The London Interbank Offered Rate (LIBOR) is the most popular interest rate benchmark. LIBOR facilitates establishing interest rates for various financial instruments, including intercompany financing transactions. LIBOR is a term-based rate with several maturity periods. The periods can be overnight, weekly, one month, three months, six months, and twelve months. LIBOR will be phased out by the end of 2021 initiating a new phase of Transfer Pricing in Thailand. Owing to this shift, a transition in the Accounting and Finance parameters in Thailand can be expected.
Reasons for Removal of LIBOR in Thailand
The major reasons behind this switch in Transfer Pricing in Thailand is as follows:
- Instead of measuring the real interest rate, LIBOR measures an assumed interest rate; and
- There was an alleged bubble burst in 2012. Several major financial organizations were manipulating the LIBOR rate by estimating their borrowing costs incorrectly. Deutsche Bank, Barclays, Citigroup, JPMorgan Chase, and the RBS were a few such organizations.
This raises doubts about the legitimacy and reliability of using LIBOR as a financial transaction benchmark. As a result, authorities and market players are planning to phase out LIBOR under current and future arrangements.
LIBOR is most common in intercompany financing transactions. However, the change will have the following effects on the financial system as a whole:
- Choosing a base rate of global recognition; and
- Determining whether the change will help companies in their current structures and planning (including hedging).
There is presently no consensus on how multinational corporations will handle the transition or calculate the arm’s-length margin/spread.
Thailand has had new transfer pricing (TP) regulations in place since 2019. These regulations require certain taxpayers to provide TP paperwork and file TP disclosure forms. TP regulations and guidance notes are still in processing. However, the ones which are in use so far are in conformity with the OECD’s TP guidelines.
The Thai Revenue Department has yet to issue any TP guidance on interest rate benchmarking. However, Thailand primarily follows the OECD’s TP recommendations.
Use of LIBOR in Thailand
In Thailand, US dollar LIBOR is used to produce Thai Baht Interest Rate Fixing (THBFIX). The use of THBFIX is as a reference rate for price valuation and cash flow determination in financial transactions, cash, and derivative products. As a result, the termination of LIBOR will have a substantial impact on enterprises’ financial market arrangements. Moreover, it will also affect the inter-company financing arrangements in Thailand.
Therefore, Thai companies must consider alternatives to their existing inter-company finance arrangements. This will be to make a smoother transition into the post-LIBOR era.
Alternatives to LIBOR in Thailand
Some countries are in the process of replacing LIBOR with other rates. Following are the details:
- Secured Overnight Financing Rate (SOFR) – United States,
- Europe’s Euro Short-Term Rate (ESTR) – Europe, and
- Sterling Overnight Interbank Average Rate (SONIA) – United Kingdom.
TP Implications in Post-LIBOR Era
There is ambiguity as to how multinational corporations will handle the transition or compute the arm’s length margin/spread.
We’ve outlined a few major TP factors that need attention right away for a smoother transition into the post-LIBOR future.
Inter-company Financial Agreements Rearrangement
Intra-group financing activities, like loans and cash pooling arrangements using LIBOR as the base, will face difficulties. Moreover, intra-group financing agreements serve as the first line of defense during TP audits. Therefore, this event will oblige corporations to either update or cancel their current intra-group agreements. Multinationals will face a significant risk of a tax adjustment if they do not update or revise their tax returns.
Tax Deductibility Evaluation
Many businesses use central treasury operations to structure their financing plans. They do so to focus on tax planning and group synergies. However, companies will need to assess the implications of the transition. They can choose either to increase the borrower’s interest burden or examine the thin capitalization implications. This will be to ensure that the transition does not result in a restriction on tax deductibility. Thailand currently has no thin capitalization rules.
Companies may also consider a decentralized strategy. By this, subsidiaries could obtain funds from local banks whenever it was convenient. This might help companies avoid the hassle of creating or amending agreements on a year-to-year/periodic basis. Moreover, this will help them to avoid inter-company transactions and the TP risks that come with them. A decentralized strategy, on the other hand, is only recommended on a case-by-case basis.
