Group companies don’t act at arm’s length in times of need

Originally published: March 2024

Tax rules generally split profits between entities based on the the arm’s length principle (ALP). But group companies support each other in official and unofficial ways. If a group company guarantees a loan, boosting the creditworthiness is a service with an ALP supported guarantee fee. But banks can offer lower interest rates even without that. Usually, no ALP fee can be imputed for such implicit support.

On intragroup loans, the OECD guidelines also consider implicit support for determining interest rates. Recent case law in Australia agrees (https://lnkd.in/ecVB-d-p). Implicit support could drop the interest rate down to closer align with group level interest rates. The lender gets a lower return and loses compensation for the credit risk. If implicit support is strong enough, the specifics of the group entity start to matter less. The entity could be doing leveraged high frequency trading or operate in a highly politically unstable emerging market with a weak currency. If you assume that the group will step in anyway if it goes wrong, the interest rate should be low.

Obviously, the court cases were nowhere as extreme. But if we always assume implicit support in a strongly integrated group, would anyone put an ALP price on real, enforceable guarantees? Why pay for what you already have? And why do borrowing group entities get all the benefit of the group credit boost (possibly a synergy benefit: (https://lnkd.in/eMZK8jND) while having none of the risk? If the intercompany loan becomes worthless, is a deduction possible? The lender never got paid for the risk, so why would the loss be deductible? It only seems to add up if credit risk within a group becomes transaction within the equity relationship (non-deductible, non-taxable, though possibly that conclusion only applies if the “implicit support” threshold has been triggered). Perhaps that’s a feasible system of applying ALP on financial transactions, it’s just not the system countries and MNEs have been following.

There’s just not one song that captures this dynamic, so I resorted to a full playlist (https://lnkd.in/eZ7npVkR). Group companies agree to Stick Together (Bryan Ferry) and say things like “if you need a friend, don’t look for a stranger” (When In Rome), “if you got a problem, don’t care what it is, I Can Help” (Billy Swan) and “Reach Out, I’ll Be There” (Four Tops). So, if there’s a request for Help! (the Beatles, the Beach Boys), you Help Out (Bo Diddley). Even in financial difficult, they get by With A Little Help From Their Friends (the Beatles), because Friends Will Be Friends (Queen) and That’s What Friends Are For (Dianne Warwick and others).

Obvious disclaimers: this is not advice. These views are my own and do not necessarily represent my employer.

Post | Feed | LinkedIn

Group companies don’t act at arm’s length in times of need – playlist by Leonard Wagenaar | Spotify