Crisis caused by COVID-19 had a sudden, negative impact on both macroeconomic conditions and the profitability of many domestic and international companies. In this context, the change in economic conditions has led to significant consequences for the transfer pricing policy adopted by the capital groups, which are forced to adapt their business models rapidly.
These circumstances seem to be even more important in a globalised world where the crisis is affecting one country or one The market has unforeseen consequences at global level. This article presents some key challenges related to transfer pricing that may arise as a result of the economic recession and how these challenges can be managed.
Comparability analysis problems
Crisis caused by COVID-19 It will undoubtedly complicate the process of drawing up comparability analyses both in terms of transfer pricing planning and in the verification phase of the assumptions previously adopted.
Identification of comparable data for transfer pricing analyses 2020 will be particularly difficult, as the financial data on independent enterprises from which such source data could come (and to which the crisis will already affect) COVID-19, will generally not be available until 2021
In addition, entities that have so far updated the comparative analysis once per three years (according to Article 11r CIT laws), should verify the need to change the approach to benchmarking for the year 2020 having regard to data for the previous years.
In the above situation, it may appear that, for example, the analysis made to the documentation for a year 2018 (with the intention to apply it also in subsequent years), which was to be "up-to-date" in the year 2020, due to changes in economic conditions, it will have to be updated in advance.
The unusual business conditions that have arisen so far 2020, could also make it necessary to change a number of existing practices for benchmarking, such as the use of multi-annual analysis including data from 2020
Often used in benchmarking analyses to averaging multi-annual financial results may prove inappropriate in the event of such sharp market collapses as in the case of COVID-19.
Furthermore, consideration should also be given to changing the approach to the application of a relatively large comparative sample, consisting of companies that are functionally comparable, but cover different industries and jurisdictions for which the crisis is facing. COVID-19 may have a different effect.
While the impact COVID-19 the benchmarking and documentation of transfer prices will likely vary from sector to sector, and even from company to company, a new perspective on the solutions to date will be needed and the need for the groups to consider making exceptions to the long-term transfer pricing policy adopted so far.
Tax payers who:
- intend to draw up a comparative analysis for the year 2020, on the basis of available market data i.e. data from previous years, since the scope of comparative data based on completely different market conditions than the current ones do not fully reflect current economic conditions,
- intend to use in the benchmarking analysis 2020 the data collected in the dossiers for the previous years, as it may appear during the review that comparable data used for previous analyses may not be up to date due to the failure to take account of losses caused by market turbulence,
- apply the practice of benchmarking with regard to multi-annual data, as the comparability of such data may be distorted in the current situation.
Allocation of costs
The distribution of costs between the members of the group, covering both intra-group costs affected by the crisis and costs directly caused by COVID-19, should be reviewed and monitored from the point of view of transfer prices.
In particular, it should be considered how such costs should be shared between a group of related parties and whether it is appropriate that a limited market risk group member should be allocated a share of such costs.
This can be illustrated by a typical multi-annual agreement with a limited risk distributor.
Typically, such an agreement provides that the distributor achieves a fixed small margin and that all other profits or losses are due to the payer.
Although the distribution agreement provides that the payer will bear most of the costs and risks associated with the transaction in the ordinary course of business, the tax authorities may question the appropriateness of the solutions adopted in a situation such as a crisis COVID-19, in which companies suffer sudden losses due to both supply chain interruptions and falling demand.
one of the question which companies should consider is to correct existing agreements with related parties, in order to take into account the deviations from the market price principle in such a way that the agreements provide for the possibility of price changes in the event of material macroeconomic events.
Particular attention should be paid to the difficulties, force majeure and other provisions that may make it necessary to transfer profits or losses in order to make the costs of the crisis more equitablely spread to a group of related parties.
In any event, the cost-sharing analysis should include a review of the rights and assets of the parties to the transaction, the risks involved and the economic justification of the transaction. The terms of the agreements concluded between related parties will be particularly important in this respect, but tax authorities will certainly also take into account the actual conduct of the transaction and the actual behaviour of the parties implementing the contract.
Business strategy
Many companies are currently taking action to introduce contingency plans, often bypassing transfer pricing issues. However, companies should already start dealing with these aspects and consider documenting business decisions on transfer pricing policy in order to confirm their legitimacy in the event of possible controls in subsequent years.
From an economic and financial point of view, it is particularly important that the capital groups are well prepared to make any necessary changes to the business strategy of companies and that business decisions made in connection with transfer pricing policies are properly documented.
In particular, the capital groups should assess whether it is necessary to review pricing strategies, the location of subsidiaries, the cost structure and contracts between related parties, and to carry out business restructuring to manage tax and transfer pricing policies.
Restructuring of loss-making activities
Capital groups that have seriously suffered from the recession may experience a decline in margins and expected future revenues, which will force them to restructure supply chains and business to reduce operating costs.
The restructuring and termination costs should be allocated to the entities of the group in accordance with the market price principle.
Restructuring of loss-making activities may, in certain circumstances, bring benefits to the restructured entity. In that case, the remuneration of the acquirer of economically significant risks, functions or assets by the restructured entity shall be considered.
The transfer of loss-making activities should also be analysed from the point of view of the acquirer whether he would be willing to purchase (e.g. due to potential economies of scale), loss-making activities and, if so, under what conditions.
Recommended actions
During the crisis, groups of related parties face a number of problems that affect their activities and strategies, including transfer pricing policies.
Therefore, these companies should assess as closely as possible the potential impact of the crisis on the value chain and consider changing their transfer pricing policy in order to adapt it to the changing economic scenario.
It is a natural phenomenon that, in rapidly changing circumstances, a single update of policy conditions may not be sufficient – it is necessary to ensure that the policy conditions applied are consistent with the period for which the policy option is applied.
Capital groups should review their contracts to examine how the impact should be taken into account COVID-19, on civil and tax implications (including transfer pricing).
Businesses should also consider which deviations from their transfer pricing policies may be appropriate for 2020 In particular, in the case of companies with a tax year ending in the next few months, this need seems particularly urgent.
It is worth noting that the decline in profits may be of interest to the competent tax authorities. The taxpayer should be able to demonstrate that such results are due to economic factors rather than transfer pricing policies adopted on a non-market basis.
Significant resources allocated to government action to control the virus will inevitably put pressure on tax authorities in the future to increase tax revenues through checks to finance these measures.
Tax payers should anticipate these challenges in order to be able to proactively manage their risks in good time. Through appropriate analysis and documentation, taxpayers should be able to significantly reduce transfer pricing risks and, if necessary, effectively defend their revised transfer pricing policies.