COVID-19 enhancing transfer Pricing Risk

  CapiTotal India      
covid-19
The Coronavirus (‘COVID-19’) pandemic has already caused major health crisis in almost entire world and has led to disruption of the worldwide economy. things has resulted in economic slowdown and is probably going to urge worse in coming time. The International fund (‘IMF’) has stated that the worldwide economy has already entered into a recession that would be worse than the one caused by the financial crisis of 2008-2009. it's already become clear that the COVID-19 pandemic has resulted during a huge shock in supply and demand throughout global industries, inevitably having a far-reaching economic impact.

This article addresses some key Transfer Pricing (‘TP’) challenges which can emerge as a results of such crisis and the way it are often proactively managed.

During economic slowdown, many companies experience huge decline in turnover and capacity utilization which results in profit erosion. There could also be a situation wherein some potential comparables aren't affected within the same way because the taxpayer or the up-to-date results for comparables aren't yet available. Broadly, the 2 challenges faced by the businesses are:

Ensuring that comparable data are correct in terms of both comparability and reflecting true economic realty; and
What approach to be followed if profitability of the corporate is less than the Arm’s Length Range or such range is negative?

* Contingency Plan

The companies are devising contingency plans to counter such impact which can end in changing functions and risk across the organization which directly affects the Transfer Pricing analysis. Since reward is directly linked to the danger , risk are assumed to earn higher rewards. However, a challenge arise in situation of a loss resulting out of economic downturn wherein no entity would really like to assume risk. This possess additional challenges to the Group wherein TP Policies has been settled on the idea of allocation of profits.

*Proactive Approach

The proactive approach to manage the Transfer Pricing Risk arising out of COVID-19 would be primarily to access the impact of COVID-19 on the Group Companies and rework the financial forecasts. Further, all the Inter-Company Agreements and Advance Pricing Agreements must be reviewed in sight of this situation. The helpful steps may be:

*Revisiting the Transfer Pricing Models

The Group companies shall redraft their existing TP models in sight of the economic downturn. just in case of a gaggle company providing shared services to the opposite group entities and have already incurred personnel or other associated costs might not be ready to provide their services thanks to many constraint like lockdown, travel restrictions etc. during this case, apportion of cost to group entities would become challenge since such intra-group services would fail to pass the benefit test. In such cases, these cost could also be treated as Shareholder Cost and should be allocated to A level which may be justified through benefit test. The royalty paying group entities shall tend Royalty-Free period if they forecast to form losses.

*Advance Pricing Agreements (‘APA’)

All the prevailing APAs should be re-examined and new ones should be re-considered thanks to the impact of the COVID-19 on the Group. APA provides certainty on agreed transfer price or margin of profit for multiple years, as long as critical assumptions are met. The critical assumptions are agreed by taxpayers and tax administrations, which just in case aren't met, allows them to reconsider the APA. If, thanks to the COVID-19 or otherwise, the agreed critical assumptions are not any longer met, the APA would get terminated. As an alternate , taxpayers and tax administrations might renegotiate the APA.

*Comparability

Steps are often taken to eliminate companies which aren't suffering from COVID-19 by comparing the decline in sales of tested party and therefore the comparable companies. Companies also can be screened supported Capacity Utilization. Since the analysis done is especially supported past data, the effect of economic downturn might not be considered within the comparable data. Hence, it's suggested to use interim or forecasted data.

Further using multiple year data might not be appropriate since the last two year data wouldn't reflect the impact of COVID-19. this is able to further pose challenge in cases wherein present year data isn't available before the date of filing of tax returns. Hence, it's recommended to use only present year data and reject multiple year data, if such option is out there . In countries like India, wherein such option aren't available, the govt may modify the principles allowing such option for the present year a minimum of .

Lastly, for the higher comparability, the financial data of the comparables are often adjusted to require into effect the present situation. for instance an adjustment supported median PLI differentials.

*Conclusion

While transfer pricing is usually subject to challenge, if proactive steps are taken, these risk are often managed. As COVID-19 continues to cause global economic downturn, it's important for the businesses to require early actions on this. There are high chances of transfer pricing scrutiny during economic downturn, hence by taking early steps to think about the potential impact and revise their TP Policies accordingly, the businesses are going to be better positioned to mitigate TP risks associated with COVID-19.
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