On 18 December 2020, the Organisation for Economic Co-operation and Development (“OECD”) published a guidance on the transfer pricing implications of the COVID-19 pandemic (“Guidance”). The Guidance represents the consensus view of the 137 members of the Inclusive Framework on BEPS regarding the application of the arm’s length principle and the OECD Transfer Pricing Guidelines in the context of the COVID-19 pandemic. The work carried out by the Inclusive Framework in the form of the said guidance supports both taxpayers who have reporting obligations for periods affected by the pandemic, and tax administrations when assessing taxpayer’s implementations of TP policies.
The impact of the COVID-19 pandemic has been profound. Many enterprises have faced or continue to face significant cash flow constraints, restrictions affecting their operations, and disruptions to their supply chains including the curtailment of their operations and corresponding reductions in output, and have been forced to change how their business is conducted (e.g. working from home). In the presence of significant financial hardship, some enterprises have reviewed their contractual arrangements with third parties to ascertain whether they remain bound by them or have attempted to renegotiate key terms, including by requesting discounts or deferred payment.
Meanwhile, the magnitude and speed of the economic impact of the pandemic mean that governments have been simultaneously providing fiscal and monetary support and introducing innovative measures to protect jobs, boost incomes and support liquidity. For businesses in 2020, the economic environment has few parallels and unfortunately, this phenomenon is likely to continue through 2021 and potentially even beyond.
However, the unique and almost unprecedented economic conditions arising from COVID-19 and government responses to the pandemic have led to practical challenges for the application of the arm’s length principle.
The Guidance confirms that the arm’s length principle has been found to work effectively in the vast majority of cases, and this principle-based approach to assessing intercompany prices is equally robust for evaluating controlled transactions in the face of the COVID-19 pandemic.
The Guidance provides practical approaches to the obstacles the pandemic has brought about in obtaining third-party comparable data. It affirms that the pandemic may reduce the reliability of historical data for comparability analysis which could lead to comparability adjustments.
Furthermore, the Guidance sheds light on the allocation of losses attributed to the COVID-19 pandemic among related parties. One issue is how exceptional, non-recurring costs arising from the pandemic should be allocated within group members.
In addition, the transfer pricing implications of government assistance programs aimed at reducing the economic impact of COVID-19 (e.g. labor subsidies or forgivable loans) are further discussed in the document. Under the new Guidance, the extent to which the unanticipated, changed economic situations affect the application of existing advance pricing agreements or alter APAs under negotiation, is examined.
Against this background, the Guidance notes that taxpayers and tax administrations should carefully follow the guidance on the accurate delineation of controlled transactions in Chapter I of the OECD TP Guidelines to identify with specificity the economically significant risks that each party to a controlled transaction assumes. Therefore, the interplay between the COVID-19 hazard risk and other economically significant risks should be evaluated when considering risk assumption in a particular controlled transaction.
The Guidance is cornered around how the arm’s-length principle and the OECD TP Guidelines apply to issues that may arise in the context of the COVID-19 pandemic, rather than around developing guidance beyond what is currently addressed in the OECD TP Guidelines. The Report focuses on four issues where it is recognized that the additional practical challenges posed by COVID-19 are most significant:
(i) Comparability analysis;
(ii) Losses and the allocation of COVID-19 specific costs;
(iii) Government assistance programs;
(iv) Advance pricing agreements (APAs).
It should be noted that the new Guidance does not form a part of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations. Given the unique economic conditions that have resulted from the COVID-19 pandemic, MNEs should review the impact of the pandemic on their transfer pricing policies and take proactive actions on documenting how and to what extent they have been affected.