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Jiří Jakoubek | May 18, 2021

The effects of the Covid-19 pandemic on transfer pricing and the attitude of the tax administrator

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The worldwide pandemic crisis has an influence on transfer pricing as well. Many mutually connected companies are dealing with a decrease in demand, extraordinary costs or other non-standard situations, which have a significant influence on their profit/loss. For this reason, the OECD issued a Guidance on transfer pricing implications of the COVID-19 pandemic (hereinafter the “OECD Guidance”) at the end of the year 2020, which focuses on application of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations from the year 2017 (hereinafter the “OECD Directive”) and the arm's length principle in relation to the current pandemic and the subsequent post-pandemic situation. The General Financial Directorate (GFD) issued the Information on the impact of the COVID-19 pandemic on transfer pricing at the end of March 2021 and published a translation of OECD Guidance on the occasion. It is possible to recapitulate that the guidance mainly confirms that the arm's length principle will remain an imperative for discussions at the OECD for a long time. Revolutionary expectations and prognoses for significant changes in the international tax environment have not been fulfilled and the OECD member states have shown that they can only agree on a deepening and confirmation of the current procedures and methods.

The OECD Guidance is intended for taxpayers when reporting accounting periods impacted by the pandemic as well as for tax administrations when evaluation the transfer pricing policy applied by the taxpayer. The guidance focuses on 4 main priorities: performing comparability analyses, losses and the allocation of COVID-19 specific costs, government intervention programmes and advance pricing agreements. From the Czech perspective, the first two are fundamental, the other two can be seen as rather a more precise formulation of the effects of the first two priority issues.

With regard to the fact that the economic impact of the pandemic differs across the economies of the individual countries, industrial and business fields, the significance and structure of the risks undergone is changing as well. The ability to document, explain and substantiate the functions performed by the taxpayer, the related risks and among other things the justification of cost bearing by the corresponding beneficiary in the group, are getting to the forefront. This is while the risk, which influences companies, is different not only for the individual segments of the market, but it especially differs for the various functional positions of companies within a group. From the guidance, a recommendation follows, which is intended especially to document the impact of the pandemic on transfer pricing, or record, to what extent a company has been impacted and to compare the fact with previous periods. The documentation should also contain information about if and how the business was also affected by other influences during the pandemic, which are unrelated to the pandemic.

The guidance primarily accentuates the importance of functional and risk analysis, which should compare and detect the differences in performed functions, the risks born and the assets used by a specific company before the pandemic and in the course of it. If the actually performed functions and the risks born by the given company in the period before the pandemic and during the pandemic do not differ, the attitude to transfer pricing should not be changed groundlessly either. It is possible to recapitulate that here the focus of the guidance is in compliance with the conclusions of the relevant case-law of the