Background

The novel Coronavirus, also known as “COVID-19”, was first identified in China in late 2019 and has now spread to dozens of countries. At the time of writing, the World Health Organization just labeled this as a global pandemic. As cases of global infection continue to rise and drastic measures are taken, such as the effective self-quarantine imposed on all of Italy, the economic impact of the virus is already being felt on a global scale. This is most clearly seen through the U.S. and global stock market plunges in recent weeks as a result of uncertainty and fear caused by the Coronavirus. As many U.S. based multinational enterprises (“MNEs”) have entities based in China, including those engaged in activities such as manufacturing or procurement, the Coronavirus is having a significant impact on the supply chains of MNEs. The economic disruption being created by the Coronavirus may even warrant a thorough review of the supply chain to evaluate whether future risk can be mitigated through geographic diversification of the key supply and production centers.

Possible Disruptions and Transfer Pricing Compliance

Manufacturing activity in China came to a standstill as the Chinese government imposed travel restrictions and quarantines in efforts to contain the Coronavirus outbreak. This may cause a lasting disruption to supply chains of MNEs who, in particular with just-in-time inventories, rely on a steady supply of finished goods and components coming out of China. As a result, entities throughout an MNE value chain may report operating losses that will disrupt the routine returns that are consistent with transfer pricing principles and a common feature of global transfer pricing policies. 

Companies may need to consider revising their forecasts and business continuity plans, as well as reassess their multinational transfer pricing planning based on the impact of the pandemic to their operations. Some preemptive steps MNEs can take include reviewing the existing intercompany agreements to consider whether these allow for economic adjustments between the parties in the event of business disruption. Similarly, reviewing the prior year documentation to assess the functional and risk profiles of related entities, and verifying if any of them are at risk. During the review, comparables used to previously benchmark transactions may no longer be functionally equivalent since the search for these comparables did not take into account losses brought on by global turmoil. 

Unfortunately, even companies that have entered advanced pricing agreements (“APA”s) may have some work to do and should review the terms of the agreement to determine whether it allows for financial adjustments as a result of such unforeseen global events. APAs guarantee certainty, but only based on critical assumptions regarding future events. They may not cover transactions under extraordinary circumstances, such as pandemics, as past transfer pricing models may be out of date.

A&M Taxand Take

As the spread of the Coronavirus continues to cause fear and uncertainty in the U.S. and global economic outlook, affected companies are well-advised to consider the potential impact early on, review their inter-company value chains and consider pro-active steps to mitigate compliance risk. MNEs can further prepare to make the appropriate transfer pricing adjustments to align with the global risk allocations and maintain adequate documentations to explain and quantify the losses caused by Coronavirus. The epidemic may leave MNEs with heavy tax burdens if not managed appropriately; therefore, it is advisable to be proactive and gather contemporaneous information.