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Transfer pricing 2020 – three problems and three solutions

Author: Parol Jalakas

The restrictions established due to the COVID-19 pandemic have disrupted transfer pricing within international corporations. Even if the restrictions were to be eased, undertakings would face major uncertainty about risks and comparables for determining market value.

One of the main transfer pricing methods is the arm’s length principle – data on transactions between third parties. However, it may be complicated to get reliable comparison data for 2020. With the sudden decline in companies’ turnover and disruptions in supply chains, transfer pricing found itself in unknown territory with no concrete picture of the relationships between risk and return.

Problem #1: are existing transfer pricing policies still valid?

Even as companies’ revenue is in freefall, operating expenses like personnel expenses and inventory costs may not have decreased. From the transfer pricing perspective, a number of previously low-risk activities such as assembly or warehousing are making a loss. Such a major change should be expressed in the intragroup transfer pricing policy – how risks have changed and why they could not be foreseen before the crisis.

Problem #2: uncertainty about how long the crisis will last

Lockdown has been a unique phenomenon from the transfer pricing perspective and companies lack certainty about when and whether the economy will return to normalcy. Although some restrictions have been eased and sales are increasing in some sectors, in other fields, it could take months or years to return to normal. The difficulty lies in putting an exact length on the crisis period. In the case of comparison data, there is also a “best before” date in play – the older the comparison data, the less realistic is an illustration of the market situation.

Problem #3: impact of state support on documentation of transfer pricing

A member of a group of companies will wonder how to properly distribute profit and government support between the various group members. If the government in the country where a group company is based supports companies with a salary compensation or a bridge loan, how should the support be divided between associated companies? A number of activities that are considered low-risk activities from the standpoint of transfer pricing, such as warehousing, may also be relatively labour intensive. As a result, it is a noteworthy challenge to decide who uses the grants and who bears the losses.

What next?

Although there are no recent historical periods similar to the lockdown months of 2020, the 2008 recession can be seen as a precedent. One of the biggest lessons learnt from that crisis was that financial audits will be carried out for years after the crisis, so documenting transfer prices as fairly and immediately as possible is important. Government budgets are under great strain due to lower tax base and the rescue measures they have offered, so tax receipts are under greater scrutiny. Thus, tax authorities can be expected to pay closer attention to transfer pricing policy in the post-COVID period.

Solution #1: reviewing the risk profile

When revenue and liquidity decline, we see risk appetite related to transfer prices increase significantly in many companies. If the company’s survival is at stake, this may be one way to hold on to and/or release scant resources.

Solution #2: revaluation of comparison data

Check whether current comparison data are still reliable, and if they are not, update them. Due to economic pressure, the subjectivity of business decisions may increase, as a result of which concrete rationales and background to any decision should be documented. When setting transfer prices, it may be beneficial to include companies operating at a loss in comparative analysis and to update the analysis on the basis of decreased business volumes in the same field. Although companies can expect more scrutiny from tax authorities, it is still wise to update transfer pricing policy than to continue using the pre-crisis transfer pricing system.

Solution #3: documenting the current situation

Although the group’s transfer pricing policy may be updated only at year’s end, it is important to document the current situation now: document decisions and the rationales for the decisions. Putting down the current situation in reports helps to mitigate risk and reduces uncertainty from future audits.

Both supply and demand are disrupted in the current economic environment, and so is transfer pricing. Intragroup transfer pricing is changing, as companies are cutting back on their volumes of activity and revenues are decreasing. Yet it is not enough merely to state the fact that the current period is unusual. Appropriate documentation of decisions and a foresighted transfer pricing policy will reduce administrative burdens in future.

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