The transfer pricing (TP) rules in Uzbekistan: implications for financial transactions and the financial sector

Section VI "Tax Control in Relation to Transfer Pricing" of the Tax Code of the Republic of Uzbekistan ("the TP rules") came into force on 1 January 2022. A round-up of the general provisions of the TP rules is presented in B1's alert: "Overview of the transfer pricing (TP) rules in Uzbekistan".

This alert contains a summary of the TP rules insofar as they apply to financial transactions and financial sector companies.

Please note that our comments are based exclusively on our interpretation of the provisions of the TP rules, information available to us immediately after the entry into force of the TP rules and our experience and knowledge of international TP principles.

Financial transactions and financial sector companies

The TP legislation of the Republic of Uzbekistan applies to various types of financial transactions and transactions concluded by financial sector companies, meaning that taxpayers need to comply with the TP rules. Presented below is a more detailed overview of the rules as applied to different types of financial transactions and subsectors of the financial market.

Credits, loans, guarantees and cash pooling

The Uzbek Tax Code does not contain provisions specifying the methodology to be used to determine whether the prices of credit, loan, guarantee, cash pooling and other financial arrangements are executed at arm’s length for taxation purposes. It is therefore to be assumed that the arm’s length nature of such transactions can be analysed using the comparable uncontrolled price (CUP) method, which is consistent with global TP practice^[1].

In conducting benchmarking studies of the prices of such transactions and identifying comparable transactions, taxpayers must follow the general rules concerning the comparability of transaction conditions which are laid down in Article 184 of the Tax Code. It is also essential to take account of other criteria, such as:

• The parties' credit histories and solvency
• The tenor of the transaction
• Currency and
• Other conditions that influence the level of the interest rate^[2].

One of the key parameters that influence the level of the interest rate or the remuneration of parties to financial transactions is credit rating, which in turn reflects the credit history and solvency of borrowers and of principals under bank guarantees. Various tools and methods may be used to determine the individual credit ratings of related borrowers — for example:

• Information on the credit rating assigned to a borrower by rating agencies (such as S&P, Moody’s, Fitch, Ahbor-Reyting, SNS RATINGS, Expert RA, ACRA, and others);
• Methodologies of international rating agencies;
• Analytical tools in databases of price reporting agencies and on platforms of international rating agencies, for example: PVTCO Calculator developed by Refinitiv Eikon, which is designed to be used to calculate a company’s credit rating based on its financial results; Moody’s RiskCalc by Moody's Analytics, which allows a borrower’s indicative standalone credit rating to be calculated based on its financial results, industry and country; and S&P solutions based on the S&P CAPITAL IQ platform (for example, CreditPro, CreditModel and PD Model), which allow a borrower’s credit rating to be determined with the aid of quantitative methods of creditworthiness assessment;
• Internal credit rating methodologies of international corporate and banking groups.

To obtain information needed to identify comparable transactions and determine the ranges of market interest rates and remunerations, taxpayers may use databases of international price reporting agencies, such as Refinitiv Eikon and Bloomberg, as well as regional databases such as Cbonds. If the CUP method is to be used to analyse credit, loan, guarantee and cash pooling arrangements, it is necessary to identify at least one comparable transaction in those databases provided that all necessary information about that comparable transaction is available.

At the same time, in assessing whether transfer prices in financial transactions are at arm’s length, taxpayers must also take into consideration the provisions of the Special Part of the Uzbek Tax Code^[3] governing the treatment of interest income and expenses. In particular:

• Income arising when loans are granted interest-free or with interest payable at below the refinancing rate should be determined based on the refinancing rate set by the Central Bank of the Republic of Uzbekistan on the date of receipt of the loan.^[4]

We should point out that the provisions of the Uzbek Tax Code are not specific about the currency of a debt obligation to which the refinancing rate may be applied in calculating interest income for taxation purposes.

• Interest expenses must be determined in line with the thin capitalisation rules, according to which the amount of controlled indebtedness must not be more than 3 times greater than equity, or not more than 13 times greater in the case of banks and leasing companies.^[5] Interest above the threshold values is not deductible.^[6]

Based on the information above, the approach to analysing interest rates in financial transactions for TP purposes may be summarised as follows:

1. Determining the ranges of market interest rates based on the TP method;
2. Comparing the results of the benchmarking study with the requirements of the provisions of the Special Part of the Uzbek Tax Code with respect to

• Interest income to check alignment with the refinancing rate and make adjustments to interest income if necessary;
• Interest expenses to check compliance with the thin capitalisation rules and make adjustments to interest expenses.

Securities, deferred settlement and derivatives transactions

Transactions involving securities and derivatives traded on the organised securities market are not required to be reported in TP documentation. A taxpayer may submit TP documentation for such transactions on a voluntary basis.^[7]

As noted above, the Uzbek Tax Code provides that where the Special Part of the Code establishes different rules for determining the price of a transaction, the rules of the Special Part of the Code will apply. In particular, it is on the basis of those rules that the prices of controlled transactions involving over-the-counter ("OTC") securities (such as shares, bonds, promissory notes, etc.) and derivatives (such as OTC options, swaps, forwards, and others) must be analysed.^[8]

According to Articles 327 and 328 of the Uzbek Tax Code, transactions involving OTC securities and derivatives are deemed to be priced at arm’s length if the transaction price is no more than 20% above or below the reference price of a security and the reference value of a derivative.

