On 18 December 2020, the OECD released its guidance on the transfer pricing implications of the COVID-19 pandemic (“the Paper”).1 It represents the consensus view of the 137 members of the Inclusive Framework on BEPS.
Although we understand that the process of drafting such guidelines, and obtaining a consensus from all relevant member states takes time, the guidance was published rather late in 2020. For companies that closed prior to 31 December 2020, the guidance was hence not yet available.
Considering that, in our view, the OECD Transfer Pricing Guidelines (“OECD TPG) as such already provided sufficient guidance on how multinational groups should deal with transfer pricing in exceptional circumstances, the value of this additional guidance is rather limited to some useful confirmations, insights and illustrations. We, of course, understand that in these unprecedented times, an organization like the OECD wants to proactively provide guidance to taxpayers and tax administrations.
As many companies have already been evaluating and acting upon the impact of the COVID-19 pandemic during 2020, it is our view that the Paper would not change anything on conclusions that were made prior to its publication where groups have applied the OECD TPG. The Paper also confirms that the OECD TPG should still be relied upon when assessing the COVID-19’s impact together with the OECD TPG’s analytical framework. We believe the additional guidance should be considered within the OECD TPG’s analytical framework.
The OECD provides inputs on 4 priority issues that were identified in consultation with Business. The 4 priority issues identified are the following: (i) comparability analysis; (ii) losses and the allocation of COVID-19-specific costs; (iii) government assistance programmes and (iv) advance pricing agreements. These items are detailed further in the Paper in 4 separate chapters.
In this article, we first provide our key takeaways and then a summary of the Paper’s main elements.
2. Short-read: Key takeaways
The Paper’s most important considerations (in our view) and our related comments are summarized here below.
- The guidance on the accurate delineation of controlled transactions in Chapter I of the OECD TPG, which is required to identify the economically significant risks and to determine which party assumes these risks in a controlled transaction, clearly remains a key aspect regardless of the COVID-19 pandemic.
- As noted above, we fully agree that the OECD TPG has already provided sufficient guidance on how to deal with the impact of the COVID-19 pandemic. How economically significant risks have materialized and how these risks have been managed during the pandemic will be a key element in the overall transfer pricing assessment. Another complexity in the assessment of economically significant risks is that it may be possible that a party cannot influence the hazard associated with a pandemic, but nevertheless assumes other risks that have materialized as a result of the COVID-19 pandemic.
- The Paper states that care should be taken to determine how associated enterprises and the group as a whole respond to the manifestation of risks and the related effects.
- To us, the starting point of an impact assessment generally is the stand-alone perspective of associated enterprises – i.e. considering the arm’s length principle, the respective “options realistically available” for the parties involved. The group perspective may be relevant in certain cases, but should not be the starting point of the assessment.
- The Paper states that taxpayers should undertake reasonable and appropriate due diligence in evaluating the likely effects of the COVID-19 pandemic and in implementing appropriate changes in their transfer prices and should document the best available market evidence currently available. It is key to understand that taxpayers may face some timing issues as not all the required information (be it related to the effect of the COVID-19 pandemic or the impact on comparables) will be available in FY2020, and that assessments should be made based on information available at moment of the assessment or the closing of the financial year. Tax administrations should not attempt to make adjustments based on hindsight, as this would not be in accordance with the arm’s length principle.
- As it can be observed that third parties have reassessed certain contractual arrangements, the Paper acknowledges that contractual arrangements of controlled transactions could be renegotiated where at arm’s length, unrelated parties would have tried to renegotiate those terms and conditions.
- Considering third party behaviour that can be observed irrespective of the COVID-19 pandemic, it is our view that (related) parties that have concluded contractual arrangements can always renegotiate the terms and conditions of their arrangements. When considering such renegotiations in a related party context, the arm’s length principle and the options realistically available to both parties should always be considered.
- The Paper acknowledges that (as a result of the COVID-19 pandemic) losses could be realised by so-called limited risk entities, but also indicates that no general rule can be applied in this respect and hence a case-by-case assessment should be made.
- The OECD TPG’s existing guidance on the analysis of risks in commercial or financial relations will be particularly relevant for determining how losses are allocated between associated parties.
- In our view, it is important to stress that the mere fact that an entity has a “limited risk” nature or has been remunerated applying a “stable” routine return, does not mean that it cannot incur a loss. Even though a case-by-case analysis is required, limited risk or a stable margin does not mean than an entity cannot incur a risk and no conclusions should be made based on the applicable/historic transfer pricing policy in this respect (which is sometimes observed in practice).
- It is acknowledged that the COVID-19 pandemic has led mainly to practical challenges for companies, such as the impact of government intervention or the reliability of comparable data.
- We agree that mainly practical issues have arisen due to the COVID-19 pandemic. It is important for companies to evaluate the impact of the pandemic on their business and not to keep on applying their transfer pricing policies on ‘auto-pilot’.
- Considering that a case-by-case analysis is required, as the Paper acknowledges that the COVID-19 pandemic’s economic impact varies widely across economies, industries and businesses, it is strongly advised that taxpayers seek to contemporaneously document how, and to what extent, the pandemic has affected them.
- The Paper states that the widespread effects of the COVID-19 pandemic in an industry or within an MNE group are not sufficient to claim that a member of an MNE group has to bear the consequences of risks materializing due to the COVID-19 pandemic without an analysis of the economically significant risks. A case-by-case assessment is therefore always required.
- Documenting the pandemic’s impact as well as the decisions/considerations that were made regarding transfer pricing are important in preparing for questions in the event of future audits.
- The receipt of government assistance will be relevant in the transfer pricing assessment to the extent that the receipt of government assistance is an economically relevant characteristic in view of the controlled transaction.
- The Paper acknowledges that there may be practical difficulties in assessing the impact for comparables considering: the various different types of COVID-19 government assistance programmes across jurisdictions, the practical difficulties in obtaining detailed and reliable information about them, and the delay in data availability.
- Regarding (unilateral, bilateral and multilateral) APAs and APAs under negotiation, there may have been material changes resulting in economic conditions that were not anticipated when APAs were concluded in the past for FY2020 and potentially future financial years.
- In these cases, it is advisable to raise these issues with the relevant tax administrations in a timely manner and for tax administrations and taxpayers to adopt a collaborative and transparent approach.
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1 OECD (2020), "Guidance on the transfer pricing implications of the COVID-19 pandemic", OECD Policy Responses to Coronavirus (COVID-19), OECD Publishing, Paris, https://doi.org/10.1787/731a59b0-en.