4 minute read 30 Mar 2020
Anticipating & preparing to COVID -19 aftermath

The anti-Corona prescription for transfer pricing

By Ashwin Vishwanathan

EY India International Tax & Transaction Services- Transfer Pricing, Partner

Experienced transfer pricing professional advising companies on intercompany pricing and working with tax administration on tax policy issues.

4 minute read 30 Mar 2020
Related topics Tax COVID-19 Tax compliance

Organizations must understand the implications of COVID-19 outbreak, prepare for consequences and maximize opportunities through a proactive approach.

Today, humankind is faced with an unprecedented crisis in the form of the novel coronavirus (COVID-19). In a globally connected world, cross border movement of goods, services, people, intangibles and financial flows is imperilled. Consequently, all businesses are likely to be disrupted. While it is premature to conclude the full impact of this shock, it is opportune to understand its implications, prepare for consequences and maximize opportunities through a proactive approach.

Transactions between entities within multi-national groups (MNEs) is a significant part of global trade. Transfer pricing of these flows is a critical element of the world’s supply chain and countries’ tax ecosystems. MNEs often have entities performing centralized functions such as procurement or Intellectual Property (IP) management. They also engage specific companies within the group to contract manufacture goods, undertake R&D services and distribute products and services in identified territories. Management hubs support group companies in different regions to gain efficiency and foster better controls. Transfer pricing principles require each of these entities to get remunerated for the value they create and contribute to the supply chain. This, in turn, has consequences on the fiscal health of the countries where these entities are present.

In the present context, companies are likely to face the following challenges:

  • Shut down of commercial operations due to government-initiated lockdowns
  • Labour shortages due to restricted people movement
  • Cost escalations due to supply chain interruptions
  • Lack of demand resulting in inventory stockpiles
  • Forecasting and budgeting issues due to change in demand and supply patterns
  • Breakdowns in traditional distribution channels
  • Financial exposure in terms of working capital and credit management, receivable collections, debt and banking covenants
  • Impact on business continuity planning and governance

There could be many other direct and indirect effects on businesses. Companies will have to assess how to respond to these challenges and where the key decisions will be made. They may also need to determine as to whom such various risks and associated obligations belong in impacted intra-group transactions, and whether contracts between parties reflect this understanding. The financial ability of entities to bear such risks is likely to be tested.

Maintaining pre-agreed fixed compensation for related parties like contract manufacturers, contract service providers and limited risk distributors might become difficult given the uncertainty of profits and the looming spectre of losses. Underutilization of capacity due to shut downs and carrying costs of inventory will only compound this problem. Performance guarantees, product and service liabilities and similar legal obligations may get triggered requiring expending of costs and management time. Recognizing these early is, therefore, essential. Injecting an anti-Corona dose into transfer pricing and business planning is the need of the hour. Here are a few recommendations:

The anti-Corona prescription for transfer pricing

Imagine an MNE with manufacturing factories in affected countries, distribution affiliates in Europe and Asia operating its R&D and shared services centre in India with regional management teams based in South East Asia and the Middle East. If one were to practically apply the above prescription, the group would have to consider the following steps:

i) Examine which of these critical functions are worst hit and prioritize actions accordingly. Manufacturing in affected countries is an obvious concern and will have to be addressed first.

ii) Identify alternative manufacturing locations to ensure business continuity. Logistics would also have to revisited.

iii) Undertake a financial analysis to quantify potential cost increases, losses and evaluate the cash and tax impact.

iv) Consider what other market players are doing and how they have been impacted.

v) Set up cross functional teams comprising legal, tax, finance and operations personnel to initiate contingency plans and spur alternate action.

vi) Analyse the profits within the supply chain and recalibrate its allocation between manufacturing, distribution, services entities and the principal by repricing inter-company transactions.

vii) Alter decision making matrices and organizational hierarchies to gain better control over processes and governance.

viii) Establish internal processes to gather information and documents explaining various changes.

ix) Revise already signed APAs and discussing ongoing APAs with the tax authorities to reflect new business realities.

x) Run a ‘war room’ or ‘project management office’ to maintain and build supply chain resilience.

While businesses are still trying to navigate this disruption, companies must act swiftly, understand and prepare. Involving professional advisors early in this lifecycle will help bring to bear deeper sector experience and insights and generate robust solutions.

The old adage, “an ounce of prevention is worth a pound of cure” has never been more relevant or real.

Summary

COVID-19 is an unfortunate human tragedy. Anticipating and preparing to respond to its aftermath is the best strategy.

About this article

By Ashwin Vishwanathan

EY India International Tax & Transaction Services- Transfer Pricing, Partner

Experienced transfer pricing professional advising companies on intercompany pricing and working with tax administration on tax policy issues.

Related topics Tax COVID-19 Tax compliance