The procedure for determining the reference prices and values of OTC securities and derivatives is in turn established by the authorised body for the securities market in consultation with the Ministry of Finance of the Republic of Uzbekistan.

In practice, reference prices and values of derivatives can normally be determined using standard calculation models devised by the price reporting agencies Refinitiv Eikon or Bloomberg.

Reference prices of securities may also be determined in one of the following ways — for example, as prices calculated:

• Based on the prices of a security prevailing on the securities market, for example as a composite purchase price for an OTC security (Refinitiv Eikon Composite bid) or as the average closing price (Bloomberg generic Mid/last);
• According to the rules laid down in national legislation, for example with the aid of formulae for determining the reference price of a bond or promissory note;
• As appraised values of securities determined by an independent appraiser.

Deferred settlement transactions (such as FX TOD, TOM and Spot and FX swaps), on the other hand, may be analyzed using standard TP methods such as the CUP method since such transactions are not governed by the provisions of the Special Part of the Uzbek Tax Code.^[9]

To establish whether deferred settlement transactions are priced at arm’s length, it is possible to use publicly accessible data published by the Currency Exchange of the Republic of Uzbekistan or, if this is not available, quotes of participants in over-the-countertrading. For example, such data may include information on quotes for TOD or TOM exchange transactions for various currency pairs and FX swaps.

The banking sector

Participants in the banking sector typically engage in transactions of the types described above and also transactions such as interbank credits and deposits, repos, and others.

As a rule, the arm’s length compliance of controlled transactions in which banking sector companies are involved is analysed by applying the standard TP rules and the provisions of the Special Part of the Uzbek Tax Code for transactions involving derivatives and securities. When analysing controlled derivatives and deferred settlement transactions, banks may in practice come up against the need to determine the market price level for transactions which may number in the hundreds of thousands, and in this case it is necessary to use automated solutions for determining market price ranges to save time on manually analysing each individual transaction.

For complex transactions that entail the highly integrated involvement and interaction of two or more related entities of banking groups in the provision of services and the sale of banking products to independent clients in Uzbekistan (such as mergers and acquisitions, brokerage services, transactions on equity and debt capital markets, trading in financial instruments), it may be most appropriate to use the Profit split method. It is common for banks to conclude advance pricing agreements (APAs) with the tax authorities in relation to such transactions.

The insurance market

The TP rules do not contain special provisions regarding controlled insurance and reinsurance transactions. It follows that the standard TP methods or a combination thereof may be used to analyse such transactions.

Insurance and reinsurance transactions may, for instance, be analysed using the CUP method or the Comparable profits method under the general provisions of the TP rules. For example, to determine whether the ceding commission is at arm’s length in reinsurance transactions, the cedent’s return on costs may be determined and then compared with the arm’s length range of of return on costs for companies that perform comparable functions.

Investment funds

Controlled transactions concluded by investment funds must also satisfy the requirements of the Uzbek Tax Code.

In practice, intra-group transactions of investment funds mainly occur in two key areas, namely:

• Investment consulting services. The Comparable profits method is typically used to verify the arm’s length nature of fees in such transactions; and
• Asset management, for which remuneration is paid in the form of a management fee and a percentage of profit earned (performance fee). The CUP method may be used to determine whether those fees satisfy the arm’s length principle.

Other services

Where taxpayers operating on financial markets engage in other intra-group arrangements (for example, back-office services, IT support, granting of rights to use intangible assets, etc.), the TP rules must likewise be observed. The TP method to be used and the steps needed to determine arm’s length remuneration in such transactions must be established on a case-by-case basis.

Permanent establishments

The TP rules also provide for TP audits to be conducted in relation to foreign legal entities whose activities in the Republic of Uzbekistan give rise to a permanent establishment.

In accordance with legislation, taxable income of a permanent establishment is determined as income that it could have received if it had been a separate and distinct entity engaged in the same or similar activities under the same or similar conditions and dealing independently of the non-resident entity of which it is a permanent establishment.

It is most often international banking or insurance groups that provide services to independent clients through branches and representative offices.

Since the Uzbek Tax Code does not currently contain provisions regarding the attribution of profits to permanent establishments, we believe that guidance may be taken from the TP principles laid down in international practice^[10].

How can B1 help?

B1 would be happy to provide you with assistance in addressing the following issues regarding intra-group financial transactions and transactions of financial organizations:

• Analysing current transactions involving companies in Uzbekistan and reviewing and assessing TP risks
• Developing internal procedural rules for the interaction of structural subdivisions in the process of the application of methods for determining the market level of interest rates and remuneration, and developing methods for determining the market level of interest rates and remuneration and methods for determining credit ratings
• Developing and implementing TP models with the involvement of companies from Uzbekistan
• Preparing templates of TP documentation
• Preparing Notifications of controlled transactions
• Carrying out benchmarking studies of interest rates / remuneration in relation to Controlled Transactions
• Providing TP advice and recommendations in relation to new transactions involving companies from Uzbekistan
• Conclusion of APAs
• Carrying out benchmarking studies based on large volumes of derivatives and deferred settlement transaction with the aid of the B1FinBench automated solution.