COVID-19 impacts multinational enterprises (MNEs) around the world within every aspect of their value chain, effecting and imposing strains on the MNEs’ existing transfer pricing framework.
This article will share some preliminary thoughts and shed some light on some of the areas of importance concerning the impact of COVID-19 from a transfer pricing perspective.
The impact of COVID-19 raises a number of practical and tactical transfer pricing issues on the background of which MNEs may consider implementing business critical changes to established operating models and supply chains.
Consideration of extraordinary events
Among other considerations, MNEs should take into account the treatment of extraordinary items, the timing of the impact to taxpayer and comparables’ financial results, the inclusion of loss companies, and the significance of capital adjustments.
For many MNEs, the COVID-19 business environment will entail a sharp increase in costs, as well as a potential decline in demand which may drive down system profit, resulting in extraordinary losses impacting the MNEs’ financial results. As a result, it should be considered how to account for such unplanned fluctuating operating results from a transfer pricing perspective.
In this respect, critical transfer pricing assessments are necessary to determine whether losses and gains associated with COVID-19 should be allocated between the MNEs’ value chain participants.
Considerations may include, but are not limited to:
- An assessment of the management and allocation of risk within each company’s specific transfer pricing model.
- What does the company’s transfer pricing documentation or legal agreements say about which parties bear specific risks, force majeure clauses etc.?
- Where is special event risk borne according to the company’s transfer pricing model (e.g., principal company, local entrepreneurs)?
- Where are key risk management decisions about COVID-19 responses being made (e.g., level of supply chain diversification, changes in pricing of impacted goods/services, delays in delivery, closing/suspending of operations, public communication, etc.)?
MNEs should aim to align these considerations and may consider more long-term changes to the transfer pricing model, also being aware that tax authorities may challenge the allocation of extraordinary losses or may argue for higher profit allocation in the past or for future years in return for assuming additional risk.
In this respect, we advise to evaluate whether adjustments should be made to existing inter-company contracts in order to account for the impact of a decrease in system profit and, in the long term, to include descriptions in the transfer pricing documentation/defense files supporting the allocation of lower or higher than expected profits.
MNEs which depend on Advance Pricing Agreements (“APAs”) and/or rulings from tax authorities should review critical assumptions, as the basis for such assumptions may change due to implications on the value chain drivers and profitability of the group as touched upon above. If this is the case, it is of vital importance to reconnect with the tax authorities to determine if any critical assumptions can be revised, if they will accept a deviation this year or, worst case, if the APA would no longer be considered applicable.
Other immediate actions to be considered from a transfer pricing perspective
- Get an overview and understanding of who makes the decisions that are fundamental to the reaction to the COVID-19 crisis and ensure that these decision makers are reflected properly in the company’s functional and risk analysis.
- In this respect, we advise to archive emails/documents or similar paper trails that can serve as documentation of who have been the decision makers and the basis for making COVID-19 related decisions. The paper trails will be useful for potential transfer pricing audits a few years down the road.
- Ensure that the way your organization reacts to the crisis is aligned with the conclusions of your DEMPE analysis.
- Get an overview of local government crisis plans which your group may plan to make use of and determine whether such rescue plans may impact the current transfer pricing setup and internal compensation structure. Examples:
- Government has agreed to pay wages for people who are impacted by COVID crisis.
- Government will make compensation for lost revenue.
- If your group is already aware that the COVID-19 crisis will require adjustments of profitability levels or have significant impact on the supply chain (i.e. delay of products), we recommend that the intercompany agreements are amended now (if possible) in respect of the termination and renegotiation clauses, since adjusting profitability levels or other contractual assumptions which contradict existing agreements may cause legal and transfer pricing scrutiny.
- Amending the intercompany agreements now, when in the middle of the crisis, is recommended as this would be expected between independent parties.
- While making the above amendments, we further suggest considering whether it makes sense to update/include more detailed Force Majeure clauses in the agreements.
The challenging times associated with the COVID-19 crisis are expected to continue, and at this stage it is difficult to fully predict the extensiveness of the impact it will have on transfer pricing setups during this volatile period. EY’s transfer pricing team continues to monitor the potential impacts to transfer pricing that this may have, and we are happy to discuss any potential implications that may be affecting you and your organization.
Anne Simone Nielsen, tel. +45 2529 4783
Justin Breau, tel. +45 2529 3932
Henrik Arhnung, tel. +45 5158 2649
Henrik Morthensen, tel. +45 2529 4571