In episode two of "GILTI Conscience," tax partners Nate Carden and David Farhat talk with economist Bram Isgur of Keystone Strategy about the transfer pricing implications for intercompany loans and guarantees. "The stakes are huge," David says. "A lot of clients have to fund themselves. They have to move money across borders, and how governments look at that and how everyone gets their appropriate piece of the pie can become very complicated."
Understanding the 2022 OECD Transfer Pricing Guidelines and how it applies to guarantees and other financial transactions is essential for multinationals trying to manage intercompany lending and get their transfer pricing right.
Granted, these companies have to fund themselves, whether through intercompany debt or guaranteed loans. They have to move money across borders, but how they do that, how the rules apply in different tax jurisdictions, and how everyone gets their appropriate piece of the pie can become very complicated.
Profound transfer pricing questions tend to arise when deciding which credit rating applies to a subsidiary of a multinational because that can make a big difference on interest rates and tax implications. Another concern is that if a subsidiary has to get the stand-alone treatment because of the arm's length principle, what is the value of implicit support?
Dealing with these issues opens a can of worms that questions the core of transfer pricing as we know it. For one, why should implicit support be a borrower-only analysis when a lender can also be a part of a group? Since implicit support applies to 'important subsidiaries,' are there non-important subsidiaries?
The new guidelines attempt to address some of these issues related to the arm's length standard for cross-border transactions between associated enterprises. However, these guidelines don't apply equally across different jurisdictions. For instance, which rules should multinationals that have operations in the U.S consider, and in what scenarios do the new OECD guidelines come into effect?
In this episode of The GILTI Conscience podcast, hosts, Skadden Partners David Farhat and Nate Carden, Associate Eman Cuyler, and Clerk Stefane Victor sit down with Abraham (Bram) Isgur, Principal at Keystone Strategy. They discuss transfer pricing for cross-border intercompany loans and guarantees, the OECD guidelines, the controversies to expect and prepare for, ideas for engaging with tax authorities, and more.
Bram Isgur is a Principal at Keystone Strategy, an economics consulting firm for Fortune Global 500 companies, top law firms, and government agencies. An economist, Bram advises law firms, multinational companies, and banks on diverse issues, including tax and regulatory compliance, transfer pricing controversy, antitrust, and securities law.
Bram’s specialty areas include negotiation of multilateral Advance Pricing Agreements with the IRS and other tax authorities, transfer pricing relating to financial transactions, risk, banking and global dealing, and economic analysis to support Regulation W compliance.
- Intercompany financing transactions raise transfer pricing controversies. Intercompany loans or financial guarantees are top of mind for multinationals and tax authorities alike. For both cases, the borrowing entity’s creditworthiness is critical. However, controversy begins to arise around which credit rating applies to the borrowing company and the resulting interest rate and how the arm’s length principle should take effect.
- The implicit support dilemma. Are subsidiaries treated equally? What makes a subsidiary important and another non-important? When considered, David raise the point that since some jurisdictions treat separate subsidiaries as separate, as opposed to other jurisdictions that may want to look at the enterprise as a whole and get into the halo effect, how does one get the value from implicit support considering the arm’s length standards?
- How do the controversies around implicit support, explicit guarantees, arm's length standard affect how a multinational operate, and what does it mean to them? Bram suggests a logic that applies to intercompany loans and guarantees, where the cost has to make sense relative to the savings from the explicit guarantee. For implicit support, the OECD guidelines can point you in the safest direction.
This is GILTI Conscience: Casual Discussions on Transfer Pricing, Tax Treaties, and Related Topics, a podcast from Skadden that invites thought leaders and industry experts to discuss pressing transfer pricing issues, international tax reform efforts, and tax administration trends. We also dig into the innovative approaches companies are using to navigate the international tax environment and address the obligation everyone loves to hate. Now your hosts, Skadden partners, David Farhat and Nate Carden.