Risk Mitigation Strategies
Many businesses have cash pooling agreements in place, and the cash pooler frequently engages in hedging activities. As a result, the discontinuation of LIBOR is likely to result in mismatches between the loan product and the related hedge. Moreover, this can result in TP implications for multinationals to restructure their cash pooling arrangements. It can also determine the rates that the cash pooler should use inefficiently performing hedging activities. Therefore, foreign companies should begin investigating an alternate interest rate mechanism as soon as possible.
Availability and Timing of Data
Businesses may face hurdles in transitioning from LIBOR to an alternative rate. LIBOR was easily assessable, such as determining where to collect data and when and how often to issue such data. As a result, it’s critical to analyze the data’s availability and how quickly taxpayers and tax authorities can assess it for analysis.
Will LIBOR Analysis be of any further use?
The TP documentation on the LIBOR analysis (from January 2022) may no longer be admissible due to difficulties emerging from the LIBOR changeover. As a result, businesses will need to rethink their strategies and conduct research to support their potential inter-company financing arrangements involving linked parties.
To avoid future issues, it will also be vital to address the challenges and various solutions with regulators. This will help them on board with arriving at or accepting a single base rate.
If a company reports 200 million baht ($6.7 million) in income or more in an accounting year, the Thai Revenue Department now asks them to give details of their linked parties and transactions during the year.
The name of the party, the amount of interest expense, interest income, and the balance of loans payable and receivable at the end of the accounting year are the only details available for loans. This data will help in the analysis and evaluation of the following steps in identifying whether taxpayers will be subject to TP audits.
Impact of LIBOR phase-out for Thailand
From January 2022, the event will have a substantial impact on financial arrangements, and inter-company funding will not be exempt.
The Bank of Thailand (BOT) has formed a Steering Committee to assess commercial banks’ readiness for LIBOR discontinuance. This is in partnership with the Thai Bankers’ Association and the Association of International Banks. The committee’s major goal is to make the transition as seamless as possible by focusing on the following areas:
- Financial contracts referencing LIBOR and THBFIX, such as loans, notes, and derivative contracts, are subject to change.
- Commercial banks are being prepared for the LIBOR shift.
- Alternative Thai reference rates development strategy.
Market players should evaluate ongoing contracts referencing LIBOR or THBFIX, according to the committee. Furthermore, market players should communicate with commercial banks or counterparties ahead of time to ensure that current contracts are amended as soon as possible. We also expect the BOT to provide timely assistance to market participants and to provide or suggest alternative rates to Thai enterprises in the United States, Europe, and the United Kingdom.
Furthermore, international corporations operating in Thailand or elsewhere frequently establish policies at the corporate level, which are then implemented by the subsidiaries. As a result, many corporations’ tax structuring and planning will undoubtedly be affected by the shift. Multinational corporations will need to reassess their inter-company financing arrangements to verify that they are still appropriate.
Furthermore, given the increasing number of instances selected for TP audits, several tax authorities around the world are raising concerns about transnational inter-company financing arrangements. As a result, the phase-out of LIBOR could provide a chance for tax authorities, such as Thailand’s Revenue Department, to focus on more inter-company financing transactions.
The Bottomline
Because the LIBOR phase-out will take effect by the end of 2021, we recommend that businesses operating in Thailand begin evaluating the available options and selecting the most appropriate and suitable option for their businesses (as highlighted above) or begin a dialogue with regulators to develop consistent policy.
To avoid negative tax or legal consequences, the adjustments will need to be incorporated in inter-company agreements to move away from LIBOR references. Furthermore, multinational corporations will be required to document such analysis adequately in their TP documents in order to support and document their TP policies.
With the change in transfer pricing in Thailand, the Corporate community of will witness many changes in the financial framework. This is likely to create an impact on the accounting standards as well. If you are facing trouble due to this transfer, take our help in the accounting and taxation service. Email us your concern at [email protected] and our specialists will get back to you.
