Transfer Pricing Insider
Volume 3, Issue 1
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Thomson Reuters: Implications of the Credit Crunch
for Intercompany Loans
Source: J. Harold McClure, Senior Manager ONESOURCE Transfer Pricing
In a recent speech, Federal Reserve chairman Ben Bernanke described the ramifications of the "abrupt end of the credit boom" thusly:
1"Rising credit risks and intense risk aversion have pushed credit spreads to unprecedented levels, and markets for securitized assets, except for mortgage securities with government guarantees, have shut down. Heightened systemic risks, falling asset values, and tightening credit have in turn taken a heavy toll on business and consumer confidence and precipitated a sharp slowing in global economic activity."
While the recent recession has led to losses for many U.S. companies which would tend to increase their need to borrow funds if they wished to maintain current operations, the credit crunch has made obtaining third party loans more difficult. Consider the case of a U.S. subsidiary, which desires to obtain credit by undertaking intercompany debt issued by its foreign parent.
While interest rates on U.S. federal debt have dramatically declined during recent months, interest rates on third-party corporate debt have increased. The rise in interest rates on corporate debt is reflected in Bernanke’s observation that credit spreads have ri to "unprecedented levels". We shall note that while many multinational corporations with inbound intercompany loans may have relied on the Applicable Federal Rate (AFR) safe haven of section 1-482.2(a) for previous intercompany loans, reliance on this safe haven is not likely to address the need to comply with both U.S. transfer pricing regulations and the expectation of the foreign tax authority that the interest rate on the intercompany loan be consistent with market interest rates for comparable loans.
This paper's discussion begins by noting the credit spreads on long-term AAA and BBB government debt over the 1994 to 2008 period. The discussion next considers how the tax director for a hypothetical U.S. subsidiary that had incurred an intercompany loan two years ago might have successfully managed transfer pricing exposure by the use of the safe haven provision. The paper concludes by considering a situation where this U.S. subsidiary wishes to raise funds in today’s market through the use of an additional intercompany loan. We shall note why the safe haven provision will not successfully manage the transfer pricing exposure for this new transaction. And we shall - also address how to evaluate an arm’s length interest rate.
Credit Spreads: 1994 to 2008
The Federal Reserve publishes historical information on long-term corporate bond rates, which are rated Aaa and Baa by Moody’s. The Moody’s ratings correspond to the AAA and BBB ratings by Standard & Poor’s. Figure 1 shows the reported average monthly rates from January 1994 to December 2008.
1Stamp Lecture, London School of Economics, London, England, January 13, 2009
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