Nate Carden (00:36):
Hi everybody. This is Nate Carden, I'm here with David Farhat, Eman Cuyler, and Stefane Victor, and this is another episode of GILTI Conscience. We're recording today after the release of the 2022 OECD Guidelines and we have a great transfer pricing topic, transfer pricing with respect to guarantees and other financial transactions. This is an area that's important, not just to financial services companies, but to all companies that are trying to manage intercompany lending and get their transfer pricing right. But it's also an area with a lot of specialization and Bram and David spent a lot of time in this space. I'm a rank amateur, so I'm going to ask David first to start us out. Why should we care? What are the stakes?
David Farhat (01:22):
Thanks, Nate. The stakes are huge. As you mentioned a lot of clients have to fund themselves, they have to move money across borders. And how they do that, how governments look at that, and how everyone gets their appropriate piece of the pie can become very complicated. I'm excited to have Bram on the podcast with us. I'll throw over to him for him to introduce himself, but he's one of my favorite people in the business and I think we're going to have a very interesting conversation. So before we move on Bram, can you give us a bit about yourself and let us know what you've been up to?
Bram Isgur (01:54):
Sure. Thanks, David. So I'm Bram Isgur, I'm a Principal at Keystone Strategy. I'm an economist and I've spent a lot of time doing controversy and planning for among other things. Intercompany loans, intercompany guarantees, transfers of risk, banking, finance, and other such fun transactions, both in the U.S. and worldwide.
David Farhat (02:18):
Thanks Bram, you mentioned controversy, which always gets my ears to perk up. So we'll talk about some of that and we'll talk out how governments have gotten into this, what controversy looks like, and for the folks that have to deal with this on a day to day basis, what things they should look for, or be aware of. As we kick off and get into the start of this, can we get a little bit of background on intercompany financing transaction?
Bram Isgur (02:45):
Sure. Most people will know in the context of transfer pricing that the two most common intercompany financial transactions you're going to see are intercompany loans, whose purpose is fairly obvious. You're moving money from one place to another in the form of debt. Pretty much every multinational will have quite a few, and intercompany financial guarantees. Those financial guarantees are also very common. They're pretty much all over the place. And the reason why they exist is you often are borrowing as a multinational through a subsidiary other than your group parent. And in order to do that, you get a guarantee from the group parent and often other group members that goes to the lenders, either the banks or the public bonds and gives them recourse to the whole group. In both of those cases, one of the most central things you need to know about is what is the credit worthiness of the entity that's borrowing, either the entity that's borrowing from third parties and receiving a financial guarantee or the entity that's borrowing from an affiliate.
Bram Isgur (03:49):
So for anyone who's unfamiliar, this is a corporate credit rating. It's very similar in concept to a personal credit rating, where it gets interesting is the specific nature of the way that multinationals operate and what it means to talk about the credit quality of a subsidiary of a multinational group. So most multinationals that are large enough to actually have transfer pricing problems will have a public corporate credit rating. These will be issued by a company like S&P or Moody's or Fitch, or in some cases, more specialized companies. And it reflects effectively how likely they are to pay their debt back and their ability to borrow.
David Farhat (04:29):
So, Bram, let me stop you for a quick second there, because as we're talking about these intercompany transactions, and we're talking in the context of transfer pricing, arm’s length standard comes into place. You're talking about credit ratings, that I imagine can get very complex. New guidelines have come out OECD guidance has come out about implicit support. We've got case law around halo effect. So can you give me some insight into some of your work as an economist and how this can get complicated, how are multinational organizations dealing with that complication?
Bram Isgur (05:07):
Sure, absolutely. So I would say that the most common way that it gets complicated really is at the step of deciding what the credit rating is. In most of the controversy that I've seen, the fight hasn't been about with a BB credit rating, what's the right interest rate? The fight has been about, is it a BB credit rating we're talking about? Or is it AA credit rating? And that is where I think the deeper transfer pricing questions tend to come up.
Stefane Victor (05:35):
And just a further table set. The reason why that credit rating would be so important would be because the amount that a company would have to pay would change significantly based on its credit rating?
