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Transfer pricing and Coronavirus

Published in Newsletters, Transfer pricing news

As we are all gradually coming to terms with the fact that Coronavirus is a reality, many enterprises are having to deal with immediate operational issues and manage immediate cash-flow tensions, negotiating with employees, suppliers and financial institutions, amongst others.  Companies are focussing their efforts in putting into place measures in order to mitigate as much as possible the negative economic impact that will be faced by many businesses locally as well as internationally.  The full extent of this impact is, for the most part, currently unknown and we are dealing with new information that changes the potential outcomes on a daily basis.  Multinational enterprises are needing to make certain decisions with regard to immediate operational necessities and they do this by looking at their enterprises as a whole, not necessarily on an individual country basis, but have they thought about their transfer pricing issues?

Undoubtedly, many companies will be subject to operational losses during the next few months and potentially years. Losses will arise for several reasons, some being immediate and perhaps temporary, such as loss of revenue, cessation of the activity or the cost of making employees redundant, and some will be ongoing, such as the inability to absorb fixed costs with a reduced future production volume. For multinational enterprises, should these losses be shared between the individual countries?

Should multinational enterprises using principal structures with limited risk distributors, limited risk service providers and toll or contract manufacturing entities seek to share these losses between all of the entities in the structure or should the principal take the hit?  Perhaps, but “limited risk” means limited risk, it does not necessarily mean “no risk”.  However, whatever position is taken, you must be prepared to defend the loss-making position of a local entity against your local tax inspector in a few years’ time when the tax authorities are undertaking an audit (and the gravity of the current situation is almost forgotten).

A review of an enterprises’ current transfer pricing arrangements may shed light on how certain risks are allocated between the entities, however it is unlikely that intercompany agreements have made sufficient provisions for circumstances such as the one we are currently immersed in.

For businesses that, in some shape or form, will be surviving Coronavirus, it is recommendable to plan for the new or modified transfer pricing strategy as a priority (or at least as soon as we get back to the new “normal”) and to prepare the defence strategy for the decisions made, compiling specific evidence available at the time the decisions are made.  Issues to address include, allocation of losses, quantification of those losses, which entities will assume the financial expense, how to modify the current policies to reflect the “new normal”, restructuring of operations, reduction in margins, preparation of contemporaneous documentation (i.e. the current year) when comparable financial information is not available until 2022, analysis of risks and risk allocation, if facing cessation of an activity, what would a third party do, are there any available alternatives….