The Need for the Assessment of Related Party Loans under the Transfer Pricing Regulations

November 14, 2023

What is the market interest rate to be agreed in financing among member companies of the same Multinational Economic Group? What factors should be considered within the scope of the Transfer Pricing regulations?

This post aims to broadly answer these questions faced by member companies of the same Multinational Economic Group due to liquidity needs for working capital or other objectives the Group may establish as part of its policies.

The Arm’s Length Principle, on which the Transfer Pricing regulation is based, establishes that all transactions must be at market values or prices similar to independent companies in their commercial relationships.

According to this principle, establishing the market interest rate for financing among related companies may be more complex than the mere evaluation of the debtor’s risk, the currency, the amount of the principal, and the agreed deadline.

Given that Multinational Economic Groups can decide on the conditions of the loans to be agreed upon, they must be aware of the tax consequences, some of which are framed within the international Transfer Pricing regulations.

Currently, tax administrations focus on tax audits related to intercompany financings especially. Consequently, the authorities adjust the agreed interests and even tend to reclassify transactions recorded as capital contributions to loan accounts, depending on the context of the transaction and analyzing both lenders and borrowers. The result of the audits are adjustments to the taxable base, requesting from the parties involved the due recognition of taxes for those transactions that resulted in tax loss, if applicable. Depending on the materiality of the transactions, it could not only affect the liquidity of the companies but also turn into long and expensive litigations for the Multinational Economic Group.

Dealing with financing within the Transfer Pricing regulations means answering the following questions: Under normal market conditions. How much is the maximum amount that a third party would be willing to lend if the borrower cannot pay, or could be close to merging, or is located in a country with unstable political rules or the industry in which it operates is highly regulated? How much is the rate to be agreed, considering these risks? Can the rate agreed among related parties take the parent companies or companies with greater financial stability as implicit guarantors, among others?

Answering these questions implies performing an adequate functional analysis to identify the functions performed, assets used, and risks assumed by the parties involved in the controlled transaction.1

As the OECD illustrates in the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022 (Section B.3.2. – Functional analysis), it may occur that company A, lender of the disbursement, does not control the funds granted, but rather does the parent company P, which has the financial capacity to assume them, so the company A would only have a right to a risk-free yield.

On the other hand, belonging to an economic group also entails the transfer of a potential implicit risk of the group due to the level of subordination of the company, which implies an evaluation of the credit rating of the company and the group it belongs to.

This kind of evaluation requires documentation and technical reports supporting that the loan transactions among related companies have been agreed upon in compliance with the Arm’s Length Principle. These studies and documents will have to be carried out periodically for each loan transaction among the different companies of the group.


Regarding the points addressed herein, companies should include the following measures in their policies or procedures:

  • Quarterly monitoring of loan accounts granted/received with related parties.
  • Detailed contract on the conditions of the financing granted, specifying the market rate, deadline, currency, and guarantees (if applicable), among others.
  • The contractual terms and conditions should provide detailed information consistent with the actual proceeding of the parties involved or other facts and circumstances.
  • Specialized external advice on market interest rates to be considered, which will depend on the type of financing.
  • Monitoring of tax projections prior to the closing of the accounting year to provide for the calculation of estimated interest for direct tax recognition in the income tax return, if necessary.
  • Functional analysis to identify the functions, assets, and risks associated with the controlled transaction.
  • Establishment of intra-group financing policies and identification of the companies performing the centralizing function of these financings.