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COVID Crisis May Lead to New Wave of Transfer Pricing Disputes

Posted on Mar. 19, 2021

As the global COVID-19 crisis limits the usefulness and availability of comparables data, tax authorities may start to object to some of the novel approaches that multinationals use to support their transfer pricing policies.

During a March 18 webinar on COVID-19’s effects on transfer pricing, both practitioners and tax officials said the pandemic has made it significantly harder to apply established, comparables-based transfer pricing methods. As noted by governments, practitioners, and the OECD, identifying and obtaining financial data on comparables that could be used to support multinationals’ transfer pricing practices in 2020 is one of the main transfer pricing challenges caused by the pandemic.

Companies used in the past may no longer be appropriate comparables for purposes of applying the transactional net margin method or its U.S. equivalent, the comparable profits method, according to Marc Levey of Baker McKenzie. The OECD transfer pricing guidelines and U.S. section 482 regulations place more emphasis on functional comparability than industry, which can allow the use of companies from multiple different industries. However, because the pandemic’s economic effects have varied widely by industry, the unadjusted profitability of otherwise valid comparables may be a misleading benchmark for 2020, Levey said.

“When you have a mixture of these functionally equivalent companies in your comparables sample, it becomes very difficult to be able to utilize those in an effective way,” Levey said. “And you’re now starting to see companies look to their own internal data, their own budgeted financials, to try to create trends for purposes of comparability — but more important, trends for how to make potential adjustments. And that’s where in COVID-19 the imagination and creativity comes into place here.”

Depending on the available data, adjustments to the financial results of either the tested party or the selected comparables may be an appropriate way to support multinationals’ intercompany pricing, according to Levey.

The Lesser Evil

Carlos Pérez-Gómez Serrano of MAAT Asesores, a former head of the Mexican tax agency’s transfer pricing unit and delegate to the OECD’s Working Party 6, said the search for solutions to comparables-related problems may force multinationals to choose the least flawed approach from a set of imperfect options. In this context, use of a corroborative transfer pricing method or references to groupwide financial data may be the best option available, he said.

“Companies and tax administrations should see a corroborative analysis as something that would [provide] the best result given the subjectivity and lack of information,” Pérez-Gómez said. “The projections of the same company’s internal numbers and the consolidated financials of the group can also be a reference. I think we have to think about how we make use of this information as a reference for how COVID-19 impacts that specific multinational group.”

Referring to the OECD guidelines’ recognition of the potential value of statistical tools, Manuel de los Santos, an adviser to the OECD’s transfer pricing unit, said use of a statistical regression analysis may be another valid option. “The idea there would be to use those tools to predict the variation of, for instance, the profitability of an entity — that entity being the tested party or one of the comparables — based on the variation of another variable — in this case, GDP. So the idea would be to check out how the profitability of an entity or a comparable was affected in a previous economic downturn based on the variation of the GDP, and then [extrapolate] that to the current economic situation,” he said.

However, according to Levey, national tax administrations will not always agree — either with the taxpayer or with their counterparts in other countries — on which adjustments or other ad hoc solutions are appropriate.

“They’re not going to give the level of certainty, in particular if you’re under audit, that taxing authorities are going to all agree upon. So what we may be walking into is going to be a very, very difficult scenario of potential disputes,” Levey said. “And the disputes get even more contentious when you get into a mutual agreement procedure and you have the different countries looking at these adjustments in independent ways and not necessarily buying into the methodologies that were used for these adjustments.”

The elevated dispute risk warrants more formal guidance from national tax administrations, including on the treatment of companies that have received government assistance, the applicable comparables search criteria, and intangible-related transactions, according to Pérez-Gómez.

Bigger Problem for Some Than Others

According to Emily Muyaa of IBFD, problems associated with the use of comparables during the pandemic are particularly acute for developing countries. Muyaa, who also serves on the U.N. Transfer Pricing Subcommittee, acknowledged that access to comparables data by developing countries' tax administrations has been recognized as a major challenge since well before the COVID-19 pandemic. However, the need to account for new complexities — including adjusting for differences in the level of government assistance received by potential comparables — has made a challenging process even more difficult, she said.

“Before now, of course, a number of countries — especially developing countries — have had problems in terms of accessing comparables data. What the pandemic has done is to exacerbate this situation,” Muyaa said.

However, those challenges present new opportunities as well, according to Muyaa. Greater scrutiny of taxpayers’ internal data and wider use of safe harbors may assist developing countries in administering their transfer pricing regimes, Muyaa said. She also suggested a more prominent role for regional tax bodies, particularly by providing pooled access to comparables databases.

“I really would like to call on regional tax bodies around the world, especially within developing countries, to really see how they can move and maintain the dialogue on the issue of comparability,” Muyaa said.

Mindful of the challenges that developing countries often face, the U.S. competent authority makes a concerted effort to maintain parity with its foreign counterparts during advance pricing agreement or MAP negotiations, according to John Hughes, director of the IRS’s advance pricing and mutual agreement program.

“We view our competent authority partners as peers and as partners. Taxpayers are stakeholders, but it’s not just necessary for the process to run efficiently, but it’s important as a matter of respect — respect for the treaty and respect for the mutual agreement article and the competent authority process — that taxpayers understand the need to treat both competent authorities, or the multiple competent authorities if it’s a multilateral APA, on an equal footing,” Hughes said. “So it’s not at all uncommon for us as the U.S. competent authority to be nudging, cajoling, [or] forcing even U.S.-headquartered companies to make sure that they are providing the other competent authority with all the information that is needed to work the case.”

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