A highly important issue for corporations is the price they charge subsidiaries for intercompany financial transactions, such as loans and leases. This is especially critical for large global companies that have many subsidiaries operating in different countries around the world.

The OECD Transfer Pricing Guidance ("OECD Guidance") provides advice on the application of the arm’s length principle that must be used for intercompany transactions, which requires two related companies to set the same transfer price as if bargaining in a competitive market. There has been increased scrutiny in the transfer pricing arena regarding these transactions as governments look to ensure that the taxable profits of corporations are not artificially shifted out of their jurisdictions. Failure to comply with the rules can have a substantial financial and reputational impact.

This large international logistics company has a complicated corporate structure with many subsidiaries. The treasury group is responsible for pricing hundreds of intercompany loans, guarantees and leases and wanted to enhance its transfer pricing methodology given the large volume of activity and the heightened regulatory focus.  

Pain Points

Members of the treasury group needed an efficient and defensible way to price the large volume of intercompany loans, guarantees and leases to meet OECD Guidance and minimize tax risks. They wanted to find a more automated process that would help:

• Determine how an entity is perceived in the open market from a creditworthiness perspective.
• Consider economic conditions at a country and industry level and evaluate comparables.
• Assess both quantitative and qualitative factors underlying credit ratings to determine the influence of non-financial factors, such as the degree of diversification or strength of the management team.
• Evaluate the strength of the parent company and its impact.
• Construct a yield curve and identify appropriate interest rates and guarantee fees.
• Monitor companies on an ongoing basis.

The Solution

Specialists from Market Intelligence discussed Credit Risk Pricing, a robust solution to assist with transfer pricing workflows available as part of the Credit Analytics suite of models on the S&P Capital IQ platform. The end-to-end solution supports tax authorities, auditors, tax advisors and corporations globally with their arm’s length assessment of intercompany financial transactions.

The integrated, step-by-step approach lets users easily assess a company's creditworthiness, create a stand-alone credit score[1] and find comparable yields and a defensible interest rate in a manner that aligns with the OECD Guidance. This would enable the treasury group to:

	Obtain financial data	Users can access financial data for millions of companies or use their own financials in conjunction with Market Intelligence models to generate issuer and issue credit risk assessments. S&P Capital IQ Financials Dataset provides standardized data for 5K+ financial, supplemental and industry-specific data items for 150K+ companies globally, including 95K+ active and inactive companies across multiple industries.[2] Data is available at numerous frequencies and point-in-time representations of a financial period include press releases, original filings and restatements. The Private Company Financials Dataset provides 200+ standardized financial statement items for 12M+ private companies globally, plus 52M+ company profiles.
	Add qualitative insights	Adjustments and Overlays enable users to incorporate qualitative insights, parental support, macroeconomic stress and Loss Given Default (LGD) factors to help achieve compliance with OECD guidelines.
	Determine appropriate interest rates or guarantee fees	The solution provides an intuitive calculation for interest rates or guarantee fees and enables users to drill into the yield curve construction and credit risk components to understand how the final values for the intercompany obligations were calculated.
	Monitor companies on an ongoing basis	A credit risk dashboard lets users monitor a portfolio of companies and generate alerts according to their preferences. An export function downloads a report in PDF format.
	Receive training and ongoing support	Market Intelligence specialists are located around the world and are available for training sessions and to provide ongoing support as clients utilize different solutions and the S&P Capital IQ platform.

How Credit Risk Pricing works – a four-step process:

Step 1: Input financial data for the subsidiary or affiliate.

The analysis starts by leveraging Market Intelligence’s comprehensive database of company financials to automatically create company credit scores in the credit scoring interface. Alternatively, users can manually input their own proprietary financials. This section of the interface also provides risk factors by country and industry to capture any country-industry combination being analyzed. These inputs can be adjusted if users have an alternative perspective.

Step 2: Input additional information as desired.

