How to manage financial transactions – transfer pricing aspects in Poland

The economic situation in the global markets as well as the increase of banking reference rates, higher inflation rate could influence the conditions of intragroup financial transactions.

In the current economic situation, the importance of intragroup financial transactions has been growing. More and more companies are making nowadays decisions to borrow a loan from a related party instead of financing from an external financial institution. This approach is triggered by lower creditworthiness of the lenders or less active activity of the banks. This approach was confirmed in report prepared by the National Bank of Poland entitled “Credit Market Situation.” In Q4 2022 an increase was reported  in the margin for higher-risk loans and a decline in demand for long-term loans to entrepreneurs. One of the reasons for the decline in demand for long-term loans is the increase of intragroup financing for companies from their own resources.

Intragroup financial transactions

It is worth to remember that from the transfer pricing perspective, intragroup financial transactions cover not only loans. Group financing can also take place in the form of issuing of bonds, providing a deposit, or participating in a cash-pooling system. Financial transactions also include group guarantees or insurance services, factoring services, hedging services and other currency transactions.

Intragroup financial transactions often bring benefits to related parties, for example, in the form of obtaining additional financing, which can be used to conduct investments or to develop the business activities. By receiving a group guarantee, the company can achieve the bank financing or improve the terms of bank financing. In addition, receiving a guarantee can be a requirement for entering a tender or contract. Whereas, participation in a cash pooling system allows the day-to-day management of funds in capital groups. The entity engaged in management of the cash pooling structure allocates the financial surpluses to those entities that have cash shortages.

The attractiveness of intragroup financial transactions is also confirmed by published statistics of the Polish Ministry of Finance. About 43% of all reported intra group transactions for FY 2019 in the TP-R declaration (a dedicated tax return for transfer pricing purposes in Poland) referred to financial transactions. Moreover, in practice we observed that the values of intragroup financial transactions in terms of the value of loans capital, are high, therefore the value of potential reassessment of the value of interest could have a material impact on the settlements of the companies.

Benchmarking analysis based on reliable data is crucial

An important factor affecting the valuation of financial transactions with related parties is the dynamically changing economic environment in which related parties operate. In this respect from transfer pricing regulations perspective it is crucial to defend the arm’ s length level of interest rate by possessing a valid, reliable, high-quality benchmarking analysis for financial transactions.

In order to confirm the arm’s length level of interest rate it is not sufficient to possess any analysis. For example in the judgment of the Polish Supreme Administrative Court of June 29, 2022 (ref. no II FSK 3050/19), it was indicated that a valuable benchmarking analysis should be carried out based on the element of comparability analysis indicated in the Polish transfer pricing regulations.

The comparability study for financial transactions should include especially:

1. the period under review,
2. description of the related parties and the economic environment,
3. analysis of functions, assets, risks, and selection of the tested party (if any),
4. internal comparability analysis (if possible to be applied),
5. in case of lack of internal comparables identification of available external comparables,
6. selection of the most appropriate method and financial indicator for the application of the selected TP method,
7. analysis of available comparative data,
8. comparability adjustments,
9. calculation of the financial results.

In the opinion of the Supreme Administrative Court, the benchmarking analysis for loans presented by the tax office did not cover the obligatory elements of comparability study specified by Polish transfer pricing regulations. The substance of the tax office’s analysis was limited to a brief description of the company, a description of the loans and queries to the banks, which included interest rates and commission rates for loans granted to commercial companies. In this manner the identification and verification of comparable terms and conditions established by independent entities, including the currency of the loan, the amount of financing, the purpose of the financing, the term of the loan, the presence of collateral, the type of interest rate applied and the amount of the bank commission was carried out.

The Supreme Administrative Court pointed out that in the presented benchmarking analysis, the authority did not analyse the loan transactions comprehensively. The analysis covered only the loans themselves without taking into account that the purpose of the loan (financing of a specific investment). As a result, the analysis did not cover all the relevant comparability factors, including the assets and risks incurred within the transaction. The tax authority in its enquiries to the banks did not include significant information about the company, i.e. its credit rating, the market in which it operates and the types of collateral used, which was not applied in the pricing received.

