The OECD has published guidance to multinational groups and tax authorities on how to keep transfer pricing between related parties on market terms when the market itself is affected by COVID-19. Israel joined the OECD in 2010.
Much international trade is done via related companies in multinational groups.
Below are highlights from the OECD “Guidance on the transfer pricing implications of the COVID-19 pandemic” (December 18, 2020).
The OECD guidance should help multinationals close their books for 2020 by clarifying how to use comparable published data about unrelated groups (“comparables”) in transfer pricing studies required by law.
The main issue – what’s happening?
The OECD says that during the pandemic, taxpayers may encounter difficulties in determining arm’s length conditions due to the time lag between related party “controlled” transactions and the availability of information regarding “contemporaneous uncontrolled transactions”.
The OECD says that where possible, during the pandemic, tax authorities could consider allowing taxpayers to take into account information that becomes available after the close of the taxable year in filing their returns.
For instance, assume government intervention forces a taxpayer to close its distribution facilities for three months. Care should be taken in verifying that comparable companies have faced similar restrictions. Otherwise, it might be necessary to adjust the period over which the comparison is performed (e.g., excluding the three months the taxpayer was unable to operate).
Can loss-making comparables be used?
The OECD says loss-making comparables should not be rejected on the sole basis that they suffer losses in periods affected by the COVID-19 pandemic.
Can “limited risk distributors” justify losses?
In cases where local subsidiaries buy products from abroad and sell them to local customers, it has become common practice to limit the risks they assume in order to limit the taxable profits they report. For example, they may use “flash title” and drop-shipping, resulting in limited risk of inventory obsolescence. Can losses be justified by the pandemic?
The OECD says that where there is a significant decline in demand due to COVID-19, distributors that assume some marketplace risk might earn a loss if the decline in demand means that sales are insufficient to cover local fixed costs.
However, it will not be appropriate for a “limited-risk” distributor that does not assume a specific risk to bear that risk. For instance, a “limited risk” distributor that does not assume credit risk should not bear losses derived from the credit risk.
And the OECD warns tax authorities about taxpayers taking inconsistent positions about risks assumed pre- and post-pandemic.
Can intercompany agreements be changed?
The OECD says unrelated enterprises may opt to renegotiate a contract to support the financial survival of any of the transactional counterparties given the potential costs or business disruptions of enforcing the contractual obligations, or in view of anticipated increased future business with the counterparty. However, in the absence of clear evidence that independent parties in comparable circumstances would have revised their existing agreements, the modification of existing intercompany arrangements is not arm’s length (i.e. not okay).
What about claiming “force majeure”?
Some groups are using force majeure to change transfer pricing. The OECD says a force majeure clause is unlikely to be invoked in a long-term relationship if the pandemic proves to be a short-term disruption. But if the disruption is for a “longer period”, it is more likely to be invoked.
Should exceptional pandemic costs be included in cost plus billings?
Many enterprises have incurred exceptional, non-recurring operating costs, such as Personal Protective Equipment (PPE), reconfiguration of workspaces to enable physical distancing, IT infrastructure expenses relating to test, track and trace obligations and to implement teleworking arrangements.
The OECD says look at risks assumed. The party initially incurring an exceptional cost may not be the party assuming risks associated to that cost, and consequently such costs may indeed be passed on to parties that do assume such risks.
More generally, when reviewing a net profit indicator, exceptional costs should generally be excluded (unless they relate to the controlled transaction).
What about government assistance?
There are many types. OECD says an exhaustive analysis would not be required if it is unlikely to have a material impact on the controlled transaction.
Should advance pricing agreements with a tax authority be changed?
The OECD recommends that taxpayers approach tax authorities about a revision if there has been a material change in conditions noted in a critical assumption due to COVID-19. New advance pricing agreements are encouraged, but for shorter periods or with retrospective amendments allowed.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
leon@h2cat.com
The writer is a certified public accountant and tax specialist at Ecommerce.Tax and Harris Horoviz Consulting & Tax Ltd.