Bram Isgur (05:48):
Absolutely. And it can be a really huge difference, especially because in a lot of cases, multinationals will have quite a lot of either intercompany debt or guaranteed loans. So you can imagine if you have 40 or $50 billion of lending and that kind of credit rating difference can be a difference of three to 4% interest that you pay per year. That's a huge issue. So it's no surprise that it's top of mind for a lot of tax authorities and also top of mind for a lot of companies when they're looking at what their controversy rate risks are.
David Farhat (06:17):
Indeed, that makes a big difference for jurisdictions, like take the U.S. that may have a lot of outbound lending versus jurisdictions like Canada, Australia, or some smaller jurisdictions that may be inbound. The interest there may be very different in who wants to look at these credit ratings and treat separate subsidiaries as separate, as opposed to other jurisdictions that may want to look at the enterprise as a whole and get into the halo effect and implicit support and some of the guidelines that you said in the OECD around implicit support. So if we could spend some time on that piece a little bit, just the implicit support. How does one recognize the value of that? Right? Because as you just laid out in response to Stefane's question, interest rates could be impacted depending on the credit rating. So how do I then move the needle based on something like implicit support? What am I looking for? How do I turn qualitative issues into quantitative responses?
Bram Isgur (07:19):
And I should add that implicit support has been the topic of a lot of the controversy that we see in this area. And in a lot of cases, it really is the issue that's at the heart of the entire controversy case. And it's particularly interesting because you said how to turn the qualitative issue into a quantitative issue, and it's a very qualitative issue in an area that people might think is very quantitative or purely quantitative. So if I can start with a little bit of transfer pricing philosophy. Transfer pricing rules, as we all know are rather old. And they were designed originally in a very different time when the nature of multinationals was not at all like it is today. And they work really cleanly and simply in certain areas like when your international movement of tangible goods, lots of types of services, it's pretty clear what the rule is asking you to do.
David Farhat (08:12):
Yeah. I'm happy you said that, because if the fiction that we have in transfer pricing is that we're supposed to interact with related as though they're unrelated, we're using the arm’s length standard. To use a British phrase, this implicit support throws a spanner in the works. How do you then price actual guarantees? How do you look at a situation where you have an actual guarantee versus this implicit support? Where do we draw the line? And I like that you said, some folks are looking at it and saying, "Well, why not just take the rate of the parent and make that the rate for the group?" But then that runs contrary to everything we've done in transfer pricing. You have a cross border transaction, we have to have the arm’s length standard, you have to look at it as a standalone.
David Farhat (08:58):
So several questions, I guess, what does standalone mean? What kind of problems are we seeing in this kind of, like I said, this being thrown in the works? And last but not least, how are we as practitioners, clients, taxpayers, and governments supposed to work with this? Because based on what you said, and I know we haven't gone into a lot of the details, it seems you can go into several different directions here. And Nate, I love some of your input there and clients you've worked with and struggling with some of these issues. How do we figure out exactly what we do? And how does this gel with the basics of transfer pricing we think we understand?
Bram Isgur (09:44):
I think the first step definitely is to make sure that you decide what the question you're trying to answer is before you try to answer it. If I'm looking at what do I think the credit rating, if a multinational or multinational subsidiary is for transfer pricing purposes? One thing I could be asking about is what people call the standalone credit rating, or in some cases the orphan credit rating. And that is. What if I took this subsidiary and I just cut it off completely from the group? So I pretend that it has no owner at all, it's publicly owned. No one else is going to step in and help it, everyone is dealing at arm’s length with that. Some people would say is what transfer pricing means. It could be tricky.
Bram Isgur (10:24):
And another way, which is what is in the OECD guidelines now is that I do need to take into account that this entity is a member of a group. So one logical construct that often gets used when thinking about it is if I have say a UK multinational lending money to its U.S. subsidiary, the construct is what would I loan that money for if it was to the U.S. subsidiary of a different UK for an owner that was otherwise identical? And this is where the whole can of worms gets opened.
Nate Carden (10:59):
It's a very strange theory that tells us that the way to apply the arm’s length standard is by looking at the borrower side and what that borrower would be able to get as an interest rate in the marketplace, but then turn around and say that we don't take into account the fact that the lender is also related, right, as I point out to a lot of people, when I listen to this debate, if the theory of implicit support and you made reference to "important subsidiaries" and we should talk about how one would actually know that. But if the theory of implicit support is that, if a parent had an important sub that was borrowing from third parties, rather than letting that sub default, it would make sure that the sub made good on its debts in order to avoid having the creditor come in and take important assets.
