On 18 December 2020, the OECD published its much-anticipated “Guidance on the Transfer Pricing Implications of the COVID-19 Pandemic”.
It is clear that government restrictions and trading difficulties have created an environment in which existing transfer pricing policies will not always be appropriate. The OECD has done well to reach rapid consensus among its members on four key transfer pricing topics, namely: comparability analysis, losses and the allocation of COVID-19-specific costs, government assistance programmes and advance pricing agreements (APAs). It is hoped that taxpayers and tax administrations will be able to apply this guidance and circumvent the increase in disputes that would otherwise emerge.
The guidance begins by noting that the first task incumbent upon businesses is to document how they have been affected by the crisis, contemporaneously with the occurrence of the impacts.
The OECD states that where a multi-year transfer pricing agreement is in place which specifies a fixed price, there is no need to carry out new benchmarking for the present year, provided – crucially – that arm’s-length parties would not seek to renegotiate the agreement. Where new benchmarking is required, adjustments to pre-pandemic database figures should be considered in light of the effects of lower sales and capacity utilisation, additional costs, and government restrictions and assistance. These might be measured by comparing interim company figures with those from the previous year or with the budget for the current year, or by adjusting older comparables by reference to public information for the current year on developments in the industry or whole economy. Regression analysis could be used to calculate impacts in this way. However, the guidance warns against using information from the previous crisis in 2008-2009.
Losses and the allocation of COVID-19-specific costs
The guidance emphasises that the starting point for allocating losses is the contractual allocation of risks between the parties, taking care to consider whether certain costs may not be covered by the agreement at all. It is acceptable even for “low-risk” parties to bear losses in the short run; for example, if sales fall dramatically enough. However, taxpayers should consider whether it would be in the longer-term interests of the parties – if they were independent – to be flexible about adherence to the agreement in the short term, or even to negotiate a different longer-term arrangement.
Government assistance programmes
The guidance notes that businesses in some industries are more able to pass on costs, or more pressured to share subsidies with their customers than are businesses in other industries. Therefore, calculating the impact of government actions for the purposes of comparability analysis also requires an analysis of the degree of competition in the industry. In addition, it is stated that government assistance should only be “shared” where a) the other party would also have met the criteria for the assistance and b) arm’s-length parties would have agreed to share the assistance.
Advance Pricing Agreements
Unsurprisingly, the guidance states that APAs should be respected unless the pandemic has changed one of the fundamental assumptions underpinning them. Unfortunately, this can only be determined on a case-by-case basis. It is up to the taxpayer to make this determination and warn the tax authorities if it has happened. However, tax authorities are asked to wait for sufficient information to become available before making any decision to revise, cancel or revoke an APA.
Taxpayers are advised to:
- calculate and document the impact of the pandemic on their business;
- alert the tax administration to any likely breach of a critical APA assumption;
- review whether existing related party agreements would permit certain costs or revenues to be shared and, in any case, whether it is in the longer-term interests of the parties to do so; and
- adjust benchmarks before applying them to the current situation.