Transfer pricing in times of crisis: what should you do?

On Thursday June 11th, KPMG Meijburg & Cos transfer pricing team organized a webcast to share first experiences regarding transfer pricing issues in the context of the COVID-19 crisis. During the webcast we tried to elaborate on the main questions that clients are considering by sharing examples and experiences.

Key considerations and approach

The impact of the COVID-19 crisis for each group and how they deal with this is different. We see that some multinationals have already decided to change their transfer pricing arrangements, however others are waiting to see how the rest of the year develops. In our webcast we shared a two-step approach:

• Assess the impact of COVID-19 to your organization, and then Decide how and when to address this in your transfer pricing arrangements (if at all). Also carefully consider interaction between transfer pricing arrangements and adjustments with government measures (e.g. NOW);
• if the decision to amend your transfer pricing arrangements is taken, Implement and Document this with the relevant references to third party behaviour in your industry.

While the objective for this webcast has been to equip participants with a broader perspective of the COVID-19 impacts as they arise, there are many nuances that need to be considered on a case by case basis.

Please leave your contact details here or contact one of our transfer pricing experts to guide you through your specific case.

Following you will find a more elaborate report on the key take aways from the transfer pricing webcast.

Common transfer pricing challenges for multinationals.

In the one hour session we highlighted several key transfer pricing challenges multinational clients are facing when dealing with the COVID-19 measures in the various countries that they operate in. The main questions clients are considering include the following:

• Should I report a low and stable margin, even though little or no services are provided?
• How to manage existing financial arrangements, including liquidity and cash management?
• May existing contracts be adjusted or terminated?
• Can I invoke a force majeure clause?
• Should I adjust my transfer pricing policy now, or post COVID-19?
• Can I adjust my internal policies based on third party conduct?
• Can we stop charging Headquarter costs / management fees?

Taking action: what to consider?

Most companies are considering what to do with their transfer pricing policies, especially in dealing with a significant decrease of revenues. Even though there are different types of business models, ranging from centralized to decentralized, in all types of models challenges are faced. Although the whole group may face a loss position, routine remunerations could still result in cash tax to be paid.
In this respect, it is always important to consider if there is a need for action, and if now is the best moment for action. If you are considering to undertake measures, you should note the following:

• The start of the process should be an assessment of the intercompany agreements in place.
• From a transfer pricing perspective, it is key to consider how third parties would behave in a particular situation and try to mirror this conduct in intercompany situations.
• Many intercompany contracts typically include a “force majeure” clause. Such clause could be invoked in case of exceptional circumstances which may also take place between third parties. In cases where no force majeure clause is included in an intercompany agreement, there could still be arguments to find a possible opening to renegotiate intercompany agreements.
• As a last resort it could be considered to terminate the existing contract and renegotiate a new contract, wherein for instance a lower remuneration is agreed for a longer-term contract.

Make sure you evaluate the changes at a later time, and decide if the adjustments you made are sufficient. Changes or adjustments should always be considered on an individual basis, taking into account the specific circumstances of your company. Furthermore, this requires documentation and substantiation of the reason for invoking force majeure as well as of the revised arm’s length situation to be applied. Hereby, other realistically available alternatives should be taken into account. Even if you decide not to make any adjustments, we recommend to document the reasons why no adjustments are made.

Time to perform a new benchmark study?

Routine entities such as service providers, limited risk distributors, and contract/toll manufacturers are entitled to a routine remuneration, even if their business is currently lossmaking due to the impact of COVID-19. In most cases, benchmark studies have been performed in past years to determine the arm’s length remuneration. During the webcast a participant mentioned that LRDs are likely to show a drop in the 2020 data benchmarks and that hence it may be possible to reduce target margins for routine LRD entities. We can indeed imagine that the 2020 figures will show a drop in margins. However, for making adjustments now in 2020, such information is not yet available, so we need to consider other data sources to estimate what that drop in margin for 2020 could be.

To provide some guidance on this topic, KPMG reviewed various approaches, also recently featured in a publication. Based on this review, we suggest the following benchmark approaches:

• It can be considered to use the most recent data and make appropriate financial and other comparability adjustments by setting parameters which take into account the current business circumstances as much as possible (e.g. lower revenue thresholds, include loss-making companies).

