Articles and Views

Impact of Covid-19 on Transfer Pricing

June 3, 2020

The pace of the economy growth in 2020 has been put to a test due to the global pandemic that emerged at the beginning of year. At the time of writing this article, some cities of huge economic importance are still under a certain degree of lock-down: borders are shut to travellers, businesses are partially or totally closed and individuals’ movements are restricted to domestic travel to provide or get essential supplies.

Governments around the world urgently rolled out support packages to stabilise economies in order to help businesses as well as individuals to tide over these trying times. As of to-date, the Singapore Government has dedicated close to S$100 billion of worth of measures to battle the crisis that is induced by the global pandemic.

Once the “new” normal business operations resume, companies can anticipate that governments and tax authorities around the world will place greater emphasis on tax collection and transfer pricing matters, in order to replenish national budgets caused by the economic slowdown during the period, as well as the cost of government support packages to deal with the pandemic.  For example, Saudi Arabia has already tripled the value added tax rate, from 5% to 15%, to address the fiscal imbalance caused by a decrease in consumer and commercial spending, the lost tax revenue, and the cost of healthcare initiatives put into place in response to the pandemic.

In anticipation of the step-up on tax reviews and tax audit actions by the tax authorities, taxpayers having business transactions with related parties should pay particular attention to increase their focus on maintaining adequate documentation and records to show that the pricing of their transactions with their related parties are at arm’s length. The Singapore TP Guidelines similar to the OECD TP Guidelines recognises that associated enterprises, like independent enterprises, can sustain genuine losses due to unfavorable economic conditions like Covid-19. However, that alone does not justify the legitimacy of losses. How third parties deal with the same or similar conditions and how those reasons are documented would be critical in determining and substantiating the arm’s length pricing basis of the related party transactions. The impact of Covid-19 on businesses varies between industries and even between taxpayer companies operating within the same industry. Some sectors such as tourism and airlines may suffer more due to various restrictions on human movements and contacts, while pharmaceutical and medical equipment sectors stand to benefit economically due to surge in the demand of their products and services.

We would highlight ways that businesses can cope with the current distressing situation from a TP perspective:

Supply chain management

Many companies’ TP policies are based on patterns of global economic growth that generally prevailed over the past decade. Such historic TP policies need to be updated as the commercial supply chain may be disrupted due to Covid-19. It would be essential for companies to re-evaluate functional profiles and levels of profit for the entire supply chain and analyse which party is ultimately bearing the risk associated with decisions currently being made to deal with the business environment during the pandemic. As an example, changes may be needed to reduce levels of guaranteed profit in entities that operate under the limited risk model such as limited-risk distributors, contract manufacturers, routine support services providers, and the like; as an example.

Notwithstanding that the transfer pricing rules has provisions to allow companies to alter their transfer pricing arrangements in response to market events, each business group should consider assessing the impact of the event on their activities and income streams, based on specific facts and circumstances. Companies that decided to adjust the pricing of intercompany transactions should document the commercial rationale adequately.

Managing liquidity

Cross border financial support may be required during this period. The advancing of intragroup loans may be necessary to support its related entities’ financial requirements. However, in doing so, care must be taken to ensure that the interest rates have accounted for market-related factors such as the trending lower rate of borrowing offered by the banks, relaxed repayment schedule, etc.

For existing related party loans and financing arrangements, it would be timely to re-look at the terms and where necessary, to negotiate and adjust the interest rates and the repayment schedule to reflect the market rates and to potentially help manage the group companies’ financing costs.

Another way of managing pressure on the cash flow of the group entity is by relaxing payment terms and the credit period for the entities that are severely impacted. Given the current scenario that shows no sign of immediate recovery, such type of arrangements would be equally applicable in the third-party market players to foster long term relationships. Accordingly, it may not be a significant challenge this year to justify the same from an intragroup transaction perspective. Nonetheless, it is advisable to take proactive steps in gathering information and documenting it appropriately in accordance to the requirements of the relevant tax authorities.

Management services

Some of the management services from a head office entity provided during the pandemic may not pass the “benefits test” in the service recipient’s jurisdiction. These could be because the service recipients’ operations are temporarily closed and they have not derived economic or commercial value from the management services. As a result, the head office may decide to  retain such costs within its books as non-chargeable costs and does not derive any cost-plus margin income which may be charged to the group’s operating entities in the past. In such a scenario, it becomes imperative for the head office to document the commercial rationale for retaining such costs as its local tax authority would be interested to know the reasons for not charging costs to the service recipients.

Above are some of the key areas that can be actively managed and monitored to soften the impact of Covid-19 on Transfer Pricing compliance.  All in all, transfer pricing analysis and documentation would play a critical role in explaining to the stakeholders (including tax authorities) any changes made to the intercompany transactions or restructuring of the existing operations. It is important to prepare such analysis and robust documentation which are focused on meeting the transfer pricing compliance requirements and can satisfy the reviewing tax authority.  If you need further assistance or advice on specific transfer pricing issues, please reach out to the tax professionals at CCS for a discussion.