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FAQs | Impact of COVID-19 on transfer pricing policies

| COVID-19 | Tax

Frequently asked questions regarding the impact of COVID-19 on transfer pricing policies


Over the past decades the role of multinational companies in world trade has grown dramatically, a reflection of a greater integration of national economies and technological progress, particularly in the field of communications. This growth has raised complex issues for both tax administrations and taxpayers in each country, which have been addressed and analysed through various projects within the OECD/G20 and other international organizations. As a result of these coordination efforts, the OECD transfer pricing guidelines were established, among others, or more recently - for example - the guidelines on financial transactions.

Following the declaration of the COVID-19 outbreak as an international pandemic by the WHO on 11th March, and given its rapid spread, the current focus - both national and international - is on the social health and economic criteria. Although the short-term impact of the pandemic has quickly shifted to reality for the general public and the business community, there is clear uncertainty about the repercussions of this crisis in the mid/long term.

At the international economic level, COVID-19 is expected to affect, among other things, offshore production, international supply chains and the risk associated with financial operations. It is estimated that the situation will directly affect sectors representing up to a third of the GDP of the major economies (statement by the OECD Secretary-General at the virtual G20 summit).

In this context, relations between related entities are also affected given the rapidly changing exogenous economic circumstances. From the Andersen Tax & Legal team, and through a format of answers to frequently asked questions, we briefly evaluate some elements that the Groups of companies should consider in relation to their transfer pricing policies.

What will be the impact of COVID-19 on prior agreements for the valuation of related-party transactions?

As established in Article 18 of the 27th November Law 27/2014 on Corporate Tax (hereinafter, "LIS"), taxpayers may request the tax authorities to determine the valuation of transactions carried out between related persons or entities prior to carrying out such transactions. Such request shall be accompanied by a proposal based on the principle of free competition. These agreements (known by their acronym in English as "APAs" -Advanced Price Agreements-), shall be unilateral, bilateral, or multilateral taking into account the number of tax administrations involved.

In the context of the pandemic and given the medium- and long-term uncertainty in activities, associated businesses should re-evaluate the terms of the agreements signed -or in the process of being signed- with the administrations. Transfer pricing remuneration policies are determined through the comparability analysis of the operations which includes, in addition to the functional analysis of the parties, the associated economic circumstances and business strategies. Taking the new situation into account, depending on the case we would consider the possibility of renegotiating - or varying the terms of the current negotiation - said agreements to deal with the potential problems that a potential breach could cause.

How will the health emergency affect documentation and comparability analyses?

In accordance with Article 17 of the 10th July Royal Decree 634/2015 approving Corporate Income Tax Regulations (hereinafter "RIS"), factors of comparability (functional analysis, contractual terms, economic circumstances, business strategies and characteristics of the goods and services) must be taken into account to determine the consistency of intra-group policies within the principle of free competition. Thus, any external circumstances must be considered and reasonably adjusted to improve the degree of comparability. In this way, selected comparables which are not found in similar circumstances, or for which data are not available under these conditions, should be eliminated.

How will the health emergency affect documentation and comparability analyses? (ii)

In many cases the application of transfer pricing methodologies (LIS Article 18.4) is carried out through external comparables obtained through databases that process the information from the annual accounts of comparable independent entities. In these cases, since the transfer pricing documentation must be prepared on the date of presentation of the tax, the annual accounts information current with the year under analysis (2020) will not be available. Thus, although each case must be analysed in detail, adjusting the results of the comparable is advisable, a priori identified with the effect of COVID-19 by economic sector, supplemented by an analysis of the results of the first months of the year.

What transfer pricing aspects should we consider in case the contractual terms of the related transactions are modified?

One of the foreseeable consequences of the COVID-19 crisis is the change of global production and supply chains, due to restrictions on the movement of goods, the performance of certain non-essential activities on confinement, etc.

This may lead to multinational groups - regardless of the short-term effects on related contracts of the force majeure situation - to consider a different structure in the distribution of assets, functions, and risks between different entities in the future. This new distribution could occur, for example, with the aim of avoiding consequences in the event of potential outbreaks of the pandemic. The new approaches should lead either to modifying the pre-existing contractual terms or to a new agreement between the parties and, where appropriate, modifying the associated remuneration. For example, this new remuneration could be based on information obtained through new internal comparables (by incorporating new independent providers).

What transfer pricing issues should we consider if the contractual terms of related-party transactions are modified? (ii)

In the specific case of the contractual terms associated with the financial transactions, we must consider a possible variation in the credit rating terms of the related lending institutions (including the country risk in which they reside). This circumstance should be assessed for the purposes of determining the remuneration of the transaction (as well as other elements such as guarantees, principal, repayment terms, etc.) in the event of a possible renegotiation of intra-group contracts to reduce possible liquidity tensions in certain Group business units.

How will the COVID-19 crisis affect the distribution of profits / losses among the different companies of the same Group?

In recent years at an international level a transfer pricing scheme has been consolidated (especially in large technological groups) in which entities dedicated to distribution - wholesale/retail - in the market saw their functions and risks limited (limited risk distributors) and therefore the remuneration associated with their activities. Under this scheme, other entities assumed all these functions (marketing, management of intangibles, etc.) and risks, centralising the remaining profit that was generated after remunerating - inter alia - the ordinary distribution functions.

This paradigm of transfer pricing policy has implied the initiation of inspection procedures, due to the scarce reality in the assumption of functions and the -chance?- establishment of these activities in low tax countries, or in which the Group could have negotiated a "ruling" with the tax authorities.

The obvious question is, if in times of prosperity the profits were limited, in times of crisis is the loss limited? Should these centralising entities also assume the losses?

How will the COVID-19 crisis affect the distribution of profits / losses among the different companies of the same Group? (ii)

While we must look at the specific circumstances of each case, it is true that the OECD guidelines when referring to profit potentially understand this expression to include losses.

Thus, in section 1.58 they provide that "the assumption of risks involved in a commercial transaction affects the potential benefit of that transaction in the open market, and the allocation of the risks assumed between the parties to the agreement affects how the profits and losses resulting from the transaction are assigned under conditions of full competition through pricing".

Similarly, section 2.114, regarding allocating profits, states that this method 'identifies, in the first place, the benefit be distributed among the associated companies for the related transactions in which they have an interest. References to the terms "results" and "benefits" should be understood to apply equally to losses".

Thus, if the Group maintains a distribution of functions and risks in which certain business units are limited in their capacities, they must maintain a level of profitability according to the risk assumed.


For more information, please contact: 

Rafael Leal | Director in the Tax area

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