With the economic downturn brought about by the COVID-19 pandemic, companies face the challenge of determining whether they should modify their transfer pricing policies. The decision has to be made at a time when comparable data necessary for the analysis are not yet available. At the moment, relying on prior-year data and three-year averages of financial results of comparable companies may not be an appropriate method of setting intra-group prices.
Under normal circumstances, profit margins (of limited-risk and limited-function entities) for 2020 would be determined/tested using the data for 2016–2018 (2019). Yet, the economic downturn has introduced a volatility of profits, making it difficult to apply transfer pricing methods in a ‘standard manner’, as defined by the OECD Transfer Pricing Guidelines.
In this respect, the trends identified during the 2008-2009 global financial crisis may provide certain guidance. The KPMG LLP analysis: What’s News in Tax: COVID-19 and Transfer Pricing Policy: A Lookback Analysis of Routine Returns implies, among others, the following:
The analysis also pointed out significant differences in the impact of the downturn, both across various sectors of industry, and across individual entities within these sectors. These differences illustrate the absolute necessity of conducting a thorough market analysis when selecting comparable entities. An appropriate market analysis – often neglected in transfer pricing documentations – has never been more important than in times of an economic downturn.
If we apply the above findings to 2020, we may recommend modifying the available data (of comparable companies or of the tested entity) so as to show the results that would have been achieved had there been no COVID-19 pandemic:
As we wrote in a previous article, the Czech financial administration has indicated that even in (post)-coronavirus times, they expect local companies’ profits to be reported in the amount corresponding to the arm’s length principle. Documenting and recording all analyses and effects to support compliance with this will be the alpha and omega of future negotiations with tax authorities regarding the profitability for 2020 and subsequent periods when the effect of COVID-19 is bound to still be felt.
Lenka Pól Brožková firstname.lastname@example.org+420 222 123 295
Stanislava Volková email@example.com+420 222 123 697