Bye Bye LIBOR….

Generally, businesses are financed through debt (borrowing) and/or equity (owner’s or shareholder’s contribution). Financial transactions between related parties have become a key focus area of Transfer Pricing, as a result of the recent OECD updates and various global tax authority (including SARS) releases.

Why are tax authorities concerned about debt-financing from related persons?
Debt attracts interest and interest is typically a deductible expense. More debt will mean more interest which could reduce or erode the taxable base or profit of the entity concerned and, consequently, lower the amount of tax Revenue Authorities can collect.

Secondly, the tax authority cares about the quantum and terms of the debt. Why? Because if the quantum of the debt is not considered supportable (arm’s length), the corresponding interest deductions are also likely not supportable.

Behind the scenes, different and complex analyses have to be performed to support the quantum of debt and the interest rates paid by (and to) related parties. The latest updates regarding financial transactions also must be considered to obtain a completed analysis for transfer pricing purposes.

Heads Up! Life after LIBOR
Most of third party and intercompany loans were historically issued based on LIBOR (London Interbank Offered Rate). However, everything began to change with the financial crisis of 2008, as regulators grew wary of overreliance on that particular benchmark for two main reasons. For one, the LIBOR is based largely on estimates from global banks who are surveyed and not necessarily on actual transactions.

On the other hand, banking regulations after the financial crisis meant that there was less interbank borrowing happening, prompting some officials to express concern that the limited volume of trading activity made the LIBOR even less reliable.

And now? The LIBOR and the SOFR (Secured Overnight Financing Rate) will coexist until 2023. Thereafter, the SOFR will supplant the LIBOR as the dominant benchmark for dollar-denominated derivatives and credit products.

Conclusion
Get the basics right! Transfer mispricing and claiming deduction of excessive interest expenses can lead to tax and transfer pricing adjustments.

We can help you benchmark appropriate interest rates and perform debt carrying capacity analysis to ensure adequate and robust support is in place for your intragroup financial transactions.