Nate Carden (11:55):
Well, okay. But in this case, we're talking about a related party lender. So why wouldn't the parent that also owns the related party lender say, "Look, we don't care. Let them default. The lender owns the assets at that point. We own the lender too." So why do we think that the implicit support should be a one sided analysis?
Bram Isgur (12:18):
Well, I actually think that the construct I was describing where you say it's a subsidiary of a different group, even though that's not necessarily the official version of events, it does seem to make it easier to think about, but the OECD seems to be telling everyone to do. In that case it would be well, if I was lending money to a subsidiary of a different group, then I'm thinking about, will that parent step in and save them rather than will I step in and save them? But you're right. It is a kind of odd concept. You might think that this runs contrary to the whole point of transfer pricing, which is we want to consider everyone on their own.
Nate Carden (12:52):
And why do we imagine the borrower is subsidiary of a different group, but the lender's not a subsidiary of a different group? In other words, it feels to me like the can of worms reference is exactly right.
Bram Isgur (13:04):
I think that that's entirely fair, actually, that it's a bit of a departure from the way that transfer pricing works in most other circumstances. To some extent, the groundwork for this is the passive association concept in transfer pricing, but that was intended for something different. Passive association was really originally talking about things like, I need to buy tin and because I'm a big multinational, I can get 5% off the price of tin from my supplier, and I can't charge my subsidiaries for that 5% discount, everyone just cheers and shares alike. And that concept makes decent amount of sense when you're talking about something like that. But it gets a little bit stretched when you're talking about credit ratings.
Bram Isgur (13:47):
So I might be a UK multinational with a AA credit rating, but maybe my subsidiary that operates in Costa Rica is that really going to have a AA credit rating? Because one of the things that people often talk about with transfer pricing is putting subsidiaries of multinationals on even footing with independent local companies. There's no independent local company that looks anything like this subsidiary it's going to have a AA credit rating or anything close.
Stefane Victor (14:12):
Yeah, I just had a question touching on something that Nate mentioned about important subsidiaries. So are all subsidiaries treated the same? Is it just that there's some important, some non-important or does it matter which jurisdiction from which they operate?
Bram Isgur (14:28):
Well, that's one of the larger worms in the can. I think the answer is that it could be anything and everything in between. So I'm a big company that makes shoes, I have a U.S. subsidiary that manufactures shoes for the U.S. market sells them at the U.S. market and maybe has some relationships with foreign affiliates for things like services or branding or IP, but runs its own business. There I might start to think, "Well, how much is the parent going to care about this?" And you start to get into some really subjective questions about, well, if this local subsidiary is in trouble, does it mean that my U.S. operations aren't worth saving? How much do I care about what people hear in the news about whether my U.S. affiliate went bankrupt? And of course that one's often a moot point because in that case, you would have a very hard time finding examples of any multinational that will have a subsidiary that looks like that borrow directly from a third party with no parental guarantee.
Bram Isgur (15:29):
Now we give you another weird case. You might have a subsidiary that owns a lot of IP and licenses it out. Well, a lot of multinationals for a variety of reasons will have a lot of their key intellectual property consolidated in one entity that will license it out to other affiliates. Well, how likely are they to let that entity declare bankruptcy? You'd think the answer is probably not, it's a little bit hard to run an IP dependent multinational, if your IP went to a lender that seized it when it didn't pay its debts. But Nate's point, that's a little bit of a weird question to ask if you are the one lending it money. And of course, it's also a weird question to answer, because if you want to know how they would deal with the third party in that circumstance, well, that entity doesn't borrow money from third parties, it's most likely the answer, not without a guarantee.
