This article examines the intensified focus of the Romanian tax authorities (RTA) on transfer pricing (TP) investigations of intercompany financial transactions and its implications for multinational enterprises.
Financial transactions from plain loans to cash pools, guarantees, or more complex financial instruments may all facilitate capital flow, enable investment opportunities, and support operational efficiencies and risk management. Despite increasingly playing a strategic role for multinational enterprises, financial transactions have long been overlooked during TP investigations by the RTA, which have predominantly enquired about the operational side of businesses.
Nevertheless, after seeing the OECD's release of specific guidance on the TP analysis of financial transactions in 2020, the RTA are now increasingly targeting financial transactions. Understanding the changes thereof is crucial to enable financial executives to adapt in foresight and to manage compliance and risks while maintaining sustainable business success.
Romania's TP landscape: insight into past practices
Romania's TP regulations for financial transactions consist of rather general rules and are deemed to be completed by the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, as revised. Irrespective of a cross-border or domestic context, financial transactions between related parties are required to be conducted at arm’s length and are subject to TP documentation requirements if certain minimum thresholds are met. For example, once a Romanian taxpayer’s intercompany cumulated interest exceeds €50k in the year, the taxpayer has the burden of proof to demonstrate to the RTA that the intercompany transaction is conducted at arm’s length.
Regarding the TP analysis approach, the Romanian legislation specifically provides certain minimal aspects to be considered in relation to intercompany financing transactions. The requirements include verifying the loan's alignment with the recipient's business activities, the loan’s usage, and any deemed qualification of a profit distribution scheme; an interest TP analysis is expected to consider aspects regarding the debt’s principal and term, and its nature and purpose; any guarantees/collateral; the currency; FX risks; hedging costs; and other relevant circumstances.
However, historically, the RTA were relatively rarely seen to undertake in-depth TP investigations into a taxpayer’s intercompany financial matters. At such times, Romanian taxpayers and the RTA alike were often relying on interest rate statistics published by the National Bank of Romania (NBR) for establishing the compliance of the intercompany interest with the arm’s-length principle. Despite obvious comparability limitations, this TP analysis approach gained popularity in Romania on account of the increased simplification and wider acceptance by the RTA historically.
Romania's enhanced approach to financial transactions
Unlike in past years when financial transactions were not a focus or the focus was limited in scope and depth, multinational enterprises’ Romanian affiliates may now note a major shift in approach. For instance, some of the notable changes regarding financing transactions include the following:
Part of the taxpayer risk flagging system – financing activities are now consistently flagged by the RTA’s internal taxpayer risk evaluation system. Taxpayers increasingly need to explain risk warnings relating to, for example, interest level, intercompany debt, and various metrics about the taxpayer’s financial activities. This input then serves within a set of factors guiding the RTA’s decision about starting tax investigations.
Part of standard audit questionnaires – the RTA began to routinely ask about intercompany financing activities early within the audit process, setting the premise for more frequent and in-depth investigation thereof.
Increased challenge of taxpayer analyses – the RTA started to scrutinise the taxpayer analyses more rigorously; for example, challenging data (such as data from the NBR) for lacking sufficient comparability to the tested transaction, often requiring an assessment of the borrower’s credit rating to be incorporated into the TP analysis.
Increased sophistication and reclassification risk – the RTA started to consider borrowing capacity assessments during TP audits. In the event that the transactions’ debt nature cannot be sustained as arm’s length, the RTA consider reclassifying the non-arm’s-length debt portion and disallowing the related interest for corporate income tax purposes. The impact thereof escalates with the RTA also assessing withholding tax liabilities according to local rules, without access to relief under double tax treaties or EU directives.
Such enhanced focus extends beyond plain financing arrangements to many other financial transaction types.
Staying ahead of the curve
The RTA's focus on financial transactions requires a proactive response. Firms may need to revisit their benchmarking strategies, ensuring robust documentation that substantiates the business rationale and arm's-length nature of transactions. Adopting best practices such as credit rating assessments and borrower capacity evaluations may help to reinforce or defend compliance in Romania.
By engaging with these developments and refining compliance strategies, businesses may ensure preparedness for scrutiny in Romania, mitigating TP risks at times of rising controversies, along with uncertainties or inefficiencies relating to double taxation relief.
