As European countries begin to ease their lockdowns, the policies implemented to alleviate the impact of COVID-19 on public health are still resulting in significant operational disruption for many multinational companies.
These include staff shortages due to quarantine, limited operations of factories and logistics infrastructure, and other supply chain difficulties leading to volatile levels of demand and supply. The recent plunges in the global stock market are a reflection of the uncertainty shared by many companies on the duration and pathway to public health and economic recovery.
These challenges create significant financial and operational risks for companies across the value chain, necessitating bold decisions on how to prioritize activities, generate liquidity, mitigate risks and allocate resources. We explore the action companies should take now to position themselves in a post-COVID-19 world.
Sustainable long-term performance
Companies need to navigate the immediate impact of COVID-19 while determining the best approach for long-term performance. This involves promptly implementing measures which can provide some initial relief while anticipating the longer-term risks, consulting internal and external stakeholders, and planning sustainably for the future.
As well as revising forecasts and business continuity plans, companies will need to review their multinational transfer pricing planning based on the impact of the pandemic to their operations in order to avoid heavy tax burdens.
Five key steps to achieve sustainable long-term performance include:
- Strategy definition: Reassess group and company priorities
- Assessment: Determine short, medium and long-term options for profit allocation and restructuring in alignment with group strategy
- Design: Determine an appropriate business and operating model, with risks and profitability aligned with actual operations
- Implementation: Obtain buy-in of internal and external stakeholders, communicate plans, and roll out strategy in a concerted way
- Tax risk mitigation: Monitor approach and proactively document the impact of commercial strategy on pricing policy to manage potential scrutiny from tax authorities
Planning for recovery
Proactive transfer pricing planning is key to mitigating risks and leveraging opportunities to manage the value chain and ensure a sustainable business model post-COVID-19.
As part of their recovery plan, organizations should consider the following aspects:
- Reviewing contractual terms: Exceptional situations resulting in business disruption often allow for the review and renegotiation of contracts. Whilst many companies review legal contracts / agreements with suppliers, customers, banks and other external stakeholders, it is also important to proactively review existing intercompany agreements. Consider whether these allow for economic adjustments between parties in the event of business disruption.
- Carefully managing intra-group financing: Whilst companies assess and potentially renegotiate external financing, they will need to consider the impact on intra-group interest rates, tax burdens, foreign debt ratios, and thin capitalization rules.
- Determining the need for restructuring: Companies may adjust supply chains to continue to meet demand, or need to downsize structurally, operationally or organizationally as a cost-cutting measure. Rapid growth and contraction both require review of the group’s operating model. This can impact characterization and tax base at a local level, as well as trigger exit charges if there is a movement of functions, assets, risks, or profit potential. It is therefore crucial for companies to consider the effect of any restructuring on their transfer pricing operations to avoid tax risk.
- Considering corporate simplification: Beyond operational restructuring, companies can use this opportunity to consolidate multiple legal entities in a single jurisdiction, or determine if these can be reduced to simplified presence (a branch or representative office). Benefits can include the reduction of working capital required, compliance costs, and risk of withholding tax leakage.
- Leveraging the impact of digital strategies: Many companies will have leveraged on virtual marketplaces and e-commerce to reach more customers during lockdown. With this shift in commercial channels, they will need to reassess where value is generated with digital delivery and align profit recognition accordingly. In addition, companies can leverage digital technologies to simplify and automate transfer pricing processes and systems.
- Sustainably allocating profitability and risk: Disruption to the supply chain and operations will most severely impact companies with exposure to the manufacturing, travel, and retail industries, making it crucial to link internal pricing and profit allocation with external market conditions. Companies can proactively review the appropriateness of the model and methodology in line with functional activity and risk management capability, and make timely adjustments prior to year-end. This is particularly important for organizations which operate principal operating models, with one entity bearing a significant proportion of the profit or loss, where maintaining the existing policy may result in a non-arm’s length return. COVID-19 may also impact a company’s investments or underlying assets, requiring a review of the valuation and transaction pricing for intellectual property.
- Proactively collating defense documentation: Tax authorities will likely aim to secure revenue to support fiscal stimulus measures including tax concessions, incentives and rebates. As such, decreases in operating profit will attract scrutiny. Companies should collate documentation to explain and quantify the losses caused by COVID-19, to demonstrate that these are a result of commercial and economic factors rather than an opportunistic transfer pricing policy. Companies may also consider adjusting benchmarking studies to model in the economic impact of COVID-19, as these often use historical financial data to support the transaction. Finally, companies can consider a proactive approach in communicating the impact of COVID-19 on operating profit to tax authorities before the submission of the tax return.
How KPMG can help
In determining the most appropriate approach, companies have been able to leverage on KPMG’s practical approach for support:
- Global insights: Access to global COVID-19 governmental responses and advice on areas of focus in line with your requirements.
- Determination of potential cost savings: Proactive risk analysis on the supply chain, current legal structure and TP model to evaluate potential cost savings.
- Sustainable business model design: Allocation of risks and resources in line with business requirements post-COVID-19 to create a durable set up for the future.
- Proactive defense documentation: Proactive risk analysis on your current vs envisaged transfer pricing model to determine potential risks and cost savings, and documentation to support the desired approach.