COVID-19 implications for transfer pricing

COVID-19 RESOURCE HUB  |  Financier Worldwide

TAX & TRANSFER PRICING

Although the impact of coronavirus (COVID-19) on the global tax arena is unlikely to garner anywhere near the same level of attention as education, construction, travel, retail, leisure and hospitality, the pandemic’s repercussions for taxation, particularly transfer pricing (TP), are nevertheless significant.

“Governments across the world are struggling to release legislation and guidance addressing the most critical needs of their citizens and ensure the resilience of businesses large and small,” says Salim Rahim, a partner and chair of the global transfer pricing group at Baker McKenzie. “They have turned to tax provisions in many cases to dampen economic hardships and free much needed cash resources. Global tax practices are working hard to analyse and share new information and prior experience relevant to companies across a variety of industries.”

In ‘Transfer pricing considerations in light of COVID-19’, Deloitte describes the impact of the COVID-19 as “catastrophic” and “far reaching”, and forecasts that the pandemic will have “serious implications for many multinational groups’ transfer prices, analysis and documentation”. Outlined below are some of the key areas that Deloitte suggests companies need to actively manage and monitor.

First, existing transfer pricing policies. Extant policies will be put under pressure by an economic downturn. Moreover, adversely affected companies will be required in the future to explain low operating profits or losses to tax authorities for both the current, and coming years. According to Deloitte, it would be prudent for companies to model the impact of COVID-19 on operating results now and over the next couple of months, to help demonstrate in the future the commercial rationale for changes in TP and other planning decisions – to ultimately show that low profits or losses were not the result of non-arm’s length TP policies.

Second, TP models. Models may need to be adjusted to come in line with any commercially driven changes made to the global supply chain, and to ensure they reflect any reallocation of functions, assets and risks across the group. In Deloitte’s view, companies will have to review whether the actual conditions experienced are synonymous with previous TP policies, and legal agreements become critical – and may need to change – to show actual versus economic allocation.

Third, new or increased cross-border financial support. Such financial arrangements will need to result in an arm’s length outcome for the associated parties involved, according to Deloitte. Additionally, many jurisdictions have interest and debt limitation rules that will need to be considered.

Furthermore, says Deloitte, companies should determine whether their current TP policies remain appropriate, given the major business and economic changes COVID-19 has wrought. “Documentation is critical to evidence why it is appropriate to maintain the same TP policies or move away from them,” asserts Mr Rahim. “Considering these implications upfront, and collecting evidence now to prepare contemporaneous documentation to support the change in economic circumstances, will be critical.”

That said, according to a Baker McKenzie report – ‘Covid-19: Impact on (the Other) TP’ – compiled in partnership with Bloomberg Tax & Accounting, collecting evidence and documenting it accordingly is not without its challenges. “Documenting and maintaining TP policies in adverse economic environments can create a number of difficulties, depending on the particular market or transaction concerned,” notes the report. “The more diverse the effects of an economic crisis between companies, industries or markets, the lower the chances of finding appropriate comparable transactions and conducting a reliable TP pricing analysis. Differences that materially affect the comparison will need to be adjusted to the extent that these adjustments are reasonable.”

Looking ahead, from a TP perspective, it is clear that the COVID-19 crisis will have significant implications for companies’ existing TP arrangements, as well as carrying a financial reporting risk. And while COVID-19’s impact on TP may indeed not be the first challenge that comes to mind amid the current disruption, any company that ignores its TP issues could well be looking at an adverse adjustment, significant financial penalties or time-consuming litigation once tax authorities’ audits are launched.

© Financier Worldwide

BY

Fraser Tennant