Transfer pricing

Fédération Bancaire Française


1.The Fédération Bancaire Française (FBF) is made up of French commercial banks and credit institutions with mutual or co-operative status, making a total of nearly 500 institutions.

2.It was very interested to read the OECDs draft report on the attribution of profits to permanent establishments, and especially Part II.

Deadline for submitting comments

3.The FBF is pleased that the 1 July 2001 deadline has been moved back to 4 September 2001. It reserves the right to add to or even change the comments below when it has seen Part III of the report, on global trading in financial instruments. This is because it would seem artificial to separate Part III, global trading necessarily having an impact on the borrowing and on-lending of money, which activities are dealt with in Part II.

The basic "functionally separate entity" approach and its corollary, the interpretation of the arm's length principle as applied in the context of Article 9 of the Model Convention

4.The FBF thinks it worthwhile pointing out that the OECD's main objective is to eliminate double taxation, which hinders the development of world trade. It is in relation to this objective that the "functionally separate entity" approach, and its corollary the arm's length principle, have to be considered. Although sanctioned by international tax doctrine, this approach cannot be generally and systematically adopted, if only because banking activity, which is mainly intangible, has become globalised by its very nature (see trading of financial instruments, which is the subject of the as yet unpublished Part III of the report). Also, the lack of any separate legal status of permanent establishments, unlike subsidiaries may explain why, in certain instances, it is not possible to apply thearm's length principle (this is the case, in particular, of the attribution of capital or credit rating), making it necessary to attribute world profits and losses differently. In this regard, there are a lot of solutions in the draft report that go against the "functionally separate entity" rule and the arm's length principle.

The attribution of financial assets to the permanent establishment of a bank

5.It is preferable not to ask for specific tax reporting documents and to require only the possible adjustment for tax purposes of the local accounting documents performing the attribution. They must be assumed to take account of the actual location of the sales/trading and risk-taking functions, and of the role played by the person responsible for the bank's general policy with regard to granting loans.

6.The accounting location of assets has become current practice where banking activities are concerned. It is necessary when the accounts are kept at head office, which is becoming an increasingly widespread practice as it generates economies of scale when it comes to processing costs. The reliability of the local accounting documents is then in general spontaneously ensured by a profit and loss assignment mechanism which is akin to the tax requirement regarding the geographical location of world profits and losses. The result is that local accounts enjoy a great degree of credibility - such as to render exceptional exclusively tax adjustments that are always liable to result in double taxation.

Attribution to a permanent establishment of the overall credit rating of the banking enterprise

7.This rule can only be universal in application. It admits of no exception and condemns the thin capitalisation method rightly rejected by the draft report.

The calculation, for tax purposes, of the capital allocation of permanent establishments of banks

8.The FBF admits the principle of the territorial attribution, for tax purposes, of a banks capital, but is opposed to the application of the Basel Committee's standards to financial assets located in a permanent establishment. The reasons are that:

-that approach is hardly compatible with the attribution to the permanent establishment of the credit rating of the overall banking enterprise;

-the Basel Committee's standards are designed to cover only the credit risk, without taking account of the interest rate risk, the foreign exchange risk, etc. They do, on the other hand, cover the off-balance sheet items which, although allocated to the balance sheet statement of the permanent establishment, do not necessarily derive from the activity of the latter. More generally, while they can give rise to risks that have to be taken into consideration as regards applying a solvency ratio, off-balance sheet items do not require refinancing and do not, therefore, influence the profits or losses of a permanent establishment by virtue of deductible interest payments. But it is the appraisal of a permanent establishments results that has to be the sole concern of the tax authorities.

-the Basel Committee's standards are set to evolve in such a way that banks can take the data concerning their internal management into consideration. They will therefore cease, as a general rule, to be standardised and the tax authorities in countries where permanent establishments are located will not be able to perceive them in the abstract.

-banks would find it very difficult to allocate their capital to the weighted financial assets (and to the off-balance sheet items) of their permanent establishments in order to meet a specific tax requirement. It needs pointing out, in this connection, that allocation in this instance is on a consolidated basis which takes no account of the territoriality of permanent establishments. The legal and geographical reprocessing that would then be necessary would require a considerable amount of work without the results being sure to be reliable.

9.The FBF therefore considers it legitimate and more effective to base allocation solely on data taken from the statutory accounts. For example, the overall capital, in the accounting sense of the term, could be allocated to the balance sheet assets of permanent establishments by applying to these assets the banks overall capital/total balance sheet ratio.

The treatment of Tier 2 capital from the point of view of total accounting capital for allocation

10.The FBF is of the view that, except in altogether exceptional cases warranted by financial analysis, Tier 2 funds should be excluded from the total accounting capital to be taken into consideration in assessing the financing of permanent establishments for tax purposes.

Inter-branch dealings

11.When they are the result of a routine banking activity, inter-branch dealings must take place under normal market conditions (for example, a permanent establishment takes deposits from its head office under the same conditions as from other banks). When such dealings are more exceptional in nature, they must be valued at a market price if they derive from an activity liable to be handled between independent parties (for example, reward for taking on the risk, assuming an organisation based totally or partially on the centralisation of that risk).

Head office costs

12.As a general rule, head office costs mean expenditure decided on by head office and corresponding to its general policy. They cannot therefore be analysed as the counterpart of traded services. It follows that they can be dealt with only in terms of a proportional allocation of their cost, without head office being able to add a profit margin.

The special case of intangibles

13.Like the overall credit rating of a banking enterprise, the valuation of intangibles is in principle the result of the enterprises overall activity. Except in specific cases, its purpose is not therefore to be attributed to one entity rather than another, ending up with an inter-branch profit recognition that would inevitably be partial and hence artificial. Only in altogether exceptional cases of intangibles deriving from the activity of the head office alone (the creation of a logo, for example), would permanent establishments be required to make a contribution to the cost of the activity, which would in that case be incorporated in head office costs.