The Impact of COVID-19 on Transfer Pricing

The economic impact of the global COVID-19 pandemic on the supply chain and intercompany transactions of multinational enterprises (“MNEs”) is certain.  The severity of the impact is however currently unclear and depends on the duration and the speed by which the pandemic subsides.  MNEs will not only face disruptions to their supply chains and challenges of moving personnel across borders, but they are also likely see erosions of profit margins.

Additionally, the significant emergency funding for governmental efforts to contain the virus or to provide an economic stimulus will inevitably result in future pressure on tax authorities to boost tax revenues through audits to finance these measures.  Public opinion may also result in heightened audit activities in post COVID-19 years, since the public sentiment will push for MNEs paying their “fair share of taxes” within the national boundaries of the countries they operate in.

Even though MNEs may see more leniency during COVID-19 affected years, MNEs are likely to see increased scrutiny by tax authorities in post COVID-19 years.  Tax authorities will focus on reviewing transfer pricing policies and outcomes for historical tax years affected by COVID-19 and try to distinguish between the economic effects of the pandemic versus normal market risk as a result of business success/failure. In order to develop a contemporaneous audit defense file, MNEs must demonstrate to tax authorities that their transfer pricing arrangements were arm’s length during COVID-19 years with an in-depth analysis of the adverse factors beyond their control caused by COVID-19.

As part of building this audit defense file and applying pro-active transfer pricing planning going forward, MNEs should consider the following:

• Review existing transfer pricing policies and adjust them in the light of the global economic impact of COVID-19.
• Document the 2020 and future transfer pricing positions to ensure the successful defense of heightened audit activity post-COVID-19.
• Note that computing the economic losses associated with COVID-19 will require sophisticated economic modeling and income-based analysis, which will likely be based on unspecified methods.  
• Consider analyzing the transfer pricing positions over longer time periods (five-ten years) to allow for economic smoothing and understand the impact of the potential global economic downturn.
• Understand that benchmarks are lagged by one year and will not accurately reflect the arm’s length nature of 2020 and future intercompany transactions. Adjustments to specified methods or the use of unspecified methods can be used to assist in establishing the appropriate arm’s length range.

In the wake of COVID-19, MNEs may need to alter their transfer pricing arrangements to realign their tax policies to the new facts and circumstances created by the pandemic.  Some MNEs will have to modify their supply chains due to disruptions in countries hit hard by COVID-19 and shift more business to online platforms. Such changes would lead to increased tax scrutiny under tax law developed for the digital economy, highlighting the need to align transfer pricing positions taken with respect to the MNEs’ supply chains and the altered structures necessitated by COVID-19. Documenting and making changes to the transfer pricing policies in a contemporaneous manner will allow MNEs to defend the pricing on their intercompany transactions more effectively and with a higher chance of success to minimize adjustments.

Until more certainty about the duration of the pandemic can be gained and the picture of the impact on the economy becomes clearer, it is important for MNEs to use transfer pricing as a tool to soften the financial impact of the virus on their bottom line.  Identifying losses and attributing/allocating these losses in an efficient manner can help soften the blow and identify ways to adapt historic transfer pricing models into models that are defensible in a COVID-19 world and post recovery.