A recent LinkedIn transfer pricing discussion provided an odd answer to a reasonable question about practitioners’ experiences with Dealscan. An attorney at a Big Four accounting firm wrote:
I would be concerned that these reported prices do not fully reflect an arm’s length price because often times these banks will lend at a lower rate if the loan is tied to other services etc being provided by the banks…my view is that bond data is a more reliable indicator of a yield curve given a credit rating tranche than specific loan transactions. Certainly there are cases where actual loan data may be reliable but I think you have to put a lot of time and effort into make sure the loan data is not a loss leader for other higher priced services charged to the borrower.
Before I note why this reply is misleading, permit me to offer my thoughts on the original question. Many of the loans provided by Dealscan represent floating rate loans in the form of 12-month LIBOR rates plus a margin. Our transfer pricing practice uses this information, but we also used the corporate bond information by Thomson Reuters Eikon. Corporate bonds are often longer-term fixed interest rate loans. We do so in light of the importance of the four key comparability issues – the date of the loan, the currency of denomination, the term of the loan, and in particular the credit rating of the borrower. In July 2015, the Council of Economic Advisers published “Long-Term Interest Rates: A Survey” that noted the global decline in long-term interest rates over the past 30 years. While long-term rates may be low, short-term rates are often much lower. As such, the term structure matters as well as when the intercompany loan was made and its currency of denomination.
In my experience, however, the most crucial and difficult comparability issue involves what the appropriate credit spread should be. Our clients are strongly encourage to obtain a reliable credit rating for the related party borrower. With that – we can compare the implied credit spread for the intercompany loan to the credit spreads observed in bank loans and/or corporate bonds. We have also consulted our colleagues in the Thomson Reuters Financial & Risk group, which are seen as a very reliable source for credit spreads.
As far as the attorney’s comments, checking on comparability issues is as crucial when using corporate bonds as it is when using bank loans. His claim that banks provide subsidized loan rate that are tied to other services, however, gets standard money and banking backwards. Most banks – including J.P. Morgan Chase – may pay low interest rates on bank deposits as they provide subsidizes services to their deposit customers as witnessed by their most recent annual income statement that indicated only $7.9 billion in interest expense, but non-interest expenses that exceed non-interest income by $10.7 billion. On the other hand, interest income exceeded $51.3 million. Our friends at J. P. Morgan Chase would tell us that while loan rates may be low, this is an indication of low market rates and not an indication that they are providing subsidizes interest rates.
Documenting the arm’s length nature of your intercompany loans requires an appropriate analysis as well as reliable market information. Our transfer pricing group has significant experience with these issues and we are lucky that our colleagues at Thomson Reuters provide a wealth of financial market information so we can carefully address any comparability issues.
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