At this stage, it is difficult to predict the extent of the impact that COVID-19 will have on transfer pricing policies and perspectives, but the following discussion is intended to shed some light on key areas that taxpayers need to consider in actively managing and monitoring to mitigate the effects of economic turmoil.

Modifying or terminating intercompany contracts

Given the current economic situation, the market will be characterized by elements such as uncertainty and volatility. Stable transfer prices from the past could now cause unpredictable shifts of profits and losses in these market circumstances. These shifts of profits and losses may no longer reflect the specific underlying functions performed by group entities and therefore may not be in line with the arm’s length principle. In these circumstances, a proactive approach may need to be considered.

The group’s companies need to evaluate whether to renegotiate their intra-group agreements and adjust their transfer prices in accordance with actual market circumstances and their restructured organization.

Obviously, when adjustments are made to the transfer prices in a period of economic turmoil, the existing transfer pricing documentation is no longer up-to-date. However, it appears that when new facts are well documented and added to the existing transfer pricing documentation, tax authorities could be willing to accept certain changes in the existing transfer pricing policy. After all, a third party would also consider changing and renegotiating its price setting in similar economic circumstances.

Limited risk entities’ compensation

In times of a staggering worldwide economy, it is not uncommon for many companies to see their margins coming under increased pressure and to eventually end up in a loss position.

As it looks now, a large number of multinational companies are suffering or will suffer overall losses due to the unfavorable economic conditions that accompany a potential worldwide downturn. However, a consolidated loss does not automatically imply that all group members are loss-making during a certain period.

Belgian tax authorities generally scrutinize the taxpayer’s position when losses incur. Typical examples are group entities performing routine service activities or low-risk activities in general (for example contract or toll manufacturing) whereby remuneration is determined on a net cost-plus basis. In a recession, the question is whether this kind of guaranteed profit allocation is in line with the arm’s length principle. A situation when all the beneficiaries of the service provider are making losses, while the service provider remains in a profitable position, may seem to be artificial and not in compliance with the arm’s length principle. Would tax authorities still expect such limited risk entities to record routine profit? There is a need to take into account such transfer pricing policies and develop strategies to address these challenges.

Restructuring

In times of economic crisis, companies may adjust their business structure in order to be able to face the difficult market circumstances and keep expenditures low. Besides conventional tax planning restructuring (such as the stripping/centralization of functions), companies will also face restructurings that are more recession-driven (e.g., closing down a plant, restructuring charges due to laying off personnel or the write-down of assets). In countries such as Belgium where the restructuring leads to decrease of taxable basis (for instance, a fully-fledged distributor becomes a limited risk distributor or an agent), the restructuring may entail exit charges.

This also covers the discussion on the allocation of restructuring costs. In this respect, the OECD report on the transfer pricing aspects of business restructurings can be an interesting source of information from a Belgian perspective.

Advance pricing agreements (APAs) or rulings

Most existing APAs or transfer pricing rulings were concluded during prosperous economic times. Complying with existing APAs or rulings could become challenging during economic downturns. In general, these APAs require application of a transfer pricing method that represents the financial results of the tested company in “normal” economic circumstances. “Normal” economic circumstances are perceived as economic growth. Therefore, there is the potential for current APA terms to be breached as a result of the impacts of the epidemic. Taxpayers may need to consider renegotiating the APA (if possible) and apply new transfer prices that reflect the new position of the taxpayer.

Other possible actions

Actions to be considered may include, but are not limited to:

• Many contracts contain “force majeure” clauses. Taxpayers might consider invoking this clause in order to not comply with their contractual obligations.
• Benchmark studies performed to support the arm’s length character of intercompany transaction might need to be fine-tuned. As it is not always easy to make the necessary adjustments and remove any distortion from the set of comparable companies, an alternative solution could be to reposition the tested company within the (unadjusted) arm’s length range (e.g., towards the 25^th percentile of the interquartile range).
• Exceptional expenses linked to the COVID-19 crisis might be identifiable, and could potentially be excluded in the context of calculating the targeted margin. Limited risk does not mean no risk, especially in the context of force majeure.
• Pay attention to the use of benchmark studies in the near future, as transfer prices for a year in recession are based on data from previous years that can be characterized by significant economic growth. This will result in a discrepancy with the reality. A taxpayer can consider making and documenting the necessary adjustments to the final set of comparable figures. Alternatively, the use of loss-making comparables might be included in a benchmark analysis.
• Intercompany royalties paid could potentially be reduced to nil as long as the paying group entity is loss-making, to provide more “oxygen” to the paying entities, and make sure they are able to continue their operations over time.
• The COVID-19 key decision makers of the group need to be mapped and properly reflected in the company’s functional and risk analysis. This may be useful in case of a potential transfer pricing audit in the future.
• A certain level of solidarity could exist between group companies and has already been accepted by the tax authorities in the past. For example, it is possible to provide interest-free loans and conditional waivers of debt if a number of conditions are met.
• The economic crisis will potentially have an impact on the credit rating of the group and the individual group companies. Intercompany financing policies will have to be updated accordingly.
• Certain banks will require formal bank guarantees in relation to new loans. It is important to consider the payment, or not, of a guarantee fee, and make sure that this is in line with the latest OECD report on intercompany financing.
• Multinational groups may need to reconsider their intercompany financing and cash pool structures. Efficient cash management can result in a significant improvement of the cash position of a company during the COVID-19 crisis.
• Multinational groups may consider whether intra-group payments can be delayed or adjusted (e.g., by reducing them as mentioned above) in order to help the group manage its overall liquidity position.
• Multinational groups may consider the attribution of profits to any new permanent establishments that result from changed business circumstances and when key functions are located in different countries.

In conclusion, the current COVID-19 crisis and its impact on intercompany pricing might be the ideal triggering event to change a transfer pricing model, if desirable, without necessarily triggering a large risk for the past related to the change. This has to be considered on a case-by-case basis.

Read an April 2020 report prepared by the KPMG member firm in Belgium

For more information, contact a tax professional in Belgium with KPMG’s Global Transfer Pricing Services group:

Dirk Van Stappen | +32 3 821 19 18 | dvanstappen@kpmg.com