Bram Isgur (16:20):
And there's a lot of different ways to answer this type of question. One of them, for example, this is the route that Australia has gone down is, well, I want to know what your treasury department does with third parties. And generally speaking, the answer is we're not going to borrow money from a third party without a parental guarantee. And if you ask treasury people in a multinational this question, you get a weird look and they want to know why the tax department is asking about this, because it doesn't make sense. Another thing you can do is you can look at the guidance that the credit rating agencies, so companies like S&P, Moody's and Fitch put out. And they do have guidance about this sort of situation. And in a lot of ways, if you read what the OECD guidelines say about this, I think we'll want to get back to that in a bit.
Bram Isgur (17:10):
It doesn't look too far off from the things that the credit rating agencies say. Where you get to trouble is that when you start looking at what the credit rating agency say, a lot of it is very subjective questions. So for example, what's the intention of management with respect to this company? How integral is it to the group's operations? How integrated is it with respect to the group? And those can be hard questions to answer, and they can especially be hard questions to convince a tax authority that your answer is right rather than what you want it to know.
Nate Carden (17:42):
So if I'm a country general manager and my tax department has a high interest rate on my country's debt, I should start looking for another job because it means I'm not that important?
Eman Cuyler (17:55):
I was going to say, you touched on the OECD guidance, are other countries following their lead and also providing guidance or is it very uncertain and multinationals pretty much are taking it day by day from a planning perspective?
Bram Isgur (18:08):
That's a really good question. So the first thing to keep in mind is that the OECD's guidance, well, it's helpful in some ways, it's not a prescriptive remedy. And there's a lot of room for interpretation in that. And a lot of that room comes in terms of the very subjective types of questions that have to get asked. In the sense the OECD does not give you a checklist where you can just write it down and follow a flow chart and get to a credit rating. And you can very easily see countries taking completely opposite fuse on what it actually means. And to David's point, this is not something where every country is on a level playing field in terms of whether they like low credit ratings or high credit ratings. There're countries that tend to be net exporters of debt.
David Farhat (18:55):
And Bram, let's talk about this a little bit in the controversy arena, where we've seen how exam teams have interpreted the U.S. rules, and if we see any of the OECD rules having influence on some of the folks in the U.S.
Bram Isgur (19:11):
Oh, that's a great point. Actually we've seen a lot of cases, exam teams actually referring to the OECD guidance as interpretive of how it works in the U.S. which is certainly an arguable position. But of course, the U.S. doesn't have any explicit rules about this anywhere. So to some extent, it makes sense that it's getting looked at, at least for ITS. And of course you'll often see very aggressive positions being taken about what implicit support means anything. You see a lot of cases where one side is saying, "I don't think you're even supposed to consider implicit support. And if it exists, I think it's effect is almost zero." And the other side is saying, "I think that implicit support is so strong that your subsidiaries should be rated the same as the group parent. And there should be no difference." And that's a pretty wide gulf and it can be a gulf that's hundreds of millions of dollars of tax. Thus, it's a very thorny controversy issue.
Eman Cuyler (20:07):
For multinationals that have operations in the U.S., would you recommend that they do look to the OECD guidance since that's pretty much what they have right now?
Bram Isgur (20:16):
Well, generally speaking the recommendation I would have is not necessarily look at the OECD guidance because we're in the U.S., we don't necessarily have to follow OECD rules if U.S. rules conflict. I would say that it's a good idea to keep in mind what the controversy is, what your risk is and what your strategy is. Well, if I do go to MAP between my lender country and the U.S. to resolve this problem, what rule set do I think I'm under? In a lot of cases, it's going to wind up referring to the OECD guidelines in that case. And then you want to think about, well, what's my position under the OECD guidelines? And do I think it's different than where I am under my interpretation of U.S. law?
David Farhat (20:57):
And to that point, I think this issue is a nice one for MAP and APA and competent authority, because you talk about competing interest, you talk about the different interpretations. And I think as taxpayers, whatever you put on your return in this situation, you have some risk. Is it going to be U.S. risk? Is it going to be European, Asian risk? So on and so forth. And to your point, you have to decide, okay, where do I want my risk to sit? And do I want to think about something like competent authority and APA where I can try to eliminate as much of this risk as possible going forward? Because very intelligent people will disagree as to what the right answer is, because we have such a big can of worms. And you can't make everyone happy, so going in and hashing that out with the governments may be a good way to go.
