Transfer pricing and Financial Transactions – A Perspective from OECD and Zimbabwean Legislation
INTRODUCTION
In an increasingly globalized economy, financial transactions between related entities such
as intra-group loans, guarantees, and cash pooling, are under heightened scrutiny by tax
authorities. Both the OECD Transfer Pricing Guidelines and Zimbabwe’s Income Tax Act
provide frameworks to ensure these transactions adhere to the arm’s length principle,
preventing base erosion and profit shifting.
OECD Guidance on Financial Transactions
The Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022
provides a structured approach to evaluating intra-group financial arrangements and helps
to determine whether the conditions of certain financial transactions between associated
entities are consistent with the arm’s length principle.
Key Principles:
1. Understand the Real Nature of the Transaction – Accurate Delineation
Financial transactions must be analysed based on their economic substance, not just
legal form. It is a critical step before applying transfer pricing methods and is central
to both OECD Guidelines and Zimbabwean legislation. This includes assessing:
• The borrower’s capacity to repay and the lender’s decision-making process,
• Functions, assets and risk involved
• Characteristics of the financial instruments
• Economic circumstances of the parties
• Industry-specific factors
• Options realistically available
• Group financing policies
2. Treasury Functions – Companies often have a central team (called a treasury) that
manages money for the whole group. When this team arranges loans or cash
pooling, it must be clear:
• Why the arrangement was made
• Who benefits
• How risks and rewards are shared
Intra-group loans, cash pooling, and hedging must be evaluated for their commercial
rationale. The guidance emphasizes the need to distinguish between centralized
treasury services and independent financing arrangements. The main function of a
corporate treasury may be to optimize liquidity across the group to ensure sufficient
availability of cash.
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3. Financial Guarantees – If one company guarantees another’s loan, it must be priced
fairly. Guarantees must be priced based on the benefit conferred to the borrower.
The OECD outlines methods such as yield approach and cost-based approaches to
determine arm’s length pricing.
• Yield Approach: Compare interest rates with and without the guarantee.
• Cost Approach: Estimate the risk and potential loss the guarantor takes on.
4. Captive Insurance – Some companies set up their own insurance units. These must
be properly structured and priced to meet the arm’s length principle.
Captive insurance arrangements offer strategic benefits for Group entities but must
be carefully structured and documented to meet OECD and Zimbabwean transfer
pricing standards. Accurate delineation, functional analysis, and arm’s length pricing
are essential to defend the legitimacy of such arrangements and avoid tax
adjustments.
5. Interest Rate Benchmarking
Interest rate benchmarking under OECD guidelines requires a holistic approach that
considers market comparables, borrower risk, group dynamics, and economic
substance. By following these principles, MNEs can ensure compliance and reduce
the risk of transfer pricing adjustments.
Key principles of interest rate benchmarking include;
• Two-Sided Analysis: Interest rates must be evaluated from both the lenders
and borrower’s perspectives. This includes assessing the risks borne by each
party, the contractual terms and the compensation policy.
• Credit Rating: The borrower’s creditworthiness is a central factor. The OECD
recommends using internal or external credit rating models or considering
both standalone credit rating and implicit group support.
• Arm’s length interest rates: These should reflect market conditions and
borrower risk.
• Documentation: Comprehensive records are essential to justify pricing and
terms.
6. Zimbabwe’s Transfer Pricing Framework
Zimbabwe’s transfer pricing rules are governed by Sections 98A and 98B as read with
the 35th Schedule to the Income Tax Act [Chapter 23:06]. These provisions apply to
controlled transactions between associated persons, including intra-group financial
arrangements such as loans, guarantees, and other financing instruments.
Zimbabwe’s legislation aligns closely with OECD principles but includes local
refinements:
Key Features:
Arm’s Length Principle: Financial transactions between associated persons must
reflect terms that would apply between independent entities.
ZIMRA Oversight: The Zimbabwe Revenue Authority (ZIMRA) actively enforces
compliance, with the power to adjust taxable income if transactions deviate from
the arm’s length range.
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Application to Financial Transactions
In Zimbabwe, financial transactions such as intra-group loans and guarantees are
subject to the same scrutiny as goods and services. Taxpayers must:
• Justify interest rates using market comparables
• Demonstrate the economic substance of transactions
• Consider whether excessive debt should be reclassified as equity for tax
purposes.
The Zimbabwe Revenue Authority (ZIMRA) checks if transactions are fair. If not,
they can:
• Adjust taxable income
• Reclassify debt as equity
• Request more documentation
7. Important Considerations
The benefit a borrower receives from being part of a group must be considered
Debt vs. Equity Classification: Determining whether a financial instrument
qualifies as debt or equity is critical.
