What transfer pricing may look like in a world disrupted by COVID-19

What should companies do?

Now (immediate term)

As the impact of the pandemic is not uniform, every company may want to examine and understand the effects on its business relative to the industry in which they operate and the overall economy and record it appropriately. This includes steps like:

• Identifying how contractual arrangements have been altered
• Comparing own impact with impact on the industry
• Recording all abnormal or exceptional costs in a separate ledger for tracking
• Describing changes to business strategies, decisions made and implemented
• Preparing a profit and loss statement showing impact on revenues and costs vis-à-vis a normalized situation (in the absence of the pandemic)

These could help build evidence and documentation to support the rationale for change and present it to the tax authorities during an audit.

Next (medium term)

An MNE group may have to evolve a view of the pandemic’s effect over a slightly longer time horizon to determine liquidity needs for the business. The focus could be on revisiting transfer pricing policies based on:

• Analysis of comparable data culled from most recent quarterly results of public companies
• Simulated models of historical crises and its effect on comparable benchmarks
• Determination of whether royalty payments and management fee charges could be forgiven, debt obligations reset, and loss splits introduced
• Ideation around additional policies required to address current needs

Existing Advance Pricing Agreements could be renegotiated to take into account changes to critical assumptions. Given the value of cash, companies pursuing protracted litigation could consider settlement if it helps close long standing disputes. In the Indian context, the government’s Vivad-se-Vishwas (VsV) scheme might be an attractive option to settle income tax and transfer pricing cases and requires examination.

Beyond (long term)

Given the uncertainty of when the pandemic will end, it is reasonable to assume that companies may not want to or be able to take a long-term view. However, the current crisis is a good wake up call for the need to build supply chain resilience. The pandemic is changing the way everyone, and everything works. Vulnerabilities in cross-border supply chains have emerged and would motivate companies to rethink their global operations. Remote workforces may alter the way executive decision making is undertaken and impact distribution of value generating activities beyond the centralized models we are familiar with today. Business models may need to be reimagined given the digital surge and companies might increasingly pivot to online, mobile-first or contactless technologies and automate processes. This impetus would require long term supply chain restructuring and a futuristic transfer pricing policy reflecting the principles of digital economy taxation and a more equitable distribution of the global tax pie. These are being debated and discussed at the Organization for Economic Cooperation & Development (OECD)’s pillar one and pillar two consultations and are expected to have far reaching implications.

Concluding thoughts

In his analysis of whether COVID-19 rises to the level of a black swan event^[4], Glenn McGillivray writes, “Since the “black swan” metaphor was coined in the 2007 book^[5] of the same name, it has become fashionable to label virtually all low probability-high impact events black swans. But the danger of making an occurrence like COVID-19 appear to be astronomically rare is we will treat it as such and fail to prepare for the next pandemic.” He goes on to say, “Indeed Taleb recently weighed in on the question of whether COVID-19 is or isn’t a black swan. Spoiler alert: it isn’t.”

The critical point is many so-called unthinkable scenarios may not necessarily be beyond the realm of the plausible and companies need to plan and prepare for these. Flexibility and adaptability will be key.