David Farhat (21:46):
We talked about the safe harbor in the U.S. and the U.S. rules have a safe harbor. The OECD doesn't, and I think we can talk about some of the reasons why you don't have a safe harbor in the OECD. But Nate, if I could kick it over to you to talk about some of your views on what the safe harbor could possibly do or could possibly accomplish, and then we can have a back and forth up there.
Nate Carden (22:09):
Sure. For those that may not play in this space as much, that if you look in the section 482 regulations, you'll see a safe harbor that is essentially saying that if you're not in the business of making loans, and particularly in a more complicated world where people are providing customer with financing and where alternative ways of aging in commerce are becoming increasingly common, I'd suggest pausing on that question for a second, rather than just saying, as sometimes may have been practiced a little while ago. I'm not a bank, I'm not in business of making loans. Think about that question for a minute, but once you get past it, there's then the ability to use the applicable federal rate as it's called, which is this series of interest rates that's thrown out by the government once a month. And you can pick a point between a 100 and 130% of that.
Nate Carden (23:04):
And if that's the rate you charge, then simplifying a little bit, you're good to go. And I would say that for U.S. multinationals in particular, can be pretty interesting because one of the things that I think we should think about is, how do you keep this exercise from just consuming your entire day, if you are working in a company out there? Right. We're talking about what your arm’s length cash flows are, how important is the sub? What's the arm’s length theory? How do I price the implicit support versus the explicit support? My German sub just needs money to make payroll. And one of the real powers of the safe harbor is that it provides you with a way to do that, but I will say, I think people need to really pay close attention to when they're using the safe harbor, whether it applies and also thinking about what the implications of using the safe harbor are going to be on the other side of the transaction.
David Farhat (24:01):
Question I had, even talking about the can of worms, because I think this makes it a bit more acute. What happens to things like explicit guarantees? How do we deal with all of those things? Right. It changes the dynamics of how we operate, because if we're using a cost allocation, and even if we're looking at just implicit support, how do you... I guess it goes back to my original question about quantifying some of this benefit, what's the difference between implicit support and explicit support? What's the Delta there? How do I price that? If I have to look at implicit support, if I have an explicit guarantee to related party, is that almost invalid? Do I have to now knock that down a bit from a pricing perspective? What does it mean if I am a taxpayer and I'm just trying to do the right thing?
Bram Isgur (24:54):
Well, the general approach that gets taken for a lot of intercompany loans and guarantees, in particular as it relates to looking at what you're asking about is, you follow the logic of, well, I have a subsidiary that's borrowing from a third party and it's borrowing with an explicit guarantee and it's paying say 4% interest. And I think that if it didn't have that explicit guarantee, it would be paying 7%. So I look at the transfer pricing construct, and I say, well, there's a benefit being received by this subsidiary. And the benefit is it saves 3% interest. So whatever I pay, it needs to make sense relative to the benefit being 3% savings. And you can argue about what exactly that means, whether it means that you should pay all of the 3% or most of the 3% or half of the 3%. But broadly speaking, that concept will make sense to most transfer pricing people.
Bram Isgur (25:49):
And with respect to implicit support, I think where it comes in is that without the guarantee, it would've borrowed at 7% line. If I think that that's with no guarantee at all, meaning no implicit support, then I basically need to carve out a portion of that benefit and say, I already got this from the implicit support that is free, and I can only charge the benefit of a explicit guarantee above and beyond what an implicit guarantee would've given me. Now, again, is that right? And is that the true meaning of arm’s length? I'm not really sure, but that is what the OECD tells us to do. And indeed, that was one of the first and most well known cases about this was exactly that issue in Canada. gN, that was the conclusion that they came to is to back out the implicit support.