The Polish Supreme Administrative Court is not the only one to question the appropriateness of using of bank offers to prepare benchmarking analyses. In the newest version of OECD guidelines it is indicated that bank bids should not be used as comparative data, because these data must reflect the conditions under which unrelated parties enter into transactions. Bank bids do not meet this requirement, because they do not reflect the conditions of actual transactions, due to the fact that they may be on a later stage the subject of negotiations. Furthermore, before granting a loan, the bank conducts a relevant credit rating analysis, which precedes the formal loan offer. Therefore, such bank bids are generally not considered as evidence to confirm the arm’s length level of interest rates in the financial transactions.

Therefore, possession of high quality benchmarking analysis for financial transactions reduces the possibility of its questioning by tax authorities during an inspection. It also limits the possibility of a potential reassessment of income. It should also be emphasized, that if a taxpayer has a benchmarking analysis, tax authority must question it before preparing its own analysis. Therefore, the higher the quality of the benchmarking study possessed, the more difficult it will be for the tax authority to question it.

Impact of macroeconomic factors

According to Polish transfer pricing regulations, the benchmarking analysis prepared for financial transactions should be updated at least every 3 years, unless a change in the economic environment significantly affects the prepared analysis and justifies a more frequent update of the benchmarking analysis.

The current economic situation in the borrower’s country or in its industry can directly affect the level of remuneration in financial transactions carried out between related parties. In recent years dynamic changes in the economic situation caused by, among others, the COVID-19 pandemic, high inflation, changes in interest rates and the war in Ukraine should have affected the conducted analyses. Among the factors that are important to analyse for financial transactions are for example: credit rating, type of interest rate, currency and the impact of the group support. In this regard, it is important to consider whether the benchmarking analysis for financial transactions prepared a year or 2 years ago will still be relevant in view of the market changes since 2021.

In order to determine if an update of the benchmarking analysis is required, each financial transaction should be analysed individually. One of the key factors, that should be verified is the borrower’s credit rating. If it changes, a benchmarking analysis update should be considered.

As a good practice, it is recommended to review annually whether market factors or intra-group changes in arrangements have affected the remuneration applied in financial transactions. Based on such an analysis, it could be concluded whether an update of the benchmarking analysis is necessary. The above approach to the verification of the arm’s length nature of the transfer price was also confirmed by the individual interpretation issued on 24 March 2021 by the Polish Director of National Fiscal Information (ref. 0111-KDIB2-1.4010.395.2020.2.AR). Doubts raised by the taxpayer concerned whether the interest rate should be adjusted, in the event that the adopted interest rate level (determined at the time of concluding loan agreements) in loan transactions concluded historically, deviates from the results of the updated benchmarking analysis, i.e. is outside the interquartile range. The Polish Director of the National Fiscal Information indicated that it is the taxpayer’s responsibility to monitor the terms and conditions of the transactions on an ongoing basis and to adjust them if unrelated parties would do so. Moreover, if the interest rate terms of a previously granted loan were market-based (ex ante), but became non-market-based due to, for example, a significant changes of circumstances (e.g. exchange rate’s fluctuations, interest rate changes), the parties should adjust the transfer prices to a level consistent with the arm’s length principle, resulting from an updated benchmarking exercise.

In conclusion, the changing economic situation and the tightening credit policies of banks towards companies result in changes to the terms and conditions of financing provided between unrelated parties. Therefore, the interest rate levels in financing transactions conducted between related parties should also be updated to reflect the market conditions. Accordingly, the taxpayer should verify whether ongoing market changes affect the terms of financial transactions conducted with related parties. If so, it is important to adjust the terms of this transactions to the market conditions. Moreover, the changing economic environment may force the taxpayer to conduct a new benchmarking analysis taking into account the changing terms and conditions. This is due to the fact, that it is the taxpayer’s responsibility to conduct financial transactions with related parties on the terms that unrelated parties would have agreed. Therefore, the best solution is to regularly analyse the terms and conditions of financial transactions concluded in the market and, if necessary, adapt them to the terms and conditions in transactions between related parties.