OECD recommendations on comparability analysis during Covid-19 (Part 1)

Covid-19 has brought unprecedented social and economic challenges that will durably impact the world economy.

Specifically, the pandemic has surrounded the Multinational Enterprises (MNEs) with many issues to be managed such as:

• insufficient cash flows,
• unpredictable profitability,
• unreliable third-party data (which is at the heart of arm’s length principle),
• non-operative supply chains,
• import/export limitations,
• possible termination/amendment needs in the intragroup service agreements etc.

In this uncertain environment, an action was eagerly awaited from the Organisation for Economic Co-operation and Development (OECD), which works cooperatively with many country administrations and group companies and has an important role in forming a global consensus on transfer pricing. In this respect, on 18 December 2020, the OECD released a guidance on transfer pricing implications of Covid-19 (the Report).

The Report focuses on four major issues which have been high on the agenda of taxpayers during the pandemic.

• (i) Comparability analysis
• (ii) Losses and the allocation of Covid-19 specific costs
• (iii) Government assistance programmes
• (iv) Advance pricing agreements (APAs)

With the opening of the new financial year, MNEs have calculated their transfer prices for 2021 based on their current transfer pricing policies. However, under Covid-19 environment, taxpayers may wonder whether the comparability results reflect the independent entity behaviour.  Benchmark analysis is at the very centre of transfer pricing analysis and MNEs have been facing the below challenges on which OECD has provided guidance.

1. What sources of contemporaneous information may be used to support the performance of a comparability analysis applicable for FY 2020?

The Report states that, in principle, any form of publicly available information regarding the effects of Covid-19 on the business, industry and controlled transaction may be relevant in analysing transfer pricing policies. This can include for example information on sales volumes, macroeconomic trends, incremental or exceptional costs, budget versus actual data, and third party behaviour observed in previous recessionary periods or data available in the current year.

2. Can budgeted financial information be used to support the setting of arm’s length prices?

The OECD is in favour of using the budgeted and/or forecasted financial results, to approximate the specific effects of Covid-19 on revenues, costs and margins in terms of reduced sales volume, increased operating expenses or so. If taxpayers are able to make a robust analysis and put forward the real evidences in their actual vs forecasted, rations could be used to make an assessment of the current situation and arm’s length nature of the prices.

3. Under what circumstances are timing issues most pronounced?

The OECD acknowledges that real-time data are the most reliable data to be used in a comparability analysis while the availability of this data is very limited for certain transactions such as financial transactions. However, in most of the cases, comparable data is available only as a historic data. In the application of transactional net margin method (TNMM) for instance, commercial databases can provide taxpayers with data at mid FY 2021 at the earliest. This situation of using data from preceding years without considering the specific impact of the pandemic may lead to an unreliable benchmark. Nevertheless, the OECD suggests that in these circumstances, taxpayers will need to perform a comparability analysis based on available prior  year  financial  information  and, depending  on  the  facts  and  circumstances  of  the  case,  utilising  whatever  current  year  information  is available to support their transfer prices. This approach of the OECD definitely requires a flexibility and the exercise of  good  judgment on the parts of taxpayers and tax administrations.

4. What practical approaches may be available to address information deficiencies?

In relation to above mentioned challenge, the Report develops several pragmatic approaches with underlying the fact that tax administrations could consider these pragmatic approaches to minimise disputes where taxpayers are making good faith efforts to determine arm’s length prices in the context of the information deficiencies associated with the pandemic.

In a possible approach, taxpayers should undertake reasonable and appropriate due diligence in  evaluating  the  likely  effects  of  the  pandemic and in implementing appropriate changes in their transfer prices. MNE should document the best available market evidence currently available, which may be in the form of internal comparables, external comparables, or other relevant evidence of the economic impact of Covid-19, including its effects on the level of demand for goods and services, and on production and supply chains in particular sectors of the economy. This issue has been also underlined in the Report as the first challenge; therefore, it is vital for the Report to make a detailed internal analysis as well as industry analysis during the pandemic.

The Report makes direct reference to the OECD TP guidelines which describe two approaches for identifying and collecting data required for the transfer pricing analysis: an ex-ante approach (price setting) and an ex-post approach (outcome testing). The Report considers that tax administrations that otherwise would use the price-setting approach can allow for an outcome-testing approach, to consider information that becomes available after the close of the taxable year. Local tax authorities could provide flexibility to allow amendments to the tax returns once information becomes available.

In relation to use of more than one transfer pricing method, the Report suggests that it may be useful to corroborate the arm’s length nature of the intercompany pricing, although not required under the OECD TP guidelines.

Read OECD recommendations on comparability analysis during Covid-19 (Part 2)