Transfer Pricing implications of COVID-19

By Federico Mariscalco, HLB Italy

Economists and analysts around the world are aligned in saying that the economic crisis, that will follow the lockdown imposed by the pandemic, will be worse than the financial crisis of 2008. If this will be the case, multinational groups (“MNEs”) should carefully evaluate how this crisis will impact their transfer pricing (“TP”) policies in place as well as many other TP related aspects.

While at this stage it is difficult to fully predict the extent of the impact that COVID-19 will have on TP policies and perspectives, in this article, we outline some key areas that should be actively managed and monitored to mitigate the effects of economic turmoil.

Value chain re-organisation

Value chain analysis involves an investigation into the functions, risks, and assets of the controlled group as a whole and an evaluation of how they integrate with the group’s key value drivers. The conclusions of these analyses are used to attribute profits to the group companies basing on key functions, risks, assets, and value drivers of the business.

The COVID-19 pandemic may raise questions in cases that involve employees responsible for performing relevant functions (e.g. significant DEMPE functions when we talk about intangible assets, significant people functions in case of PEs) whom could not operate from those countries where generally the aforementioned functions are performed. For example, in cases when people are relocated or are stuck in one location due to the lockdowns or others future travel restrictions.

In such cases, MNEs should evaluate whether changes are temporary, or they have a more permanent status, which may require changes to the TP policies. Due to COVID-19, many companies will probably face restructuring solutions that are more recession-driven (e.g. closing down a plant, restructuring charges due to laying off personnel or the write-down of assets). In some countries where the restructuring leads to decrease of taxable basis (e.g. a fully-fledged distributor becomes a limited risk distributor or an agent), the restructuring may entail exit charges.

In this regard, any risk of potential business restructuring should be carefully assessed. If a business restructuring is identified due to COVID-19 impacts, for instance on MNE’s key functions, the valuation of intangibles or of going concerns may be estimated on the base of Discounted Cash Flows method. However, in such scenarios, the taxpayers should consider the COVID-19 implications while building up the forecast of the entities / going concerns involved in the business restructuring.

Increased focus on TP

For taxpayers incurring in losses or low profits for FY2020, the tax authorities will analyse the reasons by focusing on TP (where possible), for example, challenging the allocation of extraordinary losses or arguing for higher profit allocation in the past or for future years in return for assuming additional risk. In this context, local jurisdictions should take into consideration the outstanding economic circumstances in which the taxpayers are operating during the period under review as well as the uncertainty in which they have to define their TP policies. Under this scenario, Advance Pricing Agreements (“APA”) will become a convenient instrument to mitigate TP risks. However, existing APAs and ruling concluded during prosperous economic times may require to be renegotiated because of the changes in economic circumstances and those changes affect the critical assumptions underlying the agreement.

Comparable returns

Normally, in the contest of TP economic analysis (for instance through a TNMM method) a common method for testing an intercompany transaction in FY2020 would be looking at the average of the three previous years, assuming that the economic circumstances in the year under analysis are similar. However, in 2020, and most likely in the following years, the economics of many companies will be negatively impacted by COVID-19, while the previous three years (2017-2019) financials are not affected. Having said that, the likelihood to obtain results, which are significantly far away from the arm’s length principle using the multiple years approach is high. However, publicly available data for comparison is not available in real time so there will also be a time lag (i.e. 2 years) in testing and supporting positions taken.

To align the comparability analysis with the changing economic conditions, companies may adopt the following strategies:

  • Inclusion of loss-making companies in the comparable set;
  • Choice for a different analysis time period than the conventional three years;
  • Specific adjustments to the financial data for comparison in order to consider the actual economic crisis (e.g. towards the 25 percentile of the interquartile range).

Loss split models might be appropriate in the current economic climate if the facts and circumstances allow for it. MNEs should carefully consider whether losses resulting from this crisis can be allocated to associated entities having a simple functional profile and limited risk.

TP compliance

TP Documentation must clearly show that low profits or losses were not the result of non-arm’s length TP policies or practices. Now and over the next couple of months, it may be prudent to model the impact of COVID-19 on operating results, to demonstrate (and document) the commercial rationale for changes in TP and other planning decisions. The main purposes are to prove that low profits were not the result of non-arm’s length TP policies.

Cross border financial support

During crisis, usually MNEs tend to centralise cash availabilities allowing optimisation and rationalisation of the treasury functions. This trend may lead to new or increased cross border financial support. Consequently, arrangements on new or increased cross border lending operations should result in an arm’s length outcome (arm’s length rates of interest charged) for the associated parties involved. However, in defining the financial needs and strategies, the MNEs should consider local specific interests and debt limitation rules, together with the applicable with-holding tax regimes. Furthermore, if the group decides to proceed with debt, there is a risk that a loan could be challenged by the Tax Authority as a non-arm’s length arrangement and recharacterised as a contribution to equity. For instance, Tax Authority could argue that the borrower might not be able to obtain funds from a third party in an uncertain business environment that we are currently experiencing. Therefore, it is important that a borrower should be able to demonstrate that it has reasonable expectations to return borrowed money under the conditions specified in the loan agreement. The proper way to do this is to prepare a TP study in advance, i.e. before the loan agreement is signed.

Review of existing financial intercompany arrangements

Existing funding arrangements could be amended or interest rates re-priced and adjusted in line with the central bank/other third-party interest rates. A general interest rate reduction (due to a financial crisis) may help to free up cash flows.

Take away

  • The MNE should consider how the disruptions of each step of the value chain potentially impact other parts of the value chain, the potential timing or duration of the disruptions and the impact of such disruptions in the entities functional and risk profiles.
  • Following potential changes in the value chain, it would be advisable to manage such aspects through specific amendments to arrangements that will be reflected in revised TP policies.
  • It will be necessary to demonstrate that changes in agreements, models and remunerations relate to the effects of COVID-19 on the supply chain and not to opportunistic behaviours.
  • Pay attention to cash pooling, intra-group loans and guarantees to arm’s lengths principle in the lights of new market conditions, together with specific local tax regulation.


The economic consequences of this pandemic will put TP policies and many other cross-border aspects under pressure, increasing the risk of double taxation and disputes. In this respect, an OECD guidance addressing the main issues in a uniform manner would be desirable.

For further clarifications and additional information, please feel free to contact us.

Get in touch
Whatever your question our global team will point you in the right direction
Start the conversation

Sign up for HLB insights newsletters