared by the National Bank of Poland entitled "Credit Market Situation." In Q4 2022 an increase was reported in the margin for higher-risk loans and a decline in demand for long-term loans to entrepreneurs. One of the reasons for the latter decline was the increase of intragroup financing for companies from their own resources.
Intragroup financial transactions
From a TP perspective, intragroup financial transactions not only cover loans. Group financing can also take place through issuing bonds, providing a deposit, or participating in a cash-pooling system. Financial transactions also include group guarantees or insurance services, factoring services, hedging services and other currency transactions.
Intragroup financial transactions often bring benefits to related parties, for example, by obtaining additional financing, which can be used to conduct investments or develop business activities. By receiving a group guarantee, the company can achieve the bank financing or improve the terms of bank financing. In addition, receiving a guarantee can be a requirement for entering a tender or contract, whereas participation in a cash pooling system allows the day-to-day management of funds in capital groups. The entity engaged in management of the cash pooling structure allocates the financial surpluses to those entities that have cash shortages.
The attractiveness of intragroup financial transactions is also confirmed by published statistics of the Polish Ministry of Finance. About 43% of all reported intra group transactions for FY 2019 in the TP-R declaration (a dedicated tax return for TP purposes in Poland) referred to financial transactions. Moreover, in practice, the values of intragroup financial transactions in terms of loans capital are high, therefore the value of potential reassessment of the value of interest could have a material impact on the settlements of the companies.
Benchmarking analysis based on reliable data is crucial
An important factor affecting the valuation of financial transactions with related parties is the changing economic environment in which related parties operate. From a TP regulations perspective it is crucial to defend the arm’s length level of interest rate by possessing a valid, reliable, high-quality benchmarking analysis for financial transactions.
To confirm the arm’s length level of interest rate it is not sufficient to pursue just any analysis. For example, in the judgment of the Polish Supreme Administrative Court of June 29, 2022, it was indicated that a valuable benchmarking analysis should be carried out based on the element of comparability analysis indicated in the Polish TP regulations.
The comparability study for financial transactions should include:
The period under review;
Description of the related parties and the economic environment;
Analysis of functions, assets, risks, and selection of the tested party (if any);
Internal comparability analysis (if possible);
In case of lack of internal comparables, identification of available external comparables;
Selection of the most appropriate method and financial indicator for the application of the selected TP method;
Analysis of available comparative data;
Comparability adjustments; and
Calculation of the financial results.
In the opinion of the Supreme Administrative Court, the benchmarking analysis for loans presented by the tax office did not cover the obligatory elements of comparability study specified by Polish TP regulations. The tax office’s analysis was limited to a brief description of the company, and a description of the loans and queries to the banks, which included interest rates and commission rates for loans granted to commercial companies. In this manner the identification and verification of comparable terms and conditions established by independent entities was completed, including:
The currency of the loan;
The amount of financing;
The purpose of the financing;
The term of the loan;
The presence of collateral;
The type of interest rate applied; and
The amount of the bank’s commission.
The Supreme Administrative Court observed that in the presented benchmarking analysis, the authority did not analyse the loan transactions comprehensively. The analysis covered only the loans themselves without considering the purpose of the loan (financing of a specific investment). Therefore, the analysis did not cover all the relevant comparability factors, including the assets and risks incurred within the transaction. The tax authority in its enquiries to the banks did not include significant information about the company, i.e. its credit rating, the market in which it operates and the types of collateral used, which was not applied in the pricing received.
The Polish Supreme Administrative Court is not alone in questioning the appropriateness of using bank offers to prepare benchmarking analyses. In the newest version of the OECD guidelines, it is indicated that bank bids should not be used as comparative data, because these data must reflect the conditions under which unrelated parties enter transactions. Bank bids do not meet this requirement, because they do not reflect the conditions of actual transactions, since they may be the subject of negotiations at a later stage. Furthermore, before granting a loan, the bank conducts a relevant credit rating analysis, which precedes the formal loan offer. Therefore, such bank bids are generally not considered as evidence to confirm the arm's length level of interest rates in the financial transactions.
Therefore, possession of high-quality benchmarking analysis for financial transactions reduces the possibility of its questioning by tax authorities during an inspection. It also limits the possibility of a potential reassessment of income. It should also be emphasised, that if a taxpayer has a benchmarking analysis, the tax authority must question it before preparing its own analysis. Therefore, the higher the quality of the benchmarking study, the more difficult it will be for the tax authority to question it.
Macroeconomic factors
According to Polish TP regulations, the benchmarking analysis prepared for financial transactions should be updated at least every three years, unless a change in the economic environment significantly affects the prepared analysis and justifies a more frequent update.
The current economic situation in the borrower's country or in its industry can directly affect the level of remuneration in financial transactions carried out between related parties. In recent years, dynamic changes in the economic situation caused by, among other things, the COVID-19 pandemic, high inflation, changes in interest rates and the war in Ukraine should have affected the conducted analyses. Among the factors that are important to analyse for financial transactions are: credit rating, type of interest rate, currency and the impact of the group support. It is important to consider whether the benchmarking analysis for financial transactions prepared a year or two ago will still be relevant in view of the market changes since 2021.
To determine if an update of the benchmarking analysis is required, each financial transaction should be analysed individually. One of the key factors that should be verified is the borrower's credit rating. If it changes, a benchmarking analysis update should be considered.
As good practice, it is recommended to review annually whether market factors or intra-group changes in arrangements have affected the remuneration applied in financial transactions. Based on such an analysis, it can be concluded whether an update of the benchmarking analysis is necessary. The above approach to the verification of the arm's length nature of the transfer price was also confirmed by the individual interpretation issued on March 24 2021 by the Polish Director of National Fiscal Information (PDNFI). Doubts raised by the taxpayer concerned whether the interest rate should be adjusted, in the event that the adopted interest rate level (determined at the time of concluding loan agreements) in loan transactions concluded historically, deviates from the results of the updated benchmarking analysis.
The PDNFI indicated that it is the taxpayer's responsibility to monitor the terms and conditions of the transactions on an ongoing basis and to adjust them if unrelated parties would do so. Moreover, if the interest rate terms of a previously granted loan were market-based, but became non-market-based due to, for example, a significant changes of circumstances, the parties should adjust the transfer prices to a level consistent with the arm's length principle from an updated benchmarking exercise.
In conclusion, the changing economic situation and the tightening credit policies of banks towards companies changes the terms and conditions of financing provided between unrelated parties. Therefore, the interest rate levels in financing transactions conducted between related parties should also be updated to reflect the market conditions. Accordingly, the taxpayer should verify whether ongoing market changes affect the terms of financial transactions conducted with related parties. If so, it is important to adjust the terms of this transaction to the market conditions.
Moreover, the changing economic environment may force the taxpayer to conduct a new benchmarking analysis, considering the changing terms and conditions. This is because it is the taxpayer’s responsibility to conduct financial transactions with related parties on the terms that unrelated parties would have agreed. Therefore, the best solution is to regularly analyse the terms and conditions of financial transactions concluded in the market and, if necessary, adapt them to those between related parties.
