This article is taken from our quarterly newsletter, Canadian Overview, published by the Canadian member firms of Moore North America. The articles in our newsletter are part of our mission to become the partner of choice for your success by keeping you up to date.
BY AVINASH (AVI) S. TUKREL FROM SEGAL LLP
As we know, the world is changing fast, and certain events are only accelerating this phenomenon, such as COVID-19 and the current political context, with the forthcoming elections in the United States (U.S.), the imminent departure of the United Kingdom (U.K.) from the European Union (BREXIT), the trade quarrels being waged by the economic superpowers and climate change, among other emergencies with global repercussions.
COVID-19, which triggered the most recent health crisis, has been classified as a pandemic by the World Health Organization (WHO). This pandemic has not only affected individual health and strained healthcare systems around the world, it has also had a significant impact on international economies and financial markets, including global supply chains and profitability, which will be felt for many years to come.
years.
Initially, China had to close its factories, which had an impact on global production results and caused delays in distribution to end customers. Factory closures in China and confinement to strategic international economic centers have had cascading effects on other industries, including oil & gas, air transport, hospitality and retail. Governments around the world have announced
emergency fiscal measures, including Central Banks which have cut interest rates on borrowing considerably to protect their economies from the effects of the recession.
As the macro-economic impact of the COVID-19 crisis continues to be assessed, it is vital that multinationals involved in cross-border activities and business-to-business transactions manage their response to these circumstances. This includes assessing the impact the crisis has had on their profitability, as well as a potential overhaul of their global supply chains.
Here are a few suggestions to consider from the point of view of transfer pricing:
1. Review transfer pricing models and policies
If the performance of a multinational group has been significantly impacted, and the group chooses to restructure its operations by reallocating its functions, assets and risks (FARs) to better manage its supply chain, it will be important for the transfer pricing model and policy to be overhauled and updated accordingly. If these reshuffles result in changes in the transaction profile and in the general conditions governing intercompany contracts (e.g., an increase in intercompany financing and related guarantees, an increase/decrease in sales/purchase prices, interactions due to intercompany services, contract negotiations with customers, changes in credit terms, impact on inventory movements due to, among other things, supply disruptions), these changes could affect the intercompany pricing basis and the returns of arm’s-length entities attributable to each participating entity. In today’s environment, it should not be assumed that, if the parent company is traditionally in charge of strategic functions, owns the most valuable assets (including intellectual property) and assumes the greatest risks (FAR), it is the only one to centralize losses at group level, while the other entities remain profitable.
2. Establish function, asset and risk profiles and perform a value chain analysis. chain analysis
When updating transfer pricing policies and intercompany pricing models, it is essential that the multinational group performs a careful value chain analysis to reflect any changes that may have occurred in the strategic functions, asset ownership and risk acceptance of each entity.
3. Carry out an economic analysis
One of the key principles to be observed when performing an economic analysis to determine the range of returns for arm’s length entities in order to substantiate a taxpayer’s position, is to consider significant events and revisit that analysis. The traditional practice of updating a downstream repositioning by updating comparable companies, which consists in comparing/using prices according to the arm’s length comparable price method, is unlikely to reflect the most current economic realities facing the multinational group.
- To achieve this, taxpayers may need to consider the following options:
- Reallocate FAR and use the profit-sharing approach – taxpayers could consider adopting the profit-sharing approach and allocating profits/losses, as appropriate. However, when adopting this method, it is essential to meet a number of (rigorous) conditions, and to clearly establish the value generated by each party involved, which will in turn lead to the allocation of profits/losses. An over-simplistic approach to the adoption of the profit-sharing method will not only be likely to attract attention, but will also be difficult to substantiate and support the “unconnected” nature of the concept.
dependence” of such an assignment. - Generally unprofitable comparables – when carrying out a benchmarking study to identify a comparable set, the approach of categorically rejecting generally unprofitable companies may need to be reconsidered.
- Use of the arm’s length comparable price method – when a taxpayer relies on price benchmarks using the arm’s length comparable price method, it is important that the five comparability factors be assessed in the context of any changes and to determine whether the price comparison remains appropriate.
- Reallocate FAR and use the profit-sharing approach – taxpayers could consider adopting the profit-sharing approach and allocating profits/losses, as appropriate. However, when adopting this method, it is essential to meet a number of (rigorous) conditions, and to clearly establish the value generated by each party involved, which will in turn lead to the allocation of profits/losses. An over-simplistic approach to the adoption of the profit-sharing method will not only be likely to attract attention, but will also be difficult to substantiate and support the “unconnected” nature of the concept.
4. Employees and border agreements
Border agreements affect key personnel (employees), and it is therefore crucial that multinational groups assess the impact of changes currently being made to immigration laws in the context of a crisis such as COVID-19. These changes will have a direct impact on employees seconded to other countries, as well as on the inter-company agreements in question. What’s more, if employees traveling for business reasons are unable to return to their home countries due to travel restrictions and security advisories that justify long-distance employment contracts, such contracts could result in permanent establishments for the multinational group. Although the Canada Revenue Agency (CRA) has ruled that there is no permanent establishment if employees are in Canada due to travel restrictions, this ruling may vary from country to country.
5. Governance and implementation of changes
When multinational groups make changes to the transfer pricing model and policy, these changes must be implemented in a way that is consistent with the Group’s strategy.
should be immediately reflected in intercompany agreements, intercompany accounting documents and invoices, and groups should ensure that the required year-end adjustments are applied before the year-end closing or before filing the annual tax return, to reflect current facts and circumstances.
6. Document impact on business
If multinational groups have made changes to their transfer pricing model and policy, or have been adversely affected by the COVID-19 crisis, it will be imperative for taxpayers to be able to articulate such changes or the reasons for such changes in profitability in their annual transfer pricing documentation. While this may vary by business sector, it will be essential to document any yield differential in the first instance to defend the new transfer pricing position with the tax authorities. Otherwise, if a taxpayer proceeds with an Advance Pricing Arrangement (APA), it should model and document the impact on the business, as this will be considered a change to the crucial underlying assumptions on which the APA is/will be based.
7. Manage transfer pricing obligations
If a multinational group has to prepare and file a country-by-country return, or comply with country-by-country reporting obligations, local transfer pricing declarations, or file a group master file, it will need to monitor any changes in filing deadlines (which may be pushed back in the short term). Such statements should include both quantitative information (adjustments, amounts written off, asset disposals, etc.) and qualitative information on the impact on the multinational group’s activities. If one or more entities are subject to a transfer pricing audit, it is important to manage deadlines with the tax authority accordingly, and to agree any delays in submitting the required information.
8. Other taxes
If a multinational group is restructuring its operations due to the impact of COVID-19, and inter-company transactions are subject to withholding taxes, Goods and Services Tax (GST)/Harmonized Sales Tax (HST)/Value Added Tax (VAT), etc., it will be crucial that the effect of these taxes be assessed when making the changes. Alternatively, if a multinational group leaves a certain market, it may have to meet expatriation and compliance tax obligations prior to such closure or disposal.
In these uncertain times, managing the risks of transfer pricing will become crucial for companies and governments alike. Until recently, multinational groups have been able to observe the Organization for Economic Cooperation and Development’s (OECD) renewed vigilance on transfer pricing and tax transparency as part of the BEPS 2.0 project. In view of this continued key focus from the OECD and international tax authorities, and global crises such as the COVID-19 pandemic, transfer pricing arrangements are likely to attract increasing attention from tax authorities and be seen as a catalyst for tax revenues to balance financial deficits and manage tax collection targets.
