Focus on four areas: comparability analysis; losses and the allocation of COVID-19 specific costs; government assistance programmes; advance pricing agreements.
Every year has a few defining moments, but the past one has contained so many world-changing challenges that now it’s even harder to predict how the new year will go, in terms of business or in our personal lives. In a still uncertain landscape, with vaccines starting to be approved and distributed all over the word and with many countries dealing with even more cases than they expected, the Organisation for Economic Co-operation and Development (OECD) released its recommendations on the transfer pricing implications of the COVID-19 pandemic in the transactions performed between related parties. Unprecedented economic conditions and government responses to the COVID-19 pandemic have led to significant challenges in the application of the arm’s length principle.
The Guidelines focuses on four areas: comparability analysis; losses and the allocation of COVID-19 specific costs; government assistance programmes; advance pricing agreements.
The Guidelines provide that a taxpayer may use a wide range of publicly available information to support the preparation of the comparability analysis of intra-group transactions performed during FY 2020. To estimate the effects of the COVID-19 pandemic, OECD proposes a number of practical approaches in preparing the comparability analysis, such as:
- an analysis of how sales volumes have changed during the COVID-19 pandemic, compared to sales generated in the pre-COVID period;
- an analysis of the change in utilisation capacity relevant for groups;
- use of macroeconomic information or indicators published by central banks, government agencies, industry or trade associations etc.
„Documentation of intra-group transactions performed during FY 2020 may raise practical difficulties in the application of the transactional net margin method, taking into consideration that the financial information for FY 2020 will not be available until mid FY 2021 at the earliest. To provide more flexibility to taxpayers and tax authorities, the Guidelines mention the possibility of applying voluntary (compensating) transfer pricing adjustments, the application of more than one transfer pricing analysis or the use loss-making independent companies as comparables, under certain conditions”, mentioned Liviu Gheorghiu (photo), Senior Manager, Mazars Romania.
Losses and COVID-19 specific costs
As a result of COVID-19, some groups have incurred extraordinary costs generated by the measures taken to limit the effects of the pandemic. In addition, certain groups have registered operational losses. The Guidelines highlight that the allocation of the specific COVID-19 costs should only be made after an assessment of the risks distribution within the group, with consideration to be given as to how independent companies would operate in similar cases.
The OECD is open to the possibility for limited risk companies to incur losses generated by the COVID pandemic, under certain conditions. In determining whether or not a limited risk entity may incur losses a detailed comparability analysis must be performed, with the emphasis on the accurate delineation of the transaction and the risk allocation profile.
Another key point mentioned in the Guidelines is if extraordinary costs arising from COVID-19 may be treated as operating costs, and how these costs should be taken into account in the comparability analysis.
Given the current economic conditions, groups may consider revising the intra-group agreements. OECD states that in order to renegotiate or amend contractual terms, the behaviour of independent parties operating in comparable circumstances should be considered.
Government assistance programmes
The Guidelines highlight that government assistance programmes offered to support taxpayers during COVID-19 pandemic may have an impact on the transfer pricing analysis, irrespective if groups or independent parties operating in the same markets have benefited from these programmes.
An important point mentioned in the Guidelines is that an assessment is necessary in order to determine whether government assistance represents an economically relevant characteristic that may have a material impact on the controlled transaction.
Advance pricing agreements (APA)
„With regard to the APAs under negotiation intended to cover FY 2020, OECD encourages the parties to adopt a flexible and collaborative approach to determine how to take into consideration the current economic conditions generated by the pandemic, including the possibility to conclude an APA covering the period affected by the COVID -19 and a separate APA covering the post-COVID period. In the case of APAs granted and valid during the pandemic, OECD recommends to analyse the critical assumptions underlying the agreements and that taxpayers should adopt a transparent and proactive approach.”, mentioned Adrian Mutea, Tax Assistant Manager, Mazars Romania.
Given that the COVID-19 pandemic has led to changes in the economic circumstances, that were not anticipated when APAs were concluded, the Guidelines provides clarifications on the possible impact of the pandemic on existing unilateral, bilateral, multilateral APAs or APAs under negotiation.