Industries: International Business
The ongoing pandemic’s effect on the global economy has the potential to upend transfer pricing policies for multinational companies. A company’s transfer pricing – which is how it prices intercompany transactions – is particularly vulnerable to a fluctuating and uncertain economy. As companies struggle with the unexpected economy of 2020, transfer pricing models are being increasingly put under pressure, and should be re-evaluated.
Following are just two examples of the transfer pricing issues companies are facing:
Operating losses – Transfer pricing policies affect the distribution of profits and losses reported for tax purposes within a corporate group. Entities described as “routine service providers” or “limited-risk distributors” often use a cost plus or targeted operating margin pricing policy that essentially guarantees a level of profitability to one entity for its role in the transaction. In the current economic environment, with many companies suffering losses on a consolidated basis, it is not unreasonable to ask if routine service providers or limited-risk distributors should also share in the group’s losses. While loss split models, where entities share in losses, may be appropriate in certain circumstances, any such change to a standing transfer pricing policy must be supported with a substantive review of the functional profiles of the entities that are party to the intercompany transaction. In FAQs released by the IRS in April, the first answer provided an example of a U.S. distributor experiencing losses due to an unexpected drop in demand for its products. The IRS stated that it expects the transfer pricing analysis for the distributor to explain how such losses comply with the arm’s length standard.
The use of non-current transfer pricing analyses – Some companies have transfer pricing policies that rely on analyses that were performed a number of years ago. Due to a significant disruption of the global economy, even analyses performed in 2019 will be put under pressure. Transfer pricing analyses often reference market pricing or the profitability of comparable companies as benchmarks, and many companies set their transfer pricing at the start of the financial year based on these previously observed benchmarks. In the case of a company suffering losses that fall outside of those benchmarks, the variance will need to be explained to tax authorities. Even if a company is able to hit its benchmarks, if those benchmarks do not contain financial results from 2020, the company will need to demonstrate that the comparable companies or pricing provided in the dated benchmarks were not significantly affected as a result of the pandemic.
Now is the right time for multinationals to start planning for potential transfer pricing disruptions in 2020 and 2021. In light of the pandemic’s effect on the global economy, companies should undertake a review of their transfer pricing policies and documentation to ensure both that the policy is feasible financially, and that it is in alignment with the current economic environment. Given that 2020 financial results are likely to depart significantly from the economic trend line, transfer pricing policies may need to change, and any changes to a company’s transfer pricing must be defended and documented.