Bram Isgur (26:45):
On which note, one of the things that's interesting about that case is that if you look at what exactly got decided. They did decide in favor of the taxpayer, but the way that the court got there, they very clearly disavow the idea that they're telling you in general, how to assess implicit support beyond saying that you need to account for it, that's worth something, but probably not everything. It's really very specific to this particular company, what we're saying. And even at the point of saying, "Well, we think that they saved 2% interest and they were paying less than that as the guarantee fee. And we think that that's okay." They didn't even tell you how to split it. They just said that what was getting paid seemed all right. And this is where you're going to get into a lot of trouble, because I would think that if you took 20 multinationals and you did a really thorough, careful assessment of the sort that Nate made the point, no one has time to do every day. You'd probably get 20 very different answers about how valuable implicit support is.
Nate Carden (27:44):
So what about asking your bank?
Bram Isgur (27:49):
That's another really good question. And that's also somewhere that a lot of people have gone. And one of the things that's interesting about that is that there's a history of people asking their bank questions like that, and also asking their bank questions like, "What would you lend me money at without a guarantee?" And showing it to tax authorities and tax authorities saying, basically, I don't trust this. Your bank has an ongoing business relationship with you. So they told you what you wanted to hear, and I'm going to throw it out. I'd rather get an opinion from an advisor, I guess.
David Farhat (28:23):
Who doesn't have an ongoing business relationship with you?
Bram Isgur (28:26):
Right. What I'll say is that's not necessarily true. I think in reality, the answer is it depends on the bank and who you asked. But certainly there are some people who work for banks and give opinions like this that are fair and neutral and probably a very good measure. But part of the issue is tax authorities just don't seem to trust them. And the OECD even put in the OECD guidelines that in general, they don't think these types of bank quotes are good evidence. And with all of that said, the one issue in particular, this implicit support, there is a fair question of how much does a bank word about what they would lend to unguaranteed subsidiary mean if in reality, the bank just doesn't lend to unguaranteed subsidiaries in this circumstance? Which also brings up the question of what do we even mean arm’s length in a context like that, where no third party does it?
Stefane Victor (29:20):
What are some practical tips that you have for companies who can't rely on a bank's word in the absence of a safe harbor, have to make very subjective calls that might be held to extremely high scrutiny?
Bram Isgur (29:35):
A couple pieces of advice. So the first one is what not to do. And what often happens for exactly the reasons Nate was saying, I've got to make payroll in Germany, I don't have time for this. Is you wind up with a little bit of a patchwork and you have loans floating willy-nilly around your multinational. And in particularly you often have these subjective judgment calls getting made willy-nilly. So it is truth that different countries can have different rules and different precedent. But a lot of the time what's going to turn on, especially under the new OECD rules is your answer to subjective questions about how important a particular type of company is to your group. And so one thing you can do to help yourself is make sure that you're at least answering those subjective judgment calls consistently throughout the world.
Bram Isgur (30:21):
So for example, it's probably not a great idea to be taking the position that you have no halo effect with any of your subsidiaries in one country, and that you have a total halo effect in another country, unless you're very clearly pointing to a difference in their law, that lets you come to a different conclusion. Similarly, I think you can actually do yourself a lot of favors by trying to be systematic and consistent about how you actually approach benchmarking loans and benchmarking guarantees worldwide, rather than treating everything as a one off exercise. And some of these depends on the needs of your multinational. If you only make one or two intercompany loans every year, maybe it's okay to just think about how you want to come down on these implicit support questions and do them. But if you're making dozens every year, maybe you should think about having a more general policy about how you're going to set that right, so that you can do it systematically.
Bram Isgur (31:15):
The other thing I would say is just in terms of common foot faults for multinationals is just poor documentation. So I think we've all seen lots of examples where when you start asking, "Can I see the loan agreement for that?" You don't get answers that leave you feeling very comforted about what the controversy position is going to end up being. And in particular, where you do have agreements, please try to follow them. If you're supposed to pay interest, please actually pay interest. And if it says you're going to do something, actually do it. Similarly, if your loan says that it can be repaid by the borrower any time, the OECD action now tells you, you need to pay attention when a third party pay this back early and refinance it at better rate if the market moves. So just keeping track of what you have, being consistent about it, being systematic to an extent about following consistent policies and about how you document and track everything, will get you all the way there.
