OECD BEPS and Transfer Pricing – Differentiating In-House Bank interest depending on Balance Sheet

To support this, several countries that are working together to streamline economic market forces through the OECD organization, have defined guidelines to prevent tax Base Erosion and Profit Shiftings that may occur from non-realistic spreads applied in In-House Bank structures. The guidelines are known as OECD  BEPS. 

In short, the OECD BEPS guidelines stipulate that In-House Banks need to have a solid and realistic substantiation of applied spreads. In addition, a solid and realistic substantiation of applied spread potentially could be interpreted by local tax authorities that spreads must differ per legal operating entity, similar to how external commercial banks assess terms & conditions for customer legal operating entities individually. 

Because of the workload involved when differentiating interest spread per operating entity corporate Treasuries and Tax departments tend to “keep things simple”. Interest spreads on InterCompany loans are rather easy to differentiate as a) IC loans do not occur very often (compared to daily sweeps in Zero Balancing solutions), and b) IC loans require individual documentation which makes it easy to set different terms for different legal operating entities. This may potentially be sustainable in companies with little history in cash pool structures. But for mature companies, there is an increased tendency from local tax authorities to scrutinize in-house Bank structures to understand whether interest spread settings comply with OECD BEPS Transfer Pricing guidelines. 

To further satisfy Transfer Pricing principles with an increased focus on OECD BEPS, more companies are applying some sort of methodology to differentiate interest spreads based on the individual legal entity balance sheets. External banks run a risk analysis for each company that wants to bank with them and additionally is looking for financing (part of the Know Your Customer requirements). 

Similar to external commercial banks, an In-House Bank may be required to apply larger spreads for legal entities that have a financially unstable balance sheet. Assessing each operating unit and applying a separate risk-related interest spread can be too labor-intensive and counterproductive. A more practical and accepted approach to this is to introduce a limited number of “risk” classes, e.g.  A-level means a healthy financial balance sheet, B-level means balance sheet is on the watch, and C-level is technically bankrupt. In-house bank spreads will need to be differentiated according to risk classes.  Periodically, e.g. once a year, legal entities are reviewed to reassess the risk class (and potentially apply a renewed interest spread). 

Any risk class review and assessment will be required to be documented. the better the documentation  (including the rationale behind applied interest spread), the more likely that local tax authorities will be less inclined to scrutinize legal entities. Documenting the rationale behind interest spreads and the review methodology can be included in the Cash Management Agreement (see the white paper “Legal aspects In-House Banking“, 2024 March, Maarten Steyerberg, Solutius. Many Treasury Management Systems will be able to support this approach. 

When an operating entity or the In-House Bank is under review by the local tax authorities, Treasury and Tax will need to be prepared to provide answers as to why the current methodology for interest spreads has been applied, and how that matches with Transfer Pricing principles. 

The better the rationale behind the current methodology is explained and documented, the fewer discussions are expected with local tax authorities, and therefore tax consequences.