The current crisis presents opportunities in the field of taxation and transfer pricing. Companies need to decide how to manage their intra-group transaction and transfer pricing systems, to reduce their current tax burden by changing intercompany prices.
Where we stand
The pandemic forms a clear and present danger for the global economy. Business supply chains are disrupted, with many businesses facing reduced demand, staff reductions and lower consumer confidence. Businesses are mobilizing their forces and energies to manage cashflow needs while trying to keep afloat. Due to reduced revenues and increased expenses, many multinational groups will face consolidated losses or experience significantly impaired operating results.
The economic impact of the pandemic will have obvious tax and transfer pricing consequences for multinational groups of companies, in particular those with centralized business models. We currently see the following potential impact from a transfer pricing point of view from a limited risk entities point of view:
- limited risk entities will report steady positive income while the business is faced with cash flow needs;
- local tax authorities challenge deduction of extraordinary expenses or losses;
- intercompany financing needs increasing due to local lack of liquidity.
In the transfer pricing landscape following BEPS (tax base erosion and profit shifting), companies should not only focus on substantiating amended pricing, but also the commercial rationale for changing intercompany transactions.
Changes in intercompany transactions require a review of intercompany agreements from a legal and economic perspective.
From the legal perspective, amending pricing in intercompany agreements may be possible based on the existence in these agreements of e.g. price adjustment, force majeure or termination clauses. In the absence of such clauses, reference can be made to behaviour by third parties under commercial law.
From an economic perspective, in addition to legal review or in the absence of intercompany agreements, companies will need to analyse the possibility to amend current intercompany transactions in line with actual conduct of the parties involved. This analysis will need to focus on
a) which party to the transaction performs which functions, and manages and incurs which risks,
b) the behaviour we currently see between third parties and
c) whether price adjustment can be considered commercially rational for both parties involved.
Amendment of transfer prices should be documented in local transfer pricing files drawn up for FY2020 (and potentially later years), containing the benchmarking analysis used to test revised intercompany prices. Application of the arm’s length principle relies on analysis of market prices and dynamics between independent parties. Current supply and demand shocks are likely to disrupt market prices in many sectors. As a result, identifying the correct prices for intra-group transactions is becoming particularly challenging.
Opportunities to look for
In looking for opportunities during the economic downturn, lower valuations could be beneficial in restructurings. For multinational entities which already wished to restructure in the past, but considered the exit costs too high, currently there is an opportunity to exit at lower costs due to lower valuations. This applies not only to transfer pricing-wise business restructuring but also to amending legal structures where shareholdings are to be transferred within the group. Also intra-group restructurings should be documented in transfer pricing documentation files.
Some companies have advance pricing arrangements (APAs) in place with tax authorities. It then comes into question whether the pandemic would result in the invalidation of the critical assumptions of existing APAs, or its impact on future profitability so as to necessitate reconsideration of the setting of critical assumptions, which could even trigger the need to bring APA matters back into discussion with the tax authorities.
If you wish to discuss this topic in more detail, please contact Sorainen transfer pricing specialists.