The COVID pandemic has affected many multinational businesses. As a result, some of them have faced adverse market conditions, supply chain, operational, and other business issues. This has resulted in extra costs and losses for many multinationals.

From a transfer pricing (TP) perspective, this raises the question of which entity in the group should bear the extra costs/losses and whether any existing TP policies need to be adjusted. This is particularly relevant for limited risk models where limited risk entities (distributors or manufacturers or service providers) typically earn a fixed routine return but incurred extra costs/losses during the pandemic. A similar question will also arise for other models (e.g. licensing, franchise etc).

In some cases, the COVID pandemic has also resulted in the relocation of personnel to different jurisdictions. This may create significant risks for the existing TP models that relied on the location of personnel in certain territories. This may also give rise to a Permanent Establishment (PE) risk and personal tax issues.

In addition to the COVID pandemic, there are wider macro trends that may impact existing TP models. These include supply chain diversity and disruption (e.g., over-reliance on Asia for manufacturing and lean stock holdings, causing shortages in the supply of certain products) and the increasing importance of environmental issues (e.g., energy-intensive operations moving to places with cheaper renewable energy).

The current and expected changes in the international tax environment also create additional pressure for multinational businesses and their TP models. These trends include:

• Increased focus on substance/functions and supporting evidence (e.g., the activities of the HMRC’s Profit Diversion Compliance Facility, and more general focus from tax authorities on tax audits);
• Increased transparency (e.g., the potential introduction of public CbC reporting in the EU);
• Tax authorities’ focus on the location of personnel and PE issues;
• Additional TP compliance requirements (e.g. the proposed Master File / Local File / Evidence log requirements in the U.K.; the introduction of TP documentation filing requirements in Denmark etc)
• The ongoing OECD’s Pillar 1 project in relation to the new nexus and profit allocation rules, and Pillar 2 project in respect of the new minimum tax rules; and
• The consequences of the new U.S. tax reform.

The implications of the COVID pandemic, coupled with the shifting international tax environment, will give rise to a number of challenges for multinational businesses from a transfer pricing and broader tax perspective.

What can your business do?

In the first place, multinational businesses should review their existing TP models and assess if any changes are required to their TP arrangements and policies. Multinationals should also consider the following actions:

• Assess how the decision-making process with regard to risk control and management of subsidiaries’ COVID responses worked during/post-pandemic and whether this was aligned with the current TP model.
• Assess the risks (PE, TP, personal, etc.) arising from employees located in overseas territories.
• Consider comparability adjustments to existing benchmarking sets in the light of COVID.
• Consider the treatment of COVID government subsidies from a TP standpoint (e.g., furlough schemes).
• Consider an impact on tax authority agreements, rulings, APAs, etc.
• Assess the impact of OECD’s Pillar 1 and Pillar 2 reforms on the tax profile of the business.

Potential benefits to the business

The primary benefit of reviewing your TP model now is the proactive mitigation of relevant tax risks. This is particularly important given an increased audit activity of tax authorities in a number of jurisdictions (e.g., in the U.K.). The TP model review may also bring other benefits, including:

• TP model aligned with operating model and business objectives;
• Model simplification and transparency;
• Reduced ETR / cash tax;
• Creation of defence file/evidence log for future tax audits; and
• Improved business controls.

For more Information on reviewing your Transfer Pricing model, please contact Richard Syratt or Deyan Mollov.