The unique economic conditions arising from COVID-19 and government responses to the pandemic have led to practical challenges for the application of the arm’s length principle. In order to help tax administrations and multinational enterprises (“MNEs”) find mutually satisfactory solutions to transfer pricing cases, the Organization for Economic Co-operation and Development (“OECD”) published Guidance on the transfer pricing implications of the COVID-19 pandemic in December 2020. The Guidance focuses on four priority areas:
The pandemic may have a significant impact on the pricing of some third-party transactions such that the reliability of historical data used in comparability analyses is reduced. A comparability analysis must specifically delineate the related party transaction, including its actual economic circumstances. Inclusion of a price adjustment mechanism in related party transactions may give flexibility while maintaining an arm’s length outcome.
Losses and the allocation of COVID-19 specific costs
The allocation of risks affects how profits or losses are determined at arm’s length. Comparables must reflect the level of risks assumed by each of the parties to the transaction. Exceptional, non-recurring operating costs arising as a result of COVID-19 should be allocated between group companies based on an assessment of how independent parties operate. Comparability adjustments may be necessary to take account of extraordinary costs.
Government assistance programs
Many governments have provided assistance through a variety of different job retention programs, and broader financial and liquidity support. The terms and conditions of these programs need to be considered when determining the effect on related party transactions, including whether support is temporary or ongoing.
Advance pricing agreements (“APAs”)
Some businesses may face challenges in applying existing APAs under current conditions. Existing APAs and their terms should be respected unless a breach of critical assumptions has occurred. However, the effects of COVID-19 and the response of governments are likely to qualify as a breach for some businesses. Tax authorities should be notified as soon as possible if the breach of critical assumptions has occurred due to COVID-19.
The impact of COVID-19 and uncertainties are expected to continue in 2021. Taxpayers should understand and weigh accurately the implications of transfer pricing decisions that will be taken during the COVID-19 pandemic and be prepared to explain and defend their decisions.
Refer to the OECD Guidance on the transfer pricing implications of the COVID-19 pandemic for more details and illustrations.