Transfer pricing: COVID-19 guidance

24 April 2020

Transfer Pricing Guidance: Businesses should ensure they have suitable inter-company policies during the Coronavirus (COVID-19) crisis

The outbreak of the COVID-19 pandemic (also known as Coronavirus) has impacted economies worldwide in an unprecedented manner with businesses looking at significant Government support while attempting to, literally, stay afloat.

The pandemic is heavily impacting economies worldwide, causing considerable shifts in financial markets and business activities for the new financial year. With businesses needing good cash management skills to reduce the stress on the financial front, transfer pricing could well be the tool to turn towards if applied in a structured approach and supported by legal agreements.

Challenges faced

Clearly, for most sectors – including leisure, hospitality and aviation – the demand shock from a bottoming out of consumers and consumption in hitherto strong markets is creating significant financial hardships. On the other hand, entities operating in sectors such as technology, healthcare, energy & utilities, supermarkets (with the ability to offer online services in the very least) may occasionally find themselves unable to keep up with the surge in demand or difficulties faced due to severe lockdown restrictions. 

Some common challenges that every company is likely to encounter in the coming short to medium term are:

  • Cost escalations from supply chain disruptions;
  • Shut down of operations from lockdowns;
  • Labour shortages;
  • Change in demand and supply patterns;
  • Break-down of traditional distribution channels; and
  • High inventory stockpiles.

To address such issues, the way in which multinational groups choose to set out their intercompany arrangements is likely to impact their ability to tide over the tough times. In many instances it would require re-looking at the group structure and realistically assessing firstly, if there is an existing and appropriate TP policy in place and then looking in detail at which entities are bearing the transfer pricing risks, if such entities possess the financial capacity to do so and whether this can be evidenced.

Businesses should also look to evaluate:

  • how are the DEMPE control functions continuing and where are the key risk bearing decisions being taken;
  • third-party behaviour, if available, to take reasonable decisions for waiving and/or providing moratoriums on royalty payments and/or management fees;
  • if there a financial control mechanism to accurately track losses and gains arising during the pandemic period and which entities are bearing these financial impacts? Having such a measure could be useful in demonstrating arm’s length behaviour before and after the pandemic periods;
  • any potential challenges from the local tax authorities in the jurisdictions where the group has a footprint.

Measures to be taken

Proactive measures ought to be taken and depending on the facts and circumstances of each case, these could involve:

  • entering into dialogues with local tax authorities to revise previously agreed arrangements (such as APAs, ATCAs, or time-bound safe harbour agreements under domestic laws) to reflect new business realities;
  • exploring potential arrangements on contentious topics such as management cross-charges – with the tax authorities and (to a lesser extent) with the related party;
  • renegotiating pre-agreed fixed compensation by the principal entity for related parties (characterised as contract manufacturers, contract service providers or limited risk distributors) for the short-to-medium term;
  • benchmark current business performance against results achieved during previous disruptive events; for example, the financial crash of 2008 rather than the customary practice of a multi-year weighted average benchmark study;

Several of these measures are possible only by having a cross functional task force comprising legal, tax, finance and operations personnel to put something in place quickly and effectively. Even then, the transfer pricing implications of where such decisions are taken and the effective management in implementing it across the Group should not be lost sight of.

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