Covid-19 – Transfer pricing impact and responses

Covid-19 will have far reaching consequences for societies, communities, companies and individuals alike. The impact of the pandemic also raises a number of transfer pricing issues on the background of which multinational enterprises may consider implementing business critical changes to established operating models and supply chains.

Consideration of extraordinary events

For many multinational enterprises (MNEs), the Covid-19 business environment will entail a shortage of supply, a sharp increase in costs, as well as a potential (significant) decline in demand which may drive down system profit, resulting in extraordinary losses impacting the MNEs’ financial results. As a result, it should be considered how to account for such unplanned fluctuating operating results from a transfer pricing perspective. Many MNEs are currently evaluating their existing transfer pricing policies and operating models in an effort to manage short and long-term liquidity needs in today’s unprecedented environment, which include:

• Determining how exceptional costs can and should be treated through current transfer pricing arrangements;
• Considering whether returns for “routine” entities/functions, such as routine distributors and contract manufacturers, can be revised given both cash flow needs and the macro-economic impact relative to third party comparability/benchmarking studies; and
• Considering potential effects on royalties and service charges.

As indicated above, critical transfer pricing assessments are necessary to determine how losses and gains associated with Covid-19 should be allocated between the MNEs’ value chain participants. Considerations may include, but are not limited to:

• An assessment of the management and allocation of risk within each company’s specific transfer pricing model.
• What does the company’s transfer pricing documentation or legal agreements say about which parties bear specific risks, restructuring costs, price adjustment and force majeure clauses etc.?
• Where is (or should) special event risk borne according to the company’s transfer pricing model?
• Where are key risk management decisions about Covid-19 responses being made?

MNEs should aim to align these considerations and may consider more long-term changes to the transfer pricing model. In this respect, we advise to evaluate whether adjustments should be made to existing intercompany contracts in order to account for the impact of a decrease in system profit and, in the long term, to include detailed support in the transfer pricing documentation or defense files supporting the allocation of lower or higher than expected profits. As the facts and circumstances may differ considerably between MNEs, there is no boilerplate “one-size-fits-all” in this respect.

MNEs which depend on Advance Pricing Agreements (“APAs”) and/or rulings from tax authorities should review critical assumptions, as the basis for such assumptions may change due to implications on the value chain drivers and profitability of the group as touched upon above. If this is the case, it is of vital importance to reconnect with the competent authorities to determine if any critical assumptions can be (or perhaps have to be) revised, if they will accept a deviation this year or, worst case, if the APA would no longer be considered applicable.

Other immediate actions to be considered from a transfer pricing perspective

• Get an overview and understanding of who makes the decisions that are fundamental to the reaction to the Covid-19 crisis and ensure that these decision makers are reflected properly in the company’s functional and risk analysis.
• Ensure that the way your organization reacts to the crisis is aligned with the conclusions of your DEMPE analysis.
• Ensure a thorough understanding of existing Government support measures throughout the world. In summary, most Governments have presented measures to support public services, people and businesses through the disruption caused by the Covid-19 outbreak. These measures focus on e.g. supporting employment, reducing costs and providing cash flow support to businesses. An understanding of such support measures which an MNE may plan to make use of and determine whether such measures may impact the current transfer pricing model and internal compensation structure is critical.
• If your group is already aware that the Covid-19 crisis will require adjustments of profitability levels or have significant impact on the supply chain (i.e. delay of products), we recommend that the intercompany agreements are reviewed and amended now (if possible) in respect of the force majeure, termination and renegotiation clauses, since adjusting profitability levels or other contractual assumptions which “contradict” existing agreements may cause legal and transfer pricing scrutiny.
• Analyze Covid-19’s impact on MNEs’ access to funding and financing, and consequences for transfer pricing of intercompany financial transactions.
• Evaluate BEPS 2.0 impact with an assumption about potential Covid-19 impact.

The challenging times associated with the Covid-19 crisis are expected to continue, and at this stage it is difficult to fully predict the magnitude of the impact it will have on transfer pricing policies during this volatile and highly uncertain period. EY’s transfer pricing team continues to monitor the potential impacts to transfer pricing that this may have, and we are happy to discuss any potential implications that may be affecting you and your organization.

Mikael Hall, Olov Persson, Linus Peterson and Clemens Mader