The application of the arm’s length principle to intragroup financial transactions

Assessing intragroup transactions and applying arm's length principle to determine accurate transfer pricing methods.

The assessment of the arm’s length nature of an intragroup transaction requires the identification of the commercial or financial relations leading to the accurate delineation and recognition of the actual transaction between the associated enterprises, and, after that, the selection and application of the most appropriate transfer pricing method.


The accurate delineation determines in the first instance whether a purported loan should be regarded as a loan for tax purposes or should be regarded as some other kind of payment, in particular a contribution to equity capital.

  • Identification of the economically relevant characteristics of the transation

The accurate delineation of the actual loan transaction should begin with a thorough identification of the economically relevant characteristics of the transaction – consisting of the commercial or financial relations between the parties and the conditions and economically relevant circumstances attaching to those relations; including, an examination of the contractual terms of the transaction, the functions performed, assets used, and risks assumed, the characteristics of the financial instruments, the economic circumstances of the parties and of the market, and the business strategies pursued by the parties.

  • Substantiation of the interest rate

Once the transaction has been accurately delineated, the next step of the analysis would require substantiation of the interest rate, the terms and conditions applied and the loan volume (or the principal amount). During the process  and consistent with the guidance in Chapter 1 of the OECD TP Guideline, one must also take into consideration the creditworthiness of the borrower.

  • Transaction assessment 

The process should assess the transaction from the perspective of both the lender and the borrower taking into account the options realistically available to both sides of the transaction.

  • Selection & application of the most appropriate transfer pricing method

The next step would be the selection and application of the most appropriate transfer pricing method. As the main compensation generated by an intra-group loan is the interest payment, the arm’s length Interest must be determined. However, it should be considered that certain other elements might also be compensated separately (e.g. fees).


Concluding remarks

A transfer pricing analysis assist taxpayers in substantiating that the loan amounts that could have been obtained from third-party creditors (under similar terms) and support the qualification of this finance transaction as debt for transfer pricing purposes (to the extent specific jurisdictions will apply the arm’s length principle for such classification pursuant to the OECD Guidance on Financial Transactions) and combined with an arm’s length interest rate, provides support for the deductibility of the interest payments from a transfer pricing perspective.


How can BDO help

With our deep understanding of transfer pricing regulations and methodologies, we assist in identifying relevant commercial or financial relations, accurately delineating transactions, and selecting appropriate transfer pricing methods. Our comprehensive analysis ensures compliance with arm's length requirements and provides robust support for substantiating loan transactions and determining arm's length interest rates, thereby optimising your transfer pricing strategies.


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