COVID-19 Transfer Pricing
There is little doubt multinational enterprises (“MNEs”) in all industries will be adversely affected by the coronavirus disease (COVID-19) during 2020 and future years. Transfer pricing can have a significant impact on an MNE’s overall tax liabilities during normal years, and crisis years offer a unique set of issues and opportunities to potentially reduce overall taxes.
Additionally, though a situation like COVID-19 is out of an MNE’s control, transfer pricing audits are more likely in tax years where adverse conditions negatively affected profit margins, leading tax authorities to challenge the underlying transfer pricing policies. However, proactive transfer pricing adjustments during system-wide losses can help an MNE reduce cash flow pressures as well as alleviate paying tax unnecessarily in jurisdictions because of adherence to pre-COVID-19 transfer pricing policies. At the same time, there are actions MNEs can take to proactively document non-transfer pricing impacts and put themselves in better position to explain to tax authorities the validity of their policies despite unexpected deviations caused by extraordinary factors such as COVID-19.
Cherry Bekaert can assist an MNE in considering how to best adjust its transfer prices to correct for unexpected deviations while avoiding tax/cash traps as well as how to document the negative impacts of these deviations.
Transfer Pricing Adjustments
MNEs typically set their transfer prices at the beginning of the year and have transfer pricing policies that were set at some point in the past. These prices and their results hold true only if the related parties meet their budgets and results are consistent with forecasts. A disaster having economic impacts such as COVID-19 happening unexpectedly will likely spark a need to give some thought to adjusting transfer pricing arrangements. Too many MNEs will not give this consideration until after the end of the year and timing is a big factor when making transfer pricing adjustments. There are many options for adjusting transfer prices during the year, after the year but before the books have closed, after the books have closed but before filing the tax return, or after the tax return is filed.
The least problematic transfer pricing adjustment scenario for an MNE is to begin thinking about COVID-19 effects on global transfer pricing arrangements and results during the 2020 year as adverse impacts unfold. In the wake of global losses for an MNE, this may mean temporarily suspending royalties and management fees or modifying transfer pricing policies on intercompany product sales. Many MNEs designed their transfer pricing policies for “limited-risk” entities (distributors, contract manufacturers, contract service providers) to achieve set profit levels, and deciding how to temporarily modify such arrangements will be critical. Tax authorities throughout the world have long held the view that limited-risk entities should earn profits. However, since a global event such as COVID-19 will lead to global losses for many MNEs, is it appropriate for limited-risk entities to share those losses? The short answer is likely yes, and the time to make adjustments to the transfer pricing policies is now.
What to Do Now
When making adjustments to transfer pricing policies, as with all things transfer pricing, it is best to have evidence of how third parties would behave under similar circumstances. Most agreements between third parties have pricing adjustment clauses and/or force majeure clauses that contemplate unforeseen events. Ideally, an MNE’s intercompany agreements will not only exist, but also have similar clauses. Tax authorities are generally more respectful of transfer pricing adjustments where these arrangements/clauses exist prior to the unexpected event. An MNE should consider implementing intercompany agreements or modifying existing agreements that incorporate such clauses.
An MNE should adjust its global budgets/forecasts for the remainder of the 2020 year as quickly as possible. From a transfer pricing perspective, this serves a couple purposes. First, this will give an indication of how transfer pricing policies will need to change to achieve the new unexpected results and how these changes can be implemented for the balance of the year. Second, transfer pricing policies can have a big impact on cash flow/needs, and changing the policies sooner can help reduce unnecessary cash pressures brought on by continuing to follow pre-COVID-19 policies. Next, reducing forecasts and pricing can be reflected in things such as estimated tax payments and customs/duties paid on intercompany goods eliminating the need to request refunds later, which may be a lengthy process. Last, contemplating revised forecasts and transfer pricing now will put an MNE in better position to quantify the impacts COVID-19 had on transfer pricing policies and results that will assist with the documentation process in the following year.
Transfer Pricing Documentation and COVID-19
Tax audits are retrospective in nature and it may be years later when an MNE faces an audit for its transfer pricing policies during year(s) affected by COVID-19. In too many cases, MNEs attempt to document their transfer pricing arrangements and explain results to a tax authority years after important facts and details are not as clear or readily available. The documentation and discussion around COVID-19 adverse impacts will be particularly critical for limited-risk entities where transfer pricing policies are set so they achieve a set profit margin or markup and results differ negatively. Also, because of time lags in obtaining data and the process typically used to search for comparables for such entities, the COVID-19 economic analysis and adjustments to comparables will be more complex than in past years. Lastly, it is recommended that taxpayers document their transfer pricing arrangements as the COVID-19 situation unfolds, not only to meet contemporaneous documentation requirements, but to also to memorialize its impacts for a potential audit covering the COVID-19 tax years that occurs several years in the future.
If you have questions or concerns on how this applies to your unique situation, please contact the Transfer Pricing team.
