Intragroup financing & Transfer pricing: the effective maturity, cornerstone of the arm’s length principle

Intragroup financing is commonly used by groups and has become the heart of numerous tax issues today. Among the complex aspects, determining the effective maturity of intragroup loans plays a central?role.

What is the difference between maturity and effective maturity?

On the one hand, maturity refers to the total duration until the expiration of a financial instrument, such as a bond. For instance, if a bond has a maturity of 10 years, this means it is expected to be fully repaid at the end of this period.

On the other hand, effective maturity is often used to describe the actual duration until expiration, taking into account early repayment options. For example, if a loan is contractually set to mature in 5 years but is renewed twice, it would result in an effective maturity of 15 years, culminating in full repayment. This?issue becomes particularly significant for financing initially considered short-term (i.e., with a maximum duration of 12 to 13 months, according to S&P Global Ratings and Moody’s Investors Services) that could ultimately be categorised as medium-term or long-term based on its effective maturity.

Why is effective maturity so strategic?

The effective maturity of intragroup financing plays a decisive role in accurately defining the nature of the operation. As such, the distinction between maturity and effective maturity is crucial for assessing the risks and potential returns of investments.

Loan or equity contribution?

When an intragroup financing has a long maturity together with a lack of effective repayment, it could lead to its reclassification as equity by tax authorities. Such reclassification is supported by Chapter X of the OECD Transfer Pricing Guidelines (2022) for Multinational Enterprises and Tax Administrations (“OECD Guidelines”), emphasising the need to align intragroup financing terms with those of independent parties.

Interest rates and credit risk

The duration of the intragroup financing impacts the calculation of the interest rate. Therefore, an inappropriate maturity would impact the analysis, and the applied rates could be seen as non-compliant with the arm’s length principle.

Market consistency

Independent lenders rarely accept indefinite or unrealistic conditions. Intragroup financing arrangements must, therefore, align with credible market practices based on comprehensive functional and economic analyses to justify the financing terms.

It is also worth noting that the interest rate applied to intragroup financing extends beyond international tax considerations (i.e., transfer pricing analysis). Indeed, in France, the rate applied between related entities also raises the issue of the deductibility of financial expenses, wherein the effective maturity influences economic analysis under Articles 212, I, a, and 39-1, 3° of the French Tax Code (“Code Général des Imp?ts”).

What best practices should be adopted?

Clearly define intragroup financing agreements

Each financing agreement should specify the exact duration, repayment schedules, and renegotiation terms. These elements must reflect conditions comparable to those observed between independent?parties.

Perform functional and economic analyses

Each financing agreement should be accompanied by a functional analysis. This includes a detailed evaluation of the functions performed, assets used, and risks assumed by the parties involved, which helps justify choices related to maturity and interest rates.

Apply the “substance over form” principle when necessary

In line with Chapter X of the OECD Guidelines and the Practical Sheet No. 4 on “Comparability,” published by the French tax authorities in January 2021, the actual behaviour of the parties should be the basis for determining an arm’s length interest rate. Therefore, if the effective maturity of a loan differs from the maturity initially stipulated in the agreement, it is advisable to adjust the rate as soon as possible, and, at least for the current and future financial years, by performing an economic analysis based on the parties’ actual behaviour.

Increasing international requirements

Both the French tax authorities and their foreign counterparts increasingly rely on the OECD Guidelines to closely scrutinise intragroup financing. In France, this has resulted in significantly detailed cases on the matter in 2024 (e.g., Paris Administrative Court of Appeal, 9th Chamber, 17 May 2024, No. 22PA05494, Min. v. Willink SAS, illustrating the importance of the maturity used by the taxpayer for economic analysis).

Furthermore, it is noteworthy that the UK tax authorities have taken a position on the specific case of cash pooling (see HMRC, Internal Manual, INTM503140 and following), recommending an analysis of how an independent treasurer would behave towards a structurally cash-rich borrower, considering their liquidity objectives, security, and expected returns on surplus cash investments. Consequently, structurally, the risk of reclassifying short-term loans as long-term financing is significant in the event of a tax?audit.

Recently, intragroup financing has also been the subject of a ruling by the Court of Justice of the European Union (4 October 2024, Case C-585/22) regarding a cross-border intragroup financing intended to finance the acquisition or increase of a stake in a non-group company that subsequently became part of the group. The judges notably examined whether the loan’s characteristics were adequately analysed to ensure it was made under arm’s length conditions, allowing the deduction of interest paid on the loan.

Indeed, the maturity of intragroup financing is no small detail: it is indeed a fundamental criterion of a robust transfer pricing policy. Thus, by integrating it as a cornerstone of your financial and tax governance, you will enhance compliance and reduce risks during audits.

Focus on the remuneration of the centralising entity in a cash pool

Current tax audit trends highlight the importance of transfer pricing issues in cash pooling operations. As?such, in?addition to the above-mentioned challenges of reclassifying short-term loans as long-term transactions and justifying the applied interest rates, tax authorities also increasingly focus on the remuneration of the centralising entity.

This remuneration must reflect the significance of the functions performed and risks borne by this entity. It?is also crucial to allocate the benefits derived from this intragroup financing among the participating companies.

Although the OECD recognises the importance of this allocation, the OECD Guidelines do not provide specific recommendations on the methodology to adopt, leading to disputes stemming from differing interpretations during a tax audit. It is thus essential to consider this additional complexity, specific to intragroup cash pooling, in advance of any (pre-)litigation scenario.