Bram Isgur (32:11):
That said, there's going to be some cases where what's happening is I'm loaning $40 billion across a jurisdictional border, and I need to take a position and someone's going to be upset with me either way, what do I do? And that's where I would say, talk to someone like David about controversy preparedness, because you cannot make everyone happy under these rules. You have to be prepared to deal with it.
David Farhat (32:34):
And going down that road a little bit, Bram, we've done some of this and had some fun conversations with different competent authorities in different jurisdictions. Can you give us some of the pressure points? What they look at, what makes them unhappy? What makes them happy? What are the things we want to bring to the table, if we're going to say we're going to use a controversy avoiding strategy and do an APA or some other kind of agreement?
Bram Isgur (32:59):
Sure. Well, generally my experience what tax authorities like is money coming into their country and what they don't like is money leaving their country. But with that aside, the first thing that I think is helpful to keep in mind is it's a good idea to understand what the boundaries of the positions you could be taking are. With loans in particular, and with guarantees, one of the places where you really often see a tough issue is with investment grade versus high yield funding. And that's the place to be really aware of when you're talking to a tax authority, especially if you're thinking about taking something into controversy. If you're close to that border and you're taking a position on one or the other, that's where you're going to have a lot of the focal point of the controversy. And then the other thing really is at least in my experience, tax authorities tend to just not be very impressed with analysis that's disconnected from the way you really run your business.
David Farhat (33:58):
Can you contrast the competent authority reaction to the exam reaction? Understanding your original point about countries don't like to see money going out, but coming in and in the exam space, you have that bag of money that you're actually debating over. But I think some of the frustrations taxpayers have is, look, these folks don't get my business. They don't get the issue. I feel like I'm teaching a course to my exam team, right. And that can happen from jurisdiction to jurisdiction, and some jurisdictions are more sophisticated than others. But can you contrast, what am I looking at if I'm going to competent authority? What kind of things do I have to keep at the top of mind? And what is it when I'm going to exam? And are they some of the same things?
Bram Isgur (34:44):
I would say that to some extent they are some of the same things. And I think the difference is that when you're talking to exam, a lot of the time an exam team is going to just take an extreme position on one side or the other, that's just the reality of how things work. So in a lot of cases, if you're dealing with a passive association issue and you're dealing with an exam team on inbound funding, their position is just going to be, we think that there's a 100% passive association and that your group rating is what we should be referring to. And, they're just going to be very unwilling to budge away from that. And if you're dealing with competent authorities, really, it's that there's somebody on the other side. And so there's going to be less appetite for an extreme position.
Bram Isgur (35:25):
Now, I think that cuts both ways. A lot of taxpayers are going to take a position that there's zero passive association, and that might be harder to sustain in a common authority negotiation. Should it have been floating or fixed? What's the credit rating? Should we have included this income source or that income source? And a bunch of accounting questions and then, oh, by the way, there's passive association and we think none of it matters. So you can at least save yourself a lot of trouble, if you can distill it down to the core issue. Present something reasonable and hope that you can get the common authorities to talk about it sensibly and fairly and reach a position that everyone is equally unhappy with.
David Farhat (36:07):
I appreciate the comments. I think we've gone through this quite a bit. Before we wrap, of course, any other questions, comments?
Nate Carden (36:16):
None for me. I just want to thank Bram.
David Farhat (36:18):
Nate Carden (36:18):
This can be viewed as a very narrow topic and in some ways it is, right. This topic only applies to companies that use money in some way. So it may or may not be relevant to you.
Bram Isgur (36:33):
Thank you for having me. It's been a very interesting conversation.
David Farhat (36:37):
Indeed, Bram. Thanks for come and we hope to have you for a few more of these conversations, not just about this issue, but other issues where we need someone who does more of the quantitative stuff than we do. But thanks so much, I hope you guys enjoyed this and we'll talk to you again soon.
Thank you for joining us for today's episode of GILTI Conscience. If you like what you're hearing, be sure to subscribe in your favorite podcast app so you don't miss any future conversations. Skadden's tax team is recognized globally for providing clients with creative and innovative solutions to their most pressing transactional planning and controversy challenges. Additional information about Skadden can be found at skadden.com.