No one could have predicted the business and economic impact of the coronavirus (COVID-19) pandemic. Many multinational groups are faced with managing the various challenges presented by COVID-19, including dealing with the serious implications of transfer pricing, given that existing transfer pricing policies will be put under pressure.
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.
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:
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 | firstname.lastname@example.org
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