Factoring and invoice discounting can be used as part of intercompany financing arrangements. The terminology involved can differ from country to country, so before attempting a transfer pricing analysis it’s critical to look behind that terminology, and understand what is actually happening from a legal and commercial perspective.
Here are four fundamental legal distinctions:
1. Outright sale of receivables vs borrowing against the security of accounts receivable
In the former case (often referred to as factoring), the fundamental nature of the transaction is a sale of the receivable from the Opco (trading entity with third party debtors) to the Finco (provider of invoice finance). In the latter, Finco is lending to Opco, using third party receivables as collateral. The use of the word ‘assignment’ in relation to the receivables does not necessarily determine the issue, because it’s possible to have an ‘assignment by way of security’. So you need to look at the documents in the round.
2. Recourse vs non recourse
What happens if the debtor of the underlying receivables (the third party customer of the group) does not pay on the due date, or at all? In non-recourse arrangements, Finco (as the purchaser of the debts) bears that credit risk entirely. In recourse arrangements, Opco (as the original owner of the debt) retains that risk through contractual indemnities or an obligation to buy back the debt.
3. Disclosed vs undisclosed
This distinction relates to the question of whether the third party debtor is notified of the arrangement, and is required to make payment to the Finco as opposed to the Opco. This can affect Finco's credit risk in the arrangements as a whole – its position is more secure if it receives the third party payments directly.
4. All or some?
Should a selection process apply before any given receivables are included in the invoice financing arrangements? If so, what are the criteria involved, and what is the process? The answer to these questions can make a material difference to the risk profile of Finco, through its ability or otherwise to reject invoices issued to customers that it deems too risky.
As with any intercompany agreements, all contractual processes need to be looked at very carefully. If they are not capable of being followed in practice, they will undermine the credibility of the taxpayer’s documentation as a whole. To avoid that outcome, it's important to understand precisely what is being described.
Personally, I would not usually recommend the use of factoring and invoice discounting in intercompany financing arrangements, unless there are very good reasons to do so. This is purely due to the administrative complexities involved.
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