Guidance on the transfer pricing implications of the COVID-19 pandemic

The Organisation for Economic Co-operation and Development (OECD) has released a much-awaited guidance report on the transfer pricing implications of COVID-19.

The OECD report recommends the reliance of tax administrators and multinational enterprises on the use of existing arm’s length principles and the OECD’s Transfer Pricing Guidelines which were issued in 2017.

The majority of practical challenges that the OECD believes businesses are likely to encounter from COVID-19 disruptions include:

• The need for maintaining steady cash-flow positions
• Severe disruptions to the supply chain including curtailment of operations in many instances; and,
• New measures that businesses have had to put in place for business continuity (like working from home, where this is a feasible option).

The report focuses on four priority issues.

1. Comparability Analysis

The Report recognises that the unprecedented changes in the economic environment has created unique challenges for performing comparability analysis; with significant changes to the nature and pricing of transactions as a direct result of the pandemic.

The OECD encourages taxpayers and tax administrations to consider practical approaches that can be adopted to address information deficiencies.

Significant emphasis is placed on using publicly available information, in any form, regarding the effects of COVID-19 on businesses, industry and intra-group transactions.

Examples of such information would be:

• Third-party behaviour as available in the current year or previous recessionary period
• Economic trends – both macro and micro – like country specific GDP data or industry indicators
• Data on sales volumes, and exceptional, non-recurring costs

2. Losses and allocation of COVID-19 specific costs

The Report acknowledges that allocation of losses within the Group entities is an area which is likely to raise disputes. Going forward, there is a greater possibility of finding such occurrences between the tax payer and the tax administration based on positions adopted by each.

To deal with this issue, the Report outlines some of the following points:

• Risk assessment of entities: The Report has drawn reference to the need for analysing risks as set out in the documentation and intercompany agreements of the MNE. This is an important requirement particularly if taxpayers are found to be taking inconsistent positions in pre- and post- COVID-19 settings.
• Treatment of “exceptional”, “non-recurring” or “extraordinary” costs: In dealing with such costs, the Report emphasises the need to analyse the nature of these costs in greater detail, including looking at other factors such as how independent enterprises treat and label them, the risks assumed by the parties, and the impact of such costs on the intercompany pricing.
• Reliance on Force Majeure clauses: The OECD recognises that independent third parties could look at re-negotiating, or at times revoking, the terms in existing agreements

3. Government assistance programs

The Report suggests that terms and conditions of government assistance programs for COVID-19 should be factored into the impact on controlled transactions. Government assistance could take the form of monetary or non-monetary assistance, such as grants, subsidies, soft loans, tax deductions, etc, which provide taxpayers with both direct and indirect economic benefits.

As a general rule, the OECD guidelines recommend that government assistance should be considered as a factor for transfer pricing outcomes in a particular jurisdiction. Where a business has received any assistance, this fact should be disclosed as relevant information in the documentation when performing the transfer pricing analysis irrespective of whether the government assistance has resulted in any economic benefit for the local entity. This disclosure would also be relevant when performing the comparability analysis and in the selection of potential comparables.

4. Advance pricing agreements (APAs)

Though APAs are very attractive for businesses and authorities as it provides certainty, there is hesitation on both sides on what terms would be reasonable to agree to during these uncertain periods arising from the pandemic.

For APAs that have been agreed upon between taxpayers and tax authorities, the Report encourages following a collaborative approach throughout the process.

For existing APAs, the Report maintains that the terms should continue to be respected, maintained and upheld unless conditions which contribute to breach of critical assumptions occur requiring a cancellation or revision of
the APA. Mere changes to business results are not factors which can be held to be a breach of the critical assumptions unless this was specifically included as such.

The Report states that, broadly, there are three results possible under the APA process during the COVID-19 period:

• The taxpayer and tax administrators may agree to a revision to the APA wherein the terms would be modified, potentially with a revised analysis of the conditions that the business is experiencing and the forecast expectations of the domestic administration;
• Both parties to the APA may agree to a cancellation of the APA in which case it would be treated as effective for the period up to the cancellation;
• A revocation of the APA in which case it would be treated as not having been entered into.