All you need to know about how Covid could stuff up your transfer pricing?

COVID Ready?…….Perhaps impossible…(like x-mas parties at NO.10…) …. so let’s aim for TP COVID Ready…?

The unprecedented and far-reaching impact of the COVID- 19 pandemic certainly did not bypass transfer pricing (“TP”). For many multinational groups, robust TP documentation has become another key issue to consider in their business and tax management strategies whilst still dealing with the operational impacts of COVID-19. This newsletter addresses the key TP impacts of COVID 19, and what businesses should be considered to effectively manage potential TP challenges from 2020 through the recovery years.

Loss-making entities, cash flow, and financing arrangements 

As a result of the economic slowdown, business disruptions, and resulting financial impact, many multinationals required additional funding from group members in addition to third-party financing arrangements. This support may have been in the form of working capital advances, intercompany loans, or discounted prices. In other cases, intercompany payments were delayed to alleviate local cash-flow requirements. Any additional inter-group financing support needs to be sense-checked to ensure it remains aligned to wider external financing arrangements and the arm’s length principle.

Many multinationals made significant losses or saw significant volatility in their financial performance because of the COVID 19 pandemic. These fluctuations will need to be carefully explained and evidenced in the TP documentation, to ensure it can be demonstrated (in so far as possible) that such losses were not because of transfer pricing but rather due to specific identifiable impacts of COVID 19. Comparability analysis has become a key challenge for Groups, due to the reliance on historical data and the delay in information typically available for third-party benchmarks. The nature and form of adjustments that would need to be performed are extremely fact-specific, and a critical part of the analysis now required in TP documentation.

Supply chain and operational changes

Due to the immediate impact of COVID 19 on global businesses, the functional profile of entities within the group supply chain may have undergone operational or risk-based changes. For example, a manufacturer may have had to cease activities and convert to a procurement entity, or there may have been a temporary transfer of functions to another jurisdiction to deal with specific COVID 19 in-country rules. Any change in functional or risk profile should trigger a review of the transfer pricing policies applied.

As such, one of the key TP trends emerging as a result of COVID 19 is that TP models may have been or may need to be adjusted to reflect any change to the intercompany transactions, value-creating activities, or functional and risk profile of relevant entities within the Group.

Contractual arrangements and TP Documentation

As always in TP, it is key to ensure that a group ensures that its intercompany contractual agreements align with the underlying substance of the arrangements. Any changing fact pattern that occurred because of the COVID 19 pandemic should be carefully captured in the relevant legal agreements. Furthermore, it is critical for groups to carefully document all economic, business, and TP model impacts in their annual TP documentation to ensure as robust support as possible for their TP position. Unfortunately, it seems TP Documentation may be getting heavier and more complicated despite our global focus on digitising and simplifying the TP process!

What next?

The tax authorities, just like everyone else are under extreme pressure to raise revenues. We have seen a dramatic increase in TP audits and disputes in recent years, which is only rising further as a result of the COVID 19 pandemic. There are pockets to be filled. TP documentation and supporting analyses have gotten more complicated and as the pressure mounts, the best bet is to be as prepared as possible. TP won’t just go away and requires ongoing investment to manage compliance and risk effectively. If you want to ensure you are as TP COVID-ready as you can be, please contact us.