Taxwise Or Otherwise
By Iris Kristine Lacebal
One of the common tax issues affecting multinational entities (MNE) is transfer pricing. Yet, at present, where the COVID-19 pandemic is seriously affecting economies worldwide, many companies may tend to overlook the transfer pricing consequences of every management decision they are taking in order to deal with more pressing and critical matters impacting the business.
To help manage possible tax challenges that may arise from transfer pricing issues, let me share with you some transfer pricing-related concerns which MNEs may take note of in light of the COVID-19 crisis.
LIQUIDITY AND CASH FLOW
In order to meet current obligations, an MNE heavily affected by the present economic slowdown may resolve to acquire additional funding from its affiliates, particularly from the parent company, on top of any external financing schemes. This may be in the form of working capital advances, additional intercompany loans, discounting of receivables, etc. The MNE may also seek to delay intercompany payments to give priority to third-party commitments.
While these intercompany arrangements should be acceptable from a transfer pricing perspective, MNEs should still be wary of how to structure the transactions so as not to defeat the arm’s-length principle. For instance, any intercompany financing policy should be aligned with the MNE group’s external approach to financial and commercial transactions.
With the anticipation of an increase in related-party financing transactions, close scrutiny of loans and other financial support extended to an MNE member could likewise be expected from tax authorities. It is therefore advisable for MNEs to revisit their intercompany financing arrangements and assess compliance with the Organization for Economic Co-operation and Development (OECD) transfer pricing guidelines as well as each local jurisdiction’s tax and transfer pricing regulations.
OPERATIONS AND VALUE CHAIN
When analyzing the reasonableness of a transfer price, it is important to determine the functional characterization of the parties involved. As economic theory implies, the level of return derived by an entity should be directly correlated to the functions it performs, assets it owns and risks it assumes. Thus, with the significant impact of COVID-19 on every business, it is likely that MNEs would encounter operations-related struggles especially in terms of the supply chain.
As businesses strategize to mitigate the effect of the health crisis, changes in the operations of MNEs may be evident, e.g., a manufacturing entity may not be able to continue to produce products and hence, may need to shift to procuring finished goods instead of manufacturing them. Therefore, in evaluating the business activities of each MNE, it is relevant to consider the accurate delineation of the functions, assets and risks before and after any business remodeling, the business reasons for and expected benefits from any change in functional profile, including the role of possible synergies, and the other options realistically available to the parties involved.
Further, the assessment of an MNE’s functional characterization in this time of crisis would likewise be significant in reviewing if the changes in functions, assets and risks would warrant a change in the transfer pricing policy. This would also help determine if an MNE is earning a return commensurate to its operations. As an example, a low-risk company performing routine functions is expected to generate stable profits considering that usually, it is the parent entity which bears the risks. Hence, any significant losses incurred by the low-risk multinational-member company during an economic downturn may be used to reassess if higher returns are warranted due to higher non-routine risks. Conversely, this could be an opportunity to check if a low-risk MNE may shoulder a portion of the losses of an MNE group firm by reducing its expected profit margin.
CONTRACTUAL ARRANGEMENTS AND INTERCOMPANY AGREEMENTS
As for the potential change and/or reallocation of certain business functions within an MNE group, it is also apparent that contractual arrangements need to be revisited. As it can be anticipated that independent parties would be renegotiating agreements such as the pricing, production volumes, payment terms, etc. given the current economic situation, related parties may follow suit by reevaluating their transfer pricing arrangements.
ROBUST TRANSFER PRICING DOCUMENTATION
Transfer pricing documentation is usually prepared to demonstrate that an associated enterprise has made reasonable efforts to comply with the arm’s-length principle. It is usually written under an implicit assumption of normal operating conditions for businesses. Considering the adverse impact of this COVID-19 epidemic on business, financial stability, workforce, and operating activities, among others, MNEs may want to reexamine if all the conditions outlined under the existing transfer pricing documentation remain reasonable, or if there is a need for realignment to encompass the present circumstances. Updated transfer pricing documentation would likewise support whether or not to maintain the existing transfer price. It would also help document that the sustained losses of a company are caused by unfavorable economic conditions and legitimate business reasons and not by transfer pricing arrangements.
In addition to robust transfer pricing documentation, MNEs should further keep all related e-mail correspondence, records and paper trails that would help establish the commercial and financial effects of the global pandemic. After all, having well-maintained transfer pricing documents could serve as the first line of defense of taxpayers against any potential transfer pricing challenges by the tax authorities.
As every sector of society is trying to cope with the pandemic, it is advisable for business owners to devise action plans holistically. Rather than exposing the company to tax risks resulting from seemingly overlooked transfer pricing issues, it is recommended that transfer pricing implications be given similar attention as other business needs and considerations.
The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.
Iris Kristine Lacebal is a senior manager at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.
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