The IMF's Annual Report for 2020 described the COVID-19 pandemic as a "crisis like no other", which has "created the worst recession since the Great Depression". The health emergency has forced many economies to a standstill. While some businesses, such as in the technology sector, have been "winners", others have faced cash flow constraints, collapse in demand, disruptions in supply chains, and curtailment or even closure of operations, prompting unprecedented government assistance.
The extraordinary turbulence which most business have faced over the last 12 months has also caused challenges for many businesses’ transfer pricing models. For example, should COVID-19 losses all be borne by the group company which earns residual profits – or should these losses be spread across all the entities in the value chain? And how do companies update their pricing for 2020 comparables, when the data for those comparables will not be available before late 2021? Many businesses, and tax advisers, had urged the OECD to publish guidance setting out an agreed international approach to these questions, to minimise the risk of different approaches being adopted in different countries.
The OECD has now published guidance on these issues and it gives a clear message: the arm’s length principle and the OECD Transfer Pricing Guidelines 2017 are “fit for purpose” in dealing with the transfer pricing implications of COVID-19, and there is no need to adopt a different approach.
The guidance, which represents the consensus view of 137 members of the Inclusive Framework on BEPS, then provides some helpful clarifications for taxpayers and tax administrations in four "priority areas".
Where taxpayers argue that the effects of the pandemic mean that arm’s length pricing for 2020 has to reflect 2020 comparables, rather than relying on historic data, the OECD recommends that the effect of the pandemic on the taxpayer’s business should first be tested by, for example, using internal data on the effects of the pandemic, by comparing budgeted or forecasted financial results to those actually achieved, and by reviewing data available from public sources on the impact of the pandemic on the industry and the business as a whole.
Where this review demonstrates that taxpayers do need to use 2020 comparables data, tax administrations are urged to consider "pragmatic" and "flexible" approaches where taxpayers are making "good faith efforts" to obtain this contemporaneous data as quickly as possible. Allowing tax returns to be amended beyond normal time limits and accepting price adjustment clauses in intra-group contracts, to take account of new data as it becomes available are some examples.
Losses and allocation of COVID-19 specific costs
The pandemic has made many businesses and tax advisers query whether limited-risk entities, which currently make a cost-plus or low TNMM return, should bear a share of the group-wide losses (including due to “exceptional”, “non-recurring” or “extraordinary” COVID-19 related costs), rather than continuing to make profits. In particular, in such a scenario, could businesses invoke a force majeure clause, to force a limited-risk entity to renegotiate the existing contractual arrangement and accept a share of the losses?
Where a company has been making a limited return historically, on the basis that it bears limited (or no) risks, the OECD warns that tax authorities should be sceptical of arguments that the company should now bear a share of pandemic risk. Such an argument, if successful, may additionally expose taxpayers to the prospect of higher arm’s length profits for that entity in the future, and for any open years in the past.
Attempts to invoke "force majeure" clauses in intra-group contracts, especially where businesses argue that a force majeure clause can be implied into the agreement, or seek to change an existing intercompany agreement to insert a force majeure clause, are likely to attract similar scrutiny.
Businesses should look for appropriate third party examples of such positions. Similarly, where an existing agreement can be terminated by giving certain months’ notice, businesses could potentially force a renegotiation of the pricing by exercising that termination right. However, where the updated pricing puts greater risk onto the limited-risk entity in bad times, businesses should expect that the corollary will be a higher return for that entity in good times.
Government assistance programmes
The OECD guidance also considers whether COVID-19 related government assistance programmes should impact arm’s length prices. Its answer, as Kenny Dalglish would put it, is “maybes aye, maybes no”!
As usual, it all depends on the facts of the specific case – which should be tested in line with the existing OECD transfer pricing guidelines.
Existing APAs should not be affected by COVID-19, unless a condition leading to the cancellation or revision of the APA (for e.g., breach of critical assumptions) has occurred. If businesses are concerned that an APA is no longer appropriate, they should approach the relevant tax administration in a timely and transparent manner. Tax administrations, on the other hand, should consider waiting for a reasonable period until data and information on the magnitude and longevity of the economic impact of COVID-19 are available before determining how to respond to a breach.
Businesses and tax administrations are also encouraged to continue negotiating APAs through the pandemic.
In short, unsurprisingly, there is nothing novel in the OECD's guidance – and businesses have been told that this is one area, at least, where the “new normal” looks very similar to the pre-pandemic position.