• Also, the use of the 2020 quarterly and half year data of public/listed companies can be considered, provided this information is available.
• In addition, margin data taken from a previous recession period can be used.

Timing considerations

Despite a decline in turnover, we have experienced that some companies are making changes and others are not, while awaiting further developments. To decide if this is the right moment to make adjustments in existing transfer pricing policies, you should take the following into consideration:

• The current period may not provide sufficient insights in the development of the transfer pricing model under the circumstances.
• As business circumstances may be complex, changes in the transfer pricing model may impact the way the business is managed and structured, e.g. the IT implementation of the changes.
• Changes in the transfer pricing policy could raise questions by local authorities and thus should be implemented consistently. Substantiate and document the reasons for the changes relating to transfer pricing.
• Companies are also considering what to do if they have an APA. In this respect we note that they are in principle bound by the APA and the transfer pricing policy agreed in that APA. Companies wanting to change the margins applied should have their arguments prepared, also with reference to third party behaviour. Here also companies are considering what is the right time to approach the Dutch tax authorities to discuss this and what data to present.

Concurrence of transfer pricing with governmental measures: NOW

In the next part of the webcast, the concurrence of transfer pricing with governmental measures in the context of the COVID-19 crisis, specifically the Dutch NOW, was discussed. The NOW is aimed at providing a compensation for payroll costs. This compensation is relative to decline in turnover. For detailed information on the NOW and the FAQ on this measure, please reach out to us, or find our replays of several webcasts KPMG Meijburg & Co. organized on this topic in the past months.

With respect to the concurrence of the NOW with Transfer Pricing, we highlighted some items:

As a general rule, the decline in turnover for the NOW is calculated at the group level of Dutch companies. For the definition of ‘group’ reference is made to the provisions of the Dutch civil code. If the decline in turnover at group level is less than 20%, but an individual operating company within the group experiences a decline in turnover of at least 20%, the NOW is possible using a separate entity approach. The key note to remember from the text adjoining the regulations is that if the separate entity approach is applied, no Transfer Pricing policies may be adjusted.

In conversations with auditors, we understand that they will be careful when reviewing the drop in revenues and will not automatically follow a change in TP. If the drop in revenue cannot (fully) be confirmed, the subsidy needs to be repaid to the Dutch government. An auditor’s statement does not have to be submitted in 2020 but this may very well be in 2021 depending on the dates as set for the final NOW subsidy application to which an auditor’s statement should be attached. The Dutch association of accountants, NBA, is currently in consultation with the Ministry of Social Affairs & Employment in order to determine what should be included in the auditor’s statement and how the auditor should perform an audit for the NOW.

Some additional questions were raised with respect to the definition of a group and the provision of the auditor’s statement in relation to an audit. On the website of the NBA, the Frequently Asked Questions (‘FAQ’) in relation to the NOW group definition, turnover definition and auditors’ statement can be found.

There is still quite some uncertainty as to whether cost plus entities that change their transfer pricing can successfully apply for the NOW. A question from one of the participants related to this uncertainty was if a successful NOW application for a service company would result in a lower cost base on which the mark up is to be calculated. Based on the Dutch Transfer Pricing Decree (2018), it can be assumed that subsidies – such as the NOW – will be deducted from the cost base only if there is a direct link between the subsidy and the supply or service and, cumulative, the subsidy in question should be granted in the form of a discount, or as a contribution to costs. For a grant like the WBSO (wage tax subsidy) there is an allowance for deduction from the cost basis. It is still unclear whether the NOW could be treated akin to a WBSO subsidy or not.

Here are some examples regarding the NOW application for cost-plus entities that we shared during the webcast:

• In a People Driven organization, e.g. a shared services center, operational expenses include mainly payroll costs. Therefore, for such companies, changes to the cost-plus percentage alone may not exceed the required 20% turnover drop. Therefore, in practice, it may be difficult to successfully apply for the NOW unless there are very good arguments and reasoning to reduce reimbursement of cost as such. This is to be investigated carefully.
• For service entities and manufacturing entities, (variable) costs are likely to have decreased. Costs – and revenue – of these cost-plus entities may decrease with more than 20% in case the multinational is heavily impacted by the crisis, without making TP adjustments. For these  companies there could be an opportunity to opt for the NOW.