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The arm's length principle of intra-group financing measures during the covid-19 crisis

16 July 2020

The covid-19-related economic conditions and liquidity shortages make the allocation of intra-group financing measures of utmost importance for they ensure the survival of the group companies. It should be noted that the effects on the financial and capital markets can also change the framework conditions of the arm's length principle, which might have considerable financial consequences for companies weakened by the crisis.

Effects of the covid-19 crisis on bank credit lines

The downturn in the economic outlook is expected to lead to an increase in credit default rates and risk spreads[1]. Banks will be forced to increase their provisions for expected credit losses (ECL), as already partly reflected in the quarterly reports in spring 2020.[2] In the first quarter, changes in risk assessments as well as higher refinancing costs and balancing restrictions also led to short-term increases in margins on loans.[3] Banks are therefore responding by raising interest rates when granting loans. A wide range of government measures, such as guarantees through credit insurance, are intended to cushion a downgrade in creditworthiness and thus keep the increase in risk premiums at a minimum.

Effects on group financing

The OECD guidelines on financial transactions require that - in addition to currency, term, collateralisation and amount of the loan - the creditworthiness of the borrower is also a key factor in determining whether the financing is at arm's length. In the event of a crisis-related granting of loans or credit within the group, it should be analysed whether it would be possible for the borrower to obtain external financing at the time the financing was granted. Or whether the borrower is expected to generate a cash flow on the basis of proper planning, which should guarantee the payment of interest and the financing amount in a manner that is consistent with the contract and the external conduct.[4] Otherwise, there could be a risk that the financing being classified as taxable equity; the tax deductibility of interest payments would thus be denied.

Changes in the external framework conditions of the financial and capital markets may also have an impact on the appropriate remuneration of existing intra-group financial transactions when applying the CUP method, whereby a distinction will have to be made as to whether the financing is at fixed or variable interest rates. The problem of negative interest rates, which banks are increasingly applying even to small financing volumes, is also an unresolved and therefore sensitive issue.. In the past, negative base rates were mostly set at nil for group financing purposes. In any case, it is necessary to analyse existing financing arrangements to determine whether comparable financing agreements with external financing providers contain price adjustment clauses or termination options based on certain key data of the company.

There may be group internal reasons for granting intra-group loans at significantly low interest rates or even interest-free. However, the arm's length principle on a stand-alone basis cannot usually be met. There may be exceptions in special cases of quite integrated business models, where a "sharing" of the financial burdens of the crisis appears to be at arm's length or where the group company with the strongest functional profile (“principal”) provides interest rate support on an operational basis in accordance with the arm's length principle. It might also be possible to avoid a need for financing in advance using a so-called "commercial subsidiary" payment by the principal. A detailed analysis of the business model of the companies involved is advised. However, any such pandemic-related interventions in arm's length transfer pricing should be clearly identified as such in order to reduce discussions with the tax authorities.

If, in compliance with the arm's length principle, group lending entities are forced to apply interest rates and creditworthiness criteria corresponding to those of banks in times of crisis (and are therefore correspondingly high), this could imply that the subsidiaries cannot bear this interest burden from an economic point of view. It would therefore be welcomed if the OECD and the Austrian government were to allow a more flexible structure of intra-group financing in order to avoid economic hardship. Furthermore, depending on the business model, for example "interest rate support on an operational basis" could be considered in order to mitigate the economic hardship in accordance with the arm's length principle.

Practical recommendation

In the event of contract adjustments or renegotiations, it is essential that the reasons for them and the procedure in line with arm's length principles be documented. The current exceptional situation requires a detailed analysis of the business model and the economic framework conditions.


[1] Simbürger, Börseblick - Ungewissheit prolongiert, ÖBA 2020, 384.

[2] BDO Newsletter, 22.04.2020, Covid-19-Auswirkungen auf den Bank- und Kapitalmarkt.


[4] OECD, Transfer Pricing Guidance on Financial Transactions, Tz 10.12 f.