Martina Nosková
Following many enquiries from taxpayers, tax administrators and tax advisors, all awaiting help in dealing with the pandemic’s effects on controlled transactions, late last year the OECD delivered its Guidance on the transfer pricing implications of the COVID-19 pandemic (“the Guidance”).
The Guidance seeks to provide clarifying comment on, and illustrations of, practical application of the arm’s length principle, in accordance with currently applicable principles established by the OECD Guideline, in the context of the pandemic. Its aim is not to develop new principles, but instead to provide members of MNE groups with practical procedures.
The OECD focused on four areas which it considers to be the most fundamental in relation to the effects of the pandemic on TP, and which we will address in this article.
- Comparability analysis (benchmarks)
A significant part of the Guidance addresses comparable companies’ available financial data for 2017 to 2019, which would normally be used to demonstrate compliance with the arm’s length principle in 2020, and its failure to reflect the impact of the current crisis. Furthermore, it notes that earliest availability of 2020 data will not be until the second half of 2021.
Although the Guidance continues to recommend applying the principle of averaging several previous tax periods, due to the specific nature of 2020, this requires an adjustment of historical numbers, using any previous year’s available data that may serve as supporting documentation proving the impact of the COVID-19 pandemic on the taxpayer. As examples of such supporting documentation, the Guidance specifies analysis of the effects of the pandemic on the taxpayer’s economic sector, business activities or controlled transactions, analysis of sales decline during the pandemic, including comparison with the previous year, and application of statistical methods such as regression analysis.
The Guidance takes a critical look at application of 2008/2009 data, as the financial crisis during that period was significantly different to the pandemic’s impact on the economy. Additionally, the overall economic situation has changed dramatically in all sectors over the last 12 years.
- Losses and exceptional costs associated with COVID-19
In general, profit/loss is allocated among related companies according to their functional and risk profiles, which as a matter of fact applies also to the companies with relatively limited profiles. Thus, it cannot be automatically claimed that a company with a limited profile could not bear losses and by using specific examples, the Guidance indicates that even such companies are not completely risk-free. In accordance with the functions it performs, if a company bears market risks, for example, and there is a significant decline in demand due to the pandemic, this company may bear a portion of the loss associated with materialization of the risk. The Guidance points out, in other words, that companies with limited risks may also bear a certain share of losses, in line with their functional and risk profiles.
Considering the exceptional costs associated with the pandemic, these should also be divided, in a similar way the profit/loss is allocated, depending on who, based on functional and risk profile, performs functions related to these costs and thus bears the resulting risks. The Guidance encourages taxpayers to examine and follow the approach applied by independent comparable companies in the case of exceptional costs. Moreover, the Guidance outlines the possibility of customers absorbing part of the costs within taxpayers’ selling prices, provided that the market situation allows this option to be exercised. Additionally, it is underlined in the Guidance that exceptional one-off costs unrelated to a controlled transaction should not be included in calculations of profit indicators for either a tested or comparable company.
The availability, substance and duration of these programs have different transfer pricing effects, given that the state aid has been provided to both, members of an MNE groups and independent parties, thus, the behavior of enterprises engaged in potentially comparable transactions was affected.
Comparable companies in jurisdictions in which entrepreneurs received adequate aid in a timely manner may present significantly more favorable results in their financial statements than those operating in jurisdictions without effective government aid. However, there is no mechanism that could take account of the impact of the state aid on the financial results of its beneficiaries when selecting companies for the purpose of a comparability analysis. Therefore, taxpayers should conduct a detailed analysis of the nature and implications of state aid received if it directly affects a controlled transaction.
- Advanced pricing arrangements (APA)
In its final section, the Guidance deals with APAs, both existing and subject to negotiation, including practical illustrations of procedures for both taxpayers and the tax administrator. More than ever before, taxpayers are expected to take a proactive approach to changes induced by the pandemic and all parties involved should respond flexibly and cooperatively to the current economic situation and its effects on controlled transactions. The pandemic does not constitute an automatic change to, or violation of, the critical assumptions for APA issuance and application (which could result in revision or cancellation of the APA, or withdrawal from it). Therefore, it is necessary to proceed on a case-by-case basis.
- What does it mean for us?
As the pandemic has affected the market in some areas dramatically and in some others only minimally, the provisions of the Guidance and practical transfer pricing implications of the pandemic need to be considered individually for Slovak taxpayers’ distinct controlled transactions, while also taking into account the procedures of the Slovak tax administration.
