The COVID-19 pandemic has had wide-ranging economic effects, causing supply chain disruptions, demand swings, business shutdowns, cash flow constraints, and increased losses (or profits in some cases) in the U.S. and around the world. In response, countries have provided unprecedented support to affected businesses in the form of subsidies, additional access to capital, relaxed regulations, and favorable tax changes. Together, these changes have led to practical challenges when applying the arm’s-length principle, an international tax and transfer pricing concept implemented by most countries that requires two related entities (such as a parent company and subsidiary) to price their intercompany transactions as if they were unrelated.
In response to the challenges of the pandemic, on Dec. 18, 2020, the Organisation for Economic Co-operation and Development (OECD) published its “Guidance on the Transfer Pricing Implications of the COVID-19 Pandemic,” which focuses on four main pandemic-related issues:
- Comparability analysis
- Losses and allocation of COVID-19-specific costs
- Government assistance programs
- Advance pricing agreements (APAs)
The guidance provided by the OECD, which is for taxpayers and tax administrations, does not add to the OECD’s existing transfer pricing guidelines. Instead it provides a practical interpretation of the guidelines in light of COVID-19’s impact on the global economy and business operations.
Generally, a normal time lag exists between when companies set intercompany prices and when contemporaneous benchmarking data is available. To address this gap, companies often use historical data (such as profitability data of comparable companies from prior years) as a basis for their current year benchmarking. The economic changes brought on by the pandemic, however, mean that using historical data no longer might be a reliable approach.
In response to the potential unreliability of historical data, the OECD guidance provides several recommended approaches, including having separate pre- and post-pandemic testing periods. Another approach is to adopt mechanisms that allow for the adjustment of 2020 prices through adjusted invoices or intercompany payments in a later period (such as in 2021) when more accurate information becomes available. This approach might require tax return adjustments or amendments. The OECD guidance also notes that it might be appropriate to include loss-making companies in a comparable company set, assuming that they otherwise satisfy comparability criteria, though this approach might not be accepted by all tax authorities.