The disruption and change brought about by the COVID-19 pandemic over the course of recent months has forced multinational enterprises (MNEs) as well as tax authorities to face some key questions as to how this unprecedented event should be reflected from a transfer pricing perspective.
Within this relatively short period of time, a wide range of potential issues and solutions have presented themselves regarding how pre-pandemic transfer pricing models and policies should be treated in order to reflect the new commercial and operational realities that taxpayers and tax authorities face. On 18 December, the OECD released its “Guidance on the transfer pricing implications of the COVID-19 pandemic” (Guidance), in an attempt to address some of these topics.
Scope of OECD Guidance on transfer pricing implications of COVID-19
The Guidance is published as a consensus view of the 137 members of the Inclusive Framework on BEPS regarding the application of the arm’s length principle and the OECD Transfer Pricing Guidelines. It is aimed at supporting both taxpayers as well as tax authorities in addressing and resolving certain issues linked to the COVID-19 impact on transfer pricing policies and arm’s length dealings between related parties. Specifically, the Guidance focuses on four key areas (“priority issues”):
(i) Comparability analysis;
(ii) Losses and the allocation of COVID-19 specific costs;
(iii) Government assistance programmes; and
(iv) Advance Pricing Agreements.
Importantly, the Guidance is explicitly intended to provide additional clarity as to how the existing OECD Transfer Pricing Guidelines (TPG) should be applied – and not to develop specialised guidance beyond that already included in the TPG.
Key areas addressed by the OECD Guidance
Focusing on the four priority issues listed above, the Guidance provides a useful commentary and practical illustrations for a number of issues that taxpayer and advisors have had to face over the course of recent months.
Starting with the COVID-19 impact on comparability analysis, it recognises and comments on challenges related to using information sources from pre-pandemic periods and how these could be used in the most appropriate manner to either set or test the arm’s length nature of intercompany transactions or relationships. When addressing one of the recent popular approaches based on the use of global financial crisis data (2008/2009) as a proxy, the OECD suggests caution. Comments on price adjustments and the treatment of loss-making companies further address some of the frequent questions that both taxpayers and tax authorities have been raising in the recent past. Another potential approach mentioned by the OECD is to compare budgeted or forecast financial results to those actually achieved and to test transfer pricing outcomes based on the financial results that taxpayers would have achieved if COVID-19 had not occurred. This is an interesting notion as it also alludes to the discussion of ex-ante versus ex-post pricing approaches already included in the OECD TPG and which became a focal point of discussion in recent years with various countries expressing a view that the ex-ante approach may be the preferred approach depending on case-specific facts and circumstances.
The topic of losses and allocation of COVID-19 specific costs is addressed in the Guidance, including a number of useful examples (e.g. is a COVID-19 specific cost a temporary expenditure or a more lasting investment?). The OECD’s commentary on the allocation of risks and losses and the potential degree of loss exposure in “limited risk” transfer pricing models acknowledges some of the difficult challenges MNEs have been facing in recent months. Another topic explicitly addressed in the Guidance, which attracted a lot of attention once the extent of the COVID-19 pandemic started to become clear, is the renegotiation of existing arrangements and potential use of force majeure clauses (see also our commentary from April this year).
A number of observations in the Guidance focus on the potential impact of government assistance programmes, or interventions, on transfer pricing topics such as price setting, allocation of actually borne risks and the impact on comparability analyses due to the change in economic characteristics that such assistance may bring.
With regard to Advance Pricing Agreements (APAs), the Guidance reaffirms the usefulness and relevance of those as a means to ensure tax certainty, providing a number of recommendations to both taxpayers and tax authorities on how to tackle some of the challenges posed by the COVID-19 pandemic. Taxpayers should approach the relevance tax administration proactively and in a timely manner in connection with any potential impact of the pandemic on their APA(s) and their critical assumptions. The Guidance provides examples of the type of information and approaches that could be used to clarify and resolve potential pandemic-driven challenges that may affect APAs. Practical examples are provided as to when revision/cancellation/revocation of an APA may need to be pursued, as well as how to handle some “daily life” logistical issues related to the handling of APAs still under negotiation.
While recognising that a number of the issues related to transfer pricing driven by the COVID-19 pandemic are not straightforward to resolve or address, the Guidance provides a set of useful and (where possible) practical examples on how taxpayers and tax administrations should proceed in order to reach the most appropriate outcome, applying the arm’s length principle. As noted, even though the Guidance is not considered to be an amendment of or formal addition to the existing OECD TPG, it represents a useful basis for MNEs and tax administrations on how to navigate the continuously uncertain times ahead.
Given the uncertainty that remains, taxpayers are well advised to proactively address the impact of the COVID-19 pandemic on their transfer pricing models and, based on the new OECD guidance, think about ways to address these challenges (e.g. by engaging in discussions with tax authorities) and last but not least reflecting the outcome of their analysis in their annual transfer pricing documentation.
In addition to our existing webinars on the impact of COVID-19 on transfer pricing, a new round of virtual sessions will be held at the beginning of 2021 to provide some practical examples and discuss experiences from a Swiss as well as global perspective gathered in recent months. Please let us know if you would like to receive an invite or simply connect with us via our website or LinkedIn.