The COVID-19 pandemic has significantly disrupted business operations and financial markets. For companies that have reorganized operations to adapt to the evolving economic and business environment, existing transfer pricing policies may no longer apply with respect to corporate structure and intercompany cash flows. Some companies have moved parts of their supply chains as a result of the pandemic, making existing transfer pricing policies obsolete. Reduced profitability or disruptions to cash flows may affect an organization’s ability to follow existing transfer pricing policies and compensate its legal entities appropriately. Companies might issue intercompany debt to help finance entities, but there is a risk that these payments may not satisfy the arm’s-length standard.1
As a result of these and other changes arising from COVID-19, many businesses are implementing structural and transfer pricing changes, driven by shifting consumer demands (for example, moving to virtual models) and modifications to supply chains (for example, localization of manufacturing). Many global companies have gone out of business, requiring customers to seek other suppliers. Changing which related party is involved in the relationship may require a change in transfer pricing. Some companies are also determining which locations are responsible for functions such as manufacturing and sourcing and are rerouting their internal supply chains. Shifting the locations of functions may necessitate adjusting companies’ transfer pricing positions to match the change in intercompany flows.
Changes to transfer pricing policies should be consistent with market behavior and be supported by appropriate documentation. Companies that update their transfer pricing policies should include in their standard annual transfer pricing documentation a detailed description of the reasons for change. The company must also ensure that third parties agree to any revisions to agreements. Finally, companies should review their updated functions and the risks and assets of all relevant legal entities, as well as intercompany agreements.
During the pandemic, companies have faced or continue to face significant cash flow restrictions. Depending on industry, businesses may have also experienced significant increases or decreases in profitability. Companies across various industries have faced disruptions to their supply chains, including limits on their operations and corresponding decreases in production, and have had to change how they conduct business (for example, with remote work). In many jurisdictions, businesses have been forced to close. In some industries, demand has collapsed, whereas in others (such as the market for videoconferencing services) it has flourished.
On December 18, 2020, the Organisation for Economic Co-operation and Development (OECD) issued its policy response to COVID-19, “Guidance on the Transfer Pricing Implications of the COVID-19 Pandemic.”2 The guidance notes that COVID-19 has created significant challenges for taxpayers when performing comparability analyses. The pandemic could impact pricing of transactions between independent enterprises and may reduce the reliance that can be placed on historical data when companies perform these analyses. As a result, taxpayers and tax administrations should address comparability adjustments.
The new guidance focuses on how the arm’s-length principle and the OECD transfer pricing guidelines (TPG)3 apply to issues that may arise due to the pandemic. The OECD recommends that taxpayers apply existing guidance under the TPG to fact patterns that result from the pandemic. Taxpayers and tax administrations should follow Chapter I of the TPG to identify economically significant risks (such as COVID-19) assumed by each party to a controlled transaction.4 According to the guidance, the application of more than one transfer pricing method may be useful to support the arm’s-length price of a controlled transaction.
Due to COVID-19, a party may invoke a force majeure clause to assert that extreme circumstances justify the nonperformance of a contract. In “Guidance on the Transfer Pricing Implications of the COVID-19 Pandemic,” the OECD specifies that a force majeure clause “defines circumstances beyond the control of parties to a transaction that can frustrate or render impossible contractual performance.”5
In response to the pandemic, some taxpayers may try to argue force majeure in situations where the relevant intercompany agreement does not contain such a clause, change an existing intercompany agreement to insert a force majeure clause, or argue that renegotiation of arm’s-length pricing would have similar economic outcomes. Force majeure clauses may be invoked to suspend, defer, or release a company from its contractual duties without liability in certain situations.
Dispute Resolution (MAPs and APAs)
As a result of the pandemic, some companies have reviewed their contractual arrangements with third parties to determine whether they can terminate the agreement. In other cases, they have attempted to renegotiate key terms of the agreement. Transfer pricing issues arising from the COVID-19 pandemic could lead to additional mutual agreement procedure (MAP) disputes. Tax administrations should consider this possibility when performing risk assessments, evaluating transfer pricing positions on audits, and reviewing taxpayer support and documentation with respect to compliance with the arm’s-length principle.
Furthermore, COVID-19 has significantly changed economic conditions in ways unanticipated when many advance pricing arrangements (APAs) covering fiscal years 2020 and beyond were made. It is important to determine to what extent these changes affect the application of existing APAs.
A primary benefit of an APA is that it ensures predictability in the tax treatment of international transactions. Some taxpayers may face challenges applying existing APAs under the economic conditions resulting from COVID-19. In those instances, taxpayers are encouraged to adopt a collaborative and transparent approach by promptly raising these issues with the relevant tax administrations. Most APAs include specific assumptions about the operational and economic conditions that will affect transactions the APA covers. Since the COVID-19 pandemic has not affected all companies equally, the individual circumstances of each taxpayer should be taken into consideration.
Jessica Silbering-Meyer, JD, MBA, is a lead editor and author with the tax and accounting business of Thomson Reuters. She is the managing editor of Journal of International Taxation and Journal of Multistate Taxation and Incentives. She is also a
member of the New York bar.
- Internal Revenue Code Section 482; Treasury Regulations Section1.482-1(b)(1).
- “Guidance on the Transfer Pricing Implications of the COVID-19 Pandemic,” OECD, December 18, 2020, www.oecd.org/coronavirus/policy-responses/guidance-on-the-transfer-pricing-implications-of-the-covid-19-pandemic-731a59b0/#section-d1e614.
- “OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017,” OECD, July 10, 2017, www.oecd.org/tax/transfer-pricing/oecd-transfer-pricing-guidelines-for-multinational-enterprises-and-tax-administrations-20769717.htm.
- Treasury Regulations Section 1.482-1(i)(8).
- “Guidance on the Transfer Pricing Implications of the COVID-19 Pandemic,” ibid., chapter 2.6.