Extraordinary economic conditions brought about by the COVID-19 pandemic and consequent responses of governments in individual countries may bring numerous practical difficulties in applying the arm’s length principle. For this reason, the Organisation for Economic Co-operation and Development (the “OECD”) issued a report on 18 December 2020 containing recommendations for taxpayers and financial administrations how to proceed when applying transfer pricing rules in periods affected by the COVID-19 pandemic.
The report by the OECD highlights the fact that the basic premise of the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the “Guidelines”),
i.e. the arm’s length principle, is seen as effectively applicable in most cases and can be relied upon under such extraordinary conditions as the circumstances arising from the COVID-19 pandemic are. The OECD additionally emphasises the fact that these recommendations do not constitute an extension of the scope of the Guidelines as such, but rather practical guidance how to use the arm’s length principle and the Guidelines in very challenging conditions of the current pandemic. The recommendations focus on four priority topics where the most significant difficulties in practical application are expected, specifically: (i) comparability analysis, (ii) losses and allocations of specific costs resulting from the COVID-19 pandemic, (iii) impact of government assistance programmes and (iv) impact on Advance Pricing Agreements (the “APA”).
The pandemic may have a significant impact on pricing between unrelated parties; for this reason, the so-far commonly used historical data may have much lower informative value and it will not be possible to entirely rely on them. Moreover, financial data for 2020 will not be available earlier than in mid-2021, more likely even later. For this reason, the recommendations indicate what alternative data can be used for the identification of the impact of the COVID-19 pandemic on the financial management of individual companies or industry sectors. In addition, it is necessary to verify, during the benchmarking analysis, that comparable companies operated in similar conditions or faced similar restrictions.
Losses and allocations of specific costs relating to COVID-19
Numerous multinational groups will record considerable losses resulting from the pandemic, be it due to the decrease in the demand, disruption to the supplier-customer chain, or extraordinary one-off costs. When allocating losses or extraordinary costs among the individual group members, it is necessary to consider numerous circumstances, especially the distribution of risks among related parties and the fact that the distribution of risks is reflected in pricing. Additionally, it is necessary to assess whether and how these costs would be distributed among independent unrelated companies. Finally, it is also possible to verify whether the COVID-19 pandemic created conditions for the possibility to use a force majeure provision.
Government assistance programmes
Governments of individual countries have provided numerous assistance programmes to taxpayers, e.g. in the form of various programmes aimed at maintaining employment or support in liquidity. Conditions and scope of these programmes, including the fact that they represent temporary or long-term support, should also be taken into account in an assessment of the impact on pricing between related parties. Both in the assessment whether such support is an economically relevant characteristic that needs to be taken into account and also whether and how such support may impact the pricing between unrelated parties, and subsequently when the benchmarking analysis is carried out.
Advance Pricing Agreements
Bearing in mind that the COVID-19 pandemic led to significant changes in economic conditions that could not have been anticipated at the time when the existing Advance Pricing Agreements (both unilateral and bilateral) were negotiated, some companies may currently face possible difficulties in the use of these applicable Advance Pricing Agreements. As it is not possible to automatically disregard or derogate from the existing agreements, the OECD recommends approaching this issue pro-actively and contacting tax administrators in order to resolve the problem as quickly as possible. Likewise, in the event of ongoing considered future APA negotiations, the OECD emphasises the benefits of certainty in taxes in the future in order to make it possible to prevent future tax disputes, and it, therefore, strongly recommends entering into such agreements, despite the possible temporary reluctance of both parties.
Having regard to the fact that the issue of the impact of the COVID-19 pandemic on relations between related parties and on transfer prices is rather comprehensive, we will discuss this topic in detail in a live broadcast on 11 February 2021, starting at 10:00 am, which will welcome Vítězslav Kapoun, head of the International Taxation Department at the General Financial Directorate. You may register on our website. (The webcast will be in Czech language.)