Executive Summary

A debt capacity analysis tests whether a borrower can sustain intercompany debt under market conditions. The arm’s length assessment of intercompany financing does not stop at pricing an interest rate; it also requires testing whether the borrower could realistically have obtained the loan, and whether the amount of debt is commercially justifiable given the facts and circumstances. By benchmarking financial ratios against independent peers, companies can demonstrate that their financing structure is commercially sound and compliant with the arm’s length principle. Dutch case law confirms that tax authorities are scrutinising debt capacity more closely. Borgen Tax has developed a dedicated tool to streamline this analysis and strengthen documentation.

Outcome Focused Conclusion

The analysis of debt capacity provides a clear view of whether a borrower can reasonably support its level of intercompany debt. By applying ratios such as debt-to-equity, interest coverage, and loan-to-value, companies can validate that their financing terms mirror those available in the open market. This assessment not only strengthens transfer pricing compliance but also mitigates the risk of tax challenges.

Dutch court decisions, such as the Amsterdam Court of Appeal noted in its judgment of 5 September 2024 (ECLI:NL:GHAMS:2024:3626), illustrate that tax authorities no longer accept unsupported assumptions about borrowing capacity. Instead, they expect a thorough analysis, supported by reliable benchmarks, to prove that an intercompany loan could also have been granted between independent parties. At Borgen Tax, we have developed a debt capacity analysis tool that applies these ratios consistently and compares them against peer data. The tool produces structured outputs that can be included directly in transfer pricing documentation, helping companies stay ahead of regulatory scrutiny.

Debt Capacity Analysis in Practice

Debt capacity analysis evaluates a borrower’s ability to take on and service debt. The method mirrors how commercial lenders assess creditworthiness. Core ratios such as debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortisation) and interest coverage highlight whether operational cash flows can reasonably support debt obligations. Balance sheet ratios such as debt-to-assets and debt-to-equity ensure that capital structures are sustainable and comparable to independent benchmarks. Tax authorities increasingly expect companies to justify intercompany debt levels with such analyses. Without this, there is a risk that excessive intercompany financing could be recharacterised as equity. Dutch case law has confirmed this trend, emphasising that courts will test whether a borrower could actually have sustained its debt under market conditions. By aligning with the OECD Transfer Pricing Guidelines, and using tools like the one developed by Borgen Tax, companies can demonstrate compliance and reduce disputes.

Benchmarks and Market Standards

Performing a benchmarking analysis is the backbone of a debt capacity analysis. Independent company data provides the reference point for evaluating whether a borrower’s ratios reflect commercial terms. The use of interquartile ranges ensures that results are not skewed by outliers but instead reflect typical market practice.

In practice, companies should consider industry specifics such as capital intensity and asset-backed financing availability. Credit rating methodologies also inform the interpretation of ratios, aligning the approach with how lenders would assess comparable risks. The increasing focus of Dutch tax authorities on these elements makes careful benchmarking essential. Borgen Tax’s tool integrates these perspectives and delivers a clear, structured report that mirrors market-standard analyses.

Key Takeaways

• A debt capacity analysis provides companies with a disciplined framework for validating intercompany financing. It helps align financing terms with commercial reality and regulatory expectations.
• Debt capacity analysis confirms whether intercompany financing reflects what an independent borrower could achieve in the open market.
• Financial ratios such as debt-to-equity, interest coverage, and loan-to-value are central in demonstrating alignment with the arm’s length principle.
• Dutch case law shows tax authorities are scrutinising debt capacity more closely, making robust analysis essential.
• Borgen Tax’s debt capacity analysis tool delivers consistent, defensible results and supports efficient transfer pricing documentation.