Building the arm’s length interest rate in the absence of comparable transactions

Abstract

The «arm’s length principle» is the international standard for determining transfer prices for tax purposes agreed to by the OECD member countries. One of the main issues in the auditing processes regarding this matter is to determine whether the interest rates agreed in loan transactions between related parties comply with this principle. For this, the Mexican Income Tax Law (LISR, 2013/2020) requires the taxpayer to present evidence of a loan contract between independent parties with an interest rate that could be comparable. This requirement proves to be onerous for compliance purposes since most of these contracts are private in nature, precluding them as part of the sample of comparable transactions. In the absence of a contract between independent parties, this article presents an option to build an arm’s length interest rate from an economic model, which results from a balance between compliance with the LISR (2013/2020) combined with the proposed recommendations in the Transfer Pricing Guidance on Financial Transactions report (OECD, 2020).