Four areas are considered that can positively or negatively impact the credit score:

Qualitative Factors: The OECD Guidelines suggests adding qualitative information, where available. For example, this could include how diversified a subsidiary is by country/product line/customer base or the quality of its management.

Implicit Parental Support & Loan Level Assessment (PGS): The OECD Guidelines acknowledges that PGS can affect the creditworthiness of the borrower, and this feature factors in the financial health of the parent company.

LGD: The OECD Guidelines states that when both an issuer and issue rating[3] are available, the issue rating is more appropriate to price the transaction. This can require looking at the LGD for the issuance and factoring that into the credit score. The solution features the LossStats approach, which returns loss and recovery estimates for companies’ debt obligations globally. It considers the seniority structure (i.e., senior secured, unsecured, subordinated loans or the actual capital structure characteristic), including potential collateralizations and industry riskiness, which are factored into an LGD-adjusted credit score.

Macroeconomic Factors: The solution provides current data on a wide range of economic factors, and a stress-testing capability offers the opportunity to look at a range of situations to see how a positive or negative environment could impact credit risk.

Step 3: Click to generate a transparent credit score assessment.

Once the financials and optional adjustments have been entered, users simply click to generate a probability of default in percentage terms and the associated letter grade credit score, which are generated using Market Intelligence’s Credit Analytics models. In addition, if information mentioned in Step 2 is entered, users will receive an LGD-adjusted credit score along with macroeconomic impacted values for the subsidiary or affiliate.

Note: There is a clear separation of credit risk at each stage (i.e., standalone, PGS support, sovereign capping and issue-level assessment), which is important and an advantage of the tool.

Step 4: Construct a yield curve and produce the final interest rate.

Use the final credit risk score to calculate the All-in Yield, Z-Spread, and their respective curves, leveraging on the GSAC Bond Sector Curve Pricing Data (Government, Supranational, Agency and Corporate). A proven methodology that includes an extensive coverage across 14 sectors, 18 different tenors, and bonds denominated on 17 different currencies, in North America, Europe and Asia Pacific regions.

Further customization is achieved with the help of the Screening tool that allows to search for selected bond characteristics and build the respective curves which will include full transparency of their constituent instruments. Interest charges or guarantee fees can then be determined by utilizing a transparent methodology for affiliates across sectors and geographies, and benchmark this against publicly available data for other borrowers with the same credit rating for loans with sufficiently similar terms and conditions.

Step 5: Documentation and Reporting

The Credit Risk Pricing solution facilitates the three-tiered approach to transfer pricing documentation, supporting master file, local file and country-by-country reporting by leveraging Market Intelligence data and analytical capabilities. Deliverables include:

• A master file with global information about a multinational corporation group, including specific information on intangibles and financial activities that can be made available to all relevant country tax administrations.
• A local file with detailed information on all relevant material intercompany transactions of the particular group entity in each country.
• A country-by-country report of income, earnings, taxes paid and certain measures of economic activity.

Key Benefits

Members of the treasury group realized that this comprehensive step-by-step approach would enable them to efficiently determine transfer prices that would meet the arm's length rule. They also realized that many tax authorities use the Credit Risk Pricing solution, which would make it easier to defend the results. They are now active users and are benefiting from having access to:      

• An integrated, step-by-step approach to assess transfer prices that follows the OECD Guidelines.
• A transparent credit score assessment that generates scores that broadly align with credit ratings from S&P Global Ratings that can stand up to close review by tax authorities.
• A screening tool to identify comparable companies, and a Plug-in to dynamically pull a comparable company’s full P&Ls into Excel to calculate profit level indicators and inner quartile ranges.
• A proven methodology to identify interest charges or guarantee fees for affiliates across sectors and geographies, and benchmark these against publicly available data for other borrowers with the same credit rating for loans, guarantees and leases with sufficiently similar terms and conditions.
• Detailed User Guides and Technical Documentation to fully understand the data and methodologies used for the calculations.
• Unrivalled training sessions and 24x7 support to meet the needs of the treasury group across multiple locations.

Click here to explore our transfer pricing solutions in more detail.