Key Indicators of Debt:
• Fixed repayment date: Debt usually has a clear schedule for repayment.
• Obligation to pay interest: Regular interest payments are expected.
• Right to enforce payment: The lender can legally demand repayment.
• Subordination status: Debt holders are typically paid before equity holders
in liquidation.
• Presence of financial covenants: These protect the lender’s interests.
• Ability to obtain similar financing from third parties: If a bank wouldn’t
offer such a loan, it may not be true debt.
• Thin capitalization: Excessive debt compared to equity may trigger
reclassification.
Key Indicators of Equity:
• No fixed repayment: Equity is invested indefinitely.
• Returns depend on profitability: Dividends are paid only if the company
earns profits.
• No obligation to repay: Investors bear the risk of loss.
• Participation in management: Equity holders may influence decisions.
• Subordination to creditors: Equity is paid last in liquidation.
The OECD also stresses accurate delineation—understanding the real nature of the
transaction by analyzing functions, risks, and economic circumstances.
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8. Nature of intra group financing transactions
Intra-group Loans
These include short-term and long-term loans between related entities. ZIMRA
requires:
• Arm’s length interest rates based on market comparables.
• Proper documentation of loan terms (maturity, repayment schedule,
currency).
• Assessment of borrower’s creditworthiness and debt capacity.
Financial Guarantees – Guarantees provided by one group entity to support
another’s borrowing must be priced appropriately. ZIMRA expects:
• Evidence of benefit conferred to the borrower.
• Use of pricing methods such as yield approach or cost-based methods.
Cash Pooling Arrangements – Centralized treasury functions must be evaluated for:
• Economic substance – prove the arrangement has real economic value
• Allocation of risk and reward
• Compensation for coordination and liquidity provision
9. ZIMRA Enforcement and Adjustments
ZIMRA may:
• Adjust taxable income to the median of the arm’s length range if pricing falls
outside acceptable limits.
• Recharacterize transactions (e.g., treating loans/ excessive debt as equity).
• Request additional documentation or conduct audits on financial
arrangements
10.Conclusion: Implications for Businesses and Compliance Considerations
As financial transactions within multinational groups come under increasing
scrutiny, businesses operating in Zimbabwe must proactively align their intra-group
financing arrangements with both OECD guidelines and local legislation.
The implications are significant:
• Heightened Regulatory Oversight: ZIMRA’s active enforcement means
companies must be prepared for audits, documentation requests, and
potential adjustments to taxable income.
• Substance Over Form: Accurate delineation of financial transactions is
essential. Businesses must ensure that the economic substance of loans,
guarantees, and treasury arrangements reflects commercial reality—not just
legal form.
• Arm’s Length Pricing: Interest rates, guarantee fees, and other financial
terms must be benchmarked against market comparables. This requires
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robust functional analysis, credit assessments, and two-sided evaluations of
risk and reward.
• Documentation is Critical: Comprehensive records supporting the rationale,
pricing, and terms of financial transactions are not optional—they are a
compliance necessity. This includes loan agreements, credit ratings,
treasury policies, and benefit analyses for guarantees.
• Debt vs. Equity Classification: Companies must carefully assess whether
financing instruments qualify as debt or equity. Misclassification can lead to
tax adjustments and affect financial reporting.
• Strategic Planning: Businesses should integrate transfer pricing
considerations into their treasury and financing strategies. This includes
evaluating the role of centralized treasury functions, cash pooling
arrangements, and captive insurance structures.
11.Key Takeaways for Clients
• Ensure all intra-group financial transactions are supported by arm’s length
documentation.
• Conduct regular benchmarking of interest rates and guarantee fees.
• Maintain clear records of the economic rationale and benefit conferred in
each transaction.
• Be prepared for ZIMRA audits and potential recharacterization of
transactions.
• Seek professional advice to navigate complex areas like debt-equity
classification and treasury function pricing.
By embedding transfer pricing compliance into financial decision-making,
businesses can mitigate risk, enhance transparency, and foster sustainable tax
practices in Zimbabwe’s evolving regulatory landscape.
DISCLAIMER
The views and opinions expressed in this article are those of the author, Maxwell
Ngorima, and do not necessarily reflect the official policy or position of the BDO
Zimbabwe. This article is intended for informational purposes only and should not
be construed as legal, tax, or financial advice. Readers are encouraged to consult
with qualified professionals for advice specific to their individual circumstances.
