This article looks at the current COVID-19 crisis and the impact it will have on Transfer Pricing and Multinational Enterprises (MNEs) who are dealing with Transfer Pricing issues.
The impact can be segregated into three key aspects of how Transfer Pricing will be impacted by recent events – these are key areas MNEs should be aware of in 2020 and 2021:
- The real time impact on Fiscal Year 2019 (FY2019) Transfer Pricing compliance that MNEs are dealing with at the present moment in time (many MNEs have December 2019 year ends for example and have reporting requirements now);
- The economic impact on FY2020 Transfer Pricing Policy design and documentation that clients will be dealing with later in the year as the impact hits business and also into 2021 when the current fiscal year is reported;
- The future impact on FY2020 transfer pricing audits that may materialize in 2021;
1. Transfer Pricing Compliance for FY2019
Tax Authority approach to filing deadlines and current year audits
It is common in MENA for the Transfer Pricing reporting process to be aligned with Corporate Income tax reporting. In this regard, we are witnessing a number of (helpful) extensions being granted by Tax Authorities in the MENA region (e.g. the General Tax Authority in Qatar has provided an extension for Tax Return submissions from 30 April to 30 June) in 2020. Other Tax Authorities may also provide extensions to filing deadlines and this will be helpful for MNEs so it is important to assess and understand this. It should be noted that clients are still receiving Transfer Pricing audit enquiry letters despite the fact that remote working has been implemented in MENA. It is likely that on site field inspections may not be so common going forward.
Discretionary tax spend versus non-discretionary
Whenever cash is king, MNEs will need to focus on what they need to do versus what could be deferred. By way of example, some Tax Authorities in the region (e.g. Egypt) require documentation to be filed with the Tax Authority each year; however, others Tax Authorities only require documentation on request. Many MNEs take the view that they can prepare documentation if requested in real time and it is my experience that it depends on the degree of complexity and risk. Resources should be allocated to the higher complexity and higher risk areas. If an area is low risk then it might enter the definition of discretionary tax spend. Conversely, dealing with tax audits is not discretionary. Minimizing cash tax leakage through TP challenges and adjustments will be important.
An important option to consider for FY2019 and beyond is with respect to tax rulings, Advance Pricing Agreements (APAs) and certainty. It may be possible to release uncertain tax provisions (providing a potential earnings benefit), reduce future tax spend and reduce potential tax adjustments/penalties by going for certainty rulings with Tax Authorities.
2. Transfer Pricing Policy Design and Documentation for FY2020 – A "Seven Step" Checklist
There are a number of economic changes that MNEs will deal with in 2020 and it is important to address this in Transfer Pricing policy design and documentation. The following seven items will be relevant and should be considered in turn:
- Capturing the impact of the crisis in the industry sections for FY2020 files – i.e. what are the key pressures being faced in the industry in terms of reduced demand, restricted supply, etc.;
- What will the impact be on risks as reported in the Functional Analysis section of FY2020 files – the changes to the risk environment may span from forex exposures due to market volatility through to employee health, motivation and productivity;
- What is the MNE's strategic response to the crisis? Strategic decisions, insurance provisions and risk management are key value drivers for transfer pricing;
- There may a requirement to movement cash/financing to areas of the business that need it and the related intra-group interest will be required on O/S balances – in addition, Central Banks may act now to reduce interest rates to try to stimulate the economy;
- Increased losses/depressed margins may result through direct impact on the business and also derived demand impact from major customers. How should/could these losses be shared between entities?, would it be appropriate at arm's length to not charge intra-group transactions in certain situations if this would exacerbate losses?;
- Business restructurings may be precipitated by the crisis (e.g. downsizing, offshoring, etc.) and will require suitable Transfer Pricing support if there are any tax advantages (such as increased losses);
- Note that certain Transfer Pricing methods that are revenue/profit based can actually lead to an increase in revenue and profitability as the parties are incentivized to add more value. It is important for MNEs to think about whether a particular Transfer Pricing model may accord with the MNE's commercial objectives to control cost and enhance revenues;
3.Increased Likelihood of Transfer Pricing Audits for FY2020
There are a few key areas of risk that may be exacerbated by the current environment.
Remote working and "E-Decisions"
Firstly, Permanent Establishment risks might be increased with remote working and employees that might be making more strategic decisions. In fact, a new precedent may be established for the ability of MNEs to make "E-Decisions" from a remote location without being on the ground in a particular location. This will be important in supporting economic substance and significance under Transfer Pricing regulations.
Support for losses/low margins
It is also important to build robust economic support to defend FY2020 losses/depressed margins. In FY2019, there were already a number of Transfer Pricing audits in the region with MNEs having to defend the commercial reasons for losses and low margins. This situation may be exacerbated in FY2020 numbers and will lead to more audit challenges from Tax Authorities.
Fiscal Policy responses
Fiscal policy at the MENA Ministries of Finance and Tax Authorities will also impact transfer pricing in terms of potential changes to corporation tax rates as a response to the economic environment. Tax Authorities may provide incentives/relaxations or we may see an increase in corporation tax rates to recover finances – in these situations it will be important for MNEs to ensure that they keep pace with new regulations and rates.
Stay safe and stay healthy. With respect to Transfer Pricing:
- Concentrate on what you need to do under Transfer Pricing laws and Corporate Income Tax laws (especially with respect to reporting deadlines) and push out anything that is not critical;
- Look for certainty via tax rulings to agree transfer pricing with a Tax Authorities if available as this can reduce significant cash tax outflows in future years;
- Capture the economic reasons for any commercial changes being made in 2020 to respond to the crisis…as this will help support your FY2020 transfer pricing position next year (follow the "seven step" checklist above).