Tax authority’s comment on related-party loan calculation makes U-turn
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Although it has been almost a year since the new transfer pricing (TP) rules came into force, no official comment is publicly available on the value of a loan transaction for TP purposes. PwC asked the State Revenue Service (SRS) to comment on how the value of a loan transaction with a related party should be measured. This article explores a theoretical opinion we received from the SRS on how to correctly calculate this value for various types of loan transactions made in the financial year.
This question is crucial where a taxpayer’s obligation to prepare and file a specified form of TP documentation with the SRS mainly depends on how the loan transaction value is interpreted.
References to statutory interpretations of loan transactions
Section 15.2 of the Taxes and Duties Act does not lay down different criteria for measuring the amount or total value of a taxpayer’s controlled transactions with related parties that vary according to the subject matter of the transaction.
According to the SRS, in applying subsections 3, 4, 7, 8, 9 and 11 of section 15.2 of the Taxes and Duties Act, the amount or total value of a controlled loan transaction means the sum of the loan principal and accrued interest for the financial period:
The SRS explains that to measure the value of a loan transaction, we should look at the combined definition of this transaction in the relevant pieces of Latvian legislation, i.e. the Corporate Income Tax (CIT) Act, the Taxes and Duties Act, and the Civil Code:
The SRS also invokes the Cabinet of Ministers’ Regulation No. 677, so in measuring the arm’s length price of a loan transaction we should consider not only interest payments but also the amount of money lent, a factor that drives the price of the transaction. Thus, the agreed interest payments alone do not determine whether a loan should be made and what rate should be applied.
Loan principal for a prolonged transaction to be included in the financial year
As we already have a clear and reasonable SRS opinion that the value of a loan transaction comprises not only the accrued interest in the financial year but also the loan principal, this raises a more important question of how to correctly measure the loan principal for financial transactions taking place in multiple financial years, assuming that –
the contract entered into before the financial year has been wholly or partly performed in the financial year; or
an agreed amount of credit line was granted in the previous financial year and its use varies over the financial year.
Although the SRS has yet to issue a written opinion on this matter, in our communication with them we have learned that regardless of the form of a loan transaction, the loan principal is the amount agreed between the parties. In fact, the transaction starts once the contract has been confirmed by both parties (lender and borrower) and a limit has been set on the transaction. A prolonged financial transaction takes place in multiple financial years and is complete when both parties have performed their obligations, i.e. the money has been received and repaid.
In view of this interpretation and our current understanding, we have prepared theoretical examples for measuring the value of various types of loan transactions (long-term and credit line) carried out in the financial year:
a taxpayer received a long-term loan of EUR 8 million in 201X; and
the taxpayer also received a credit line with an agreed credit limit in 201Y.
The table shows the total values of the loan transactions carried out in the financial year:
As we can see, the value of transactions carried out in the financial year actually reflects how the taxpayer’s financial position has changed in their books.
We expect this article to spark a lot of debate, as it signals a radically new approach to how the total value of intragroup controlled financial transactions is measured for TP purposes under section 15.2 of the Taxes and Duties Act and reported on line 6.5.1 of the CIT return for related-party transactions in the financial year.