India: LIBOR Reform – Practical aspects of Transfer Pricing implication due to discontinuance of LIBOR

London Interbank Offered Rate (LIBOR) is a global interest rate that has been widely used to price the financial transactions mainly debt, loans, derivatives, swaps, etc. since more than 40 years across various jurisdictions.

Due to evidence of manipulation and other issues over the past decade, USD LIBOR is being discontinued all across the USA with other countries following the suit gradually. Hence, there has been no fresh issuance of LIBOR denominated instruments lately.

Considering the scope of the impact, all the enterprises engaged in financial transactions shall take the final step for this transition with a comprehensive strategy adopting Alternative Reference Rates (ARRs). Accordingly, global enterprises involved in the affected transactions would resort to renegotiate the contractual terms with their counterparties to transit the LIBOR to an ARR.

The various ARRs available for such renegotiation of contractual terms such as:

• Secured Overnight Financing Rate (SOFR): SOFR is administered by Federal Reserve Bank of New York which is selected by US to replace USD LIBOR.

• Reformed Sterling Overnight Index Average(SONIA): SONIA is administered by Bank of England which is selected by UK to replace GBP LIBOR.

• Euro Short Term Rate (€STR): €STR is administered by European Central Bank which is selected by Europe to replace EUR LIBOR.

• Swiss Average Rate Overnight (SARON): SARON is administered by SIX Swiss Exchange which is selected by Switzerland to replace CHF LIBOR.

• Tokyo Overnight Average Rate (TONA): TONA is administered by Bank of Japan which is selected by Japan to replace JPY LIBOR.

Transfer Pricing Implications:

Multinational Enterprises (MNEs) also enter into intragroup contractual financial transactions. These types of arrangements are squarely covered under Transfer Pricing regulations. As businesses are in the process of adapting their external financial arrangements to a world without LIBOR, they should also consider the potential impact this fundamental change could have on the arm’s length nature of their intercompany financial transactions. After the discontinuance of LIBOR, the MNEs should ensure that all existing intercompany financing arrangements tied to LIBOR must be successfully amended in such a way that it meets the arm’s length principles using appropriate ARR.

Practical Challenges in Implication of ARR:

Appropriate benchmarking of Intragroup financing transactions has always been a contentious issue of debate across the globe. It would be, now, more difficult to determine appropriate ARR for benchmarking such transaction in line with the arm’s length principle.

The first thing companies should do is find the agreements they have with other group entities tied with LIBOR. Once they know which agreements are affected, they need to come up with a plan to change the pricing of those arrangements.

However, the road to transition does not look so easy as it would be challenging to determine appropriate spreads to be applied to ARRs as the determination of such spreads depends upon numerous factors namely denomination in currencies, maturities embedded credit risk, credit rating of each enterprise of MNEs, etc. It would be more difficult to make appropriate adjustments for the difference in contractual terms in order to align uncontrolled and controlled financial transactions.

Not only the taxpayers, the tax authorities across the various tax jurisdictions used to rely on LIBOR to benchmark the intragroup financial transactions. Now, it will be more challenging for such economies to arrive at appropriate ARR and adjust it with the appropriate spreads on account of the contractual and timing differences.

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Reference/ Citation

https://www.pwc.com/gx/en/industries/financialservices/publications/libor-reference-rate-reform.html