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When the facts change, I change my mind

When the facts change, I change my mind

Many economic facts have changed during the COVID-19 pandemic. This article outlines new OECD guidance on transfer pricing under COVID-19.

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Daniel Head

Partner, National Head of Transfer Pricing

KPMG in the UK

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Also on home.kpmg

COVID-19 has resulted in many social consequences and major disruption to the global economy. This can cause significant practical challenges for multinationals’ transfer pricing arrangements. The application of the arm’s length principle to related party transactions continues to require consideration of comparable independent businesses. However, this is not straightforward, as the economic impact of the pandemic varies widely across economies, industries and businesses. It is necessary to consider how the individual group company has been affected. In December 2020 the OECD issued supplementary guidance to explain how the general approach may result in changes to specific policies as a result of pandemic-related fact patterns. Four specific aspects are covered: comparability, losses and exceptional costs, government assistance schemes, and the impact on advance pricing agreements (APAs).

Among the OECD’s guidance are:

  • Historical comparable data may no longer be reliable and quantifying adjustments may not be straightforward. GDP data or industry statistics may be helpful; data from prior crises, such as the 2008 financial crisis, are unlikely to be comparable;
  • Entities bearing limited commercial risks may still incur losses in unusual circumstances. For example, a significant decline in demand may mean that a limited risk distributor earning a percentage margin on sales may suffer a loss if it is unable to reduce its overheads;
  • Government support programmes have been widely used to preserve employment. This may affect arm’s length pricing, and some programmes may be subject to eligibility criteria or legal constraints on modifying their related party pricing as a result; and
  • Existing APAs should be respected unless a breach of critical assumptions has occurred. This will vary from case to case. The OECD emphasises collaborative working, since the value of certainty via the APA process remains compelling.

These are not new rules, but useful practical guidance. Although trading or service levels may be reduced, even to nil, it should not be assumed that an independent counterparty would reduce or stop its payments. Services may be provided ‘on-call’ with a retainer paid; bespoke manufacturing may involve fixed ‘take or pay’ arrangements.

Moreover, even where not written into contracts, independent businesses frequently work with their customers and suppliers to support supply chain continuity, recovery planning and reputation. Examples include reducing prices, extending payment terms, or continuing to make payments despite reduced service levels.

Whether the receipt of government assistance would affect pricing depends on the economically relevant factors including competition, price elasticity and risk allocation. There are policy concerns also – tax authorities have made clear that support for local companies should not be dispersed via transfer pricing. In the UK, HMRC have suggested that if the UK employer can continue to recharge staff costs to an overseas entity, then it does not need government support.

Finally, whilst reluctance to conclude or initiate new APA negotiations is understandable given the economic uncertainty, the OECD’s continued support for the APA process is welcome. Even if the terms need to be revised, a collaborative and flexible approach, in a non-adversarial spirit, is likely to be beneficial for all parties.

The facts and their implications should be considered holistically. A review of the specific effects of the pandemic on the business’s trading and results, potential adjustments to pricing and contracts, and compliance with support scheme rules is recommended. It is far more effective to undertake this review before individual group company accounts are finalised so that any transfer pricing adjustments can be reflected in those accounts. For those whose attention is focused on financial close for 2020 now is the time to be thinking about these issues.

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