While transfer pricing policies (TP) are crafted considering normal economic risks, the current pandemic and the economic downturn it has sparked cannot be treated in a business as usual manner and requires a differential approach.
COVID-19 is a tragedy at many levels. The Congressional Research Service in their report on the Global Economic Effects of COVID-19 (updated August 7, 2020), writes, “Estimates so far indicate the virus could trim global economic growth by 3.0% to 6.0% in 2020, with a partial recovery in 2021, assuming there is not a second wave of infections. The economic fallout from the pandemic raises the risks of a global economic recession with levels of unemployment not experienced since the Great Depression of the 1930s. The human costs in terms of lives lost will permanently affect global economic growth in addition to the cost of rising levels of poverty, lives upended, careers derailed, and increased social unrest. Global trade could also fall by 13% to 32%, depending on the depth and extent of the global economic downturn, exacting an especially heavy economic toll on trade-dependent developing and emerging economies.”
This is straining cross border intra-group transactions within multinational enterprises (MNEs). The transfer pricing environment is becoming more uncertain. What do we see in the market and how should companies view this?
The story so far
Restrictions on economic activity and lockdowns have resulted in disrupted supply chains. Businesses are faced with falling demand as income levels are diminished. Manufacturing and distribution functions requiring physical labor, movement of people, transportation and logistics have been more severely hit. Some industry sectors like aviation, travel, hospitality and luxury retail have seen deeper declines compared to others. Many companies have pivoted to digital means of product and service delivery and implemented work from home measures as they adapt to operating in a COVID world. Some operating costs like travel costs within the organizations are decreasing and could help preserve margins in view of reduced toplines. Companies are focused on conserving cash and ensuring liquidity in their operations. At a time like this, transfer pricing policies which guarantee entities within the group – contract manufacturers, limited risk distributors, captive service providers – a minimum assured profit are becoming very difficult to implement. Simultaneously, risk bearing entities like licensed manufacturers and regional distributors are not earning sufficient profits in local operations to afford committed intra-group royalty or distribution rights payments. Consequently, the financial outcomes of the group and particularly the headquarter company is under stress.
While transfer pricing policies are crafted considering normal economic risks, it is clear that the current pandemic and the economic downturn it has sparked cannot be treated in a business as usual manner and requires a differential approach. Governments and tax administrations also recognize COVID-19 as an unprecedented shock and some of them like Australia and Singapore have released guidance how transfer pricing would be viewed in the current context.
How to approach the future
Every organization must assess how this pandemic has not only impacted its business currently but implications over the longer term. Based on this, clear business objectives have to be identified and a transfer pricing policy to support these objectives could be accordingly fashioned.