Corporate Guarantee and Letter of Comfort: Untangling the Transfer Pricing Quandary

Transfer Pricing (TP) regulations examine related party transactions as to whether they are undertaken between parties on an arm’s length basis or otherwise from the viewpoint of avoidance of tax leakage, i.e., whether said transactions are priced in a manner as transactions between two independent parties would have been priced. This not only mitigates tax leakage from one country to another but also ensures appropriate corporate governance (especially in listed companies dealing with public money).

In the complex landscape of TP, the issuance of corporate guarantees and letters of comfort (including the potential compensation to be charged thereon) has been a matter of significant controversy in income tax proceedings as well as in audit committee discussions.

BACKGROUND

Essentially, a corporate guarantee / letter of comfort is issued by a holding company to the bankers on behalf of its subsidiary, basis which the bank lends funds to the subsidiary. The borrowings in several cases entail a significant quantum of funds and consequentially, the above controversy has now reached corporate boardrooms and top management.

While the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022 (OECD Guidelines) covers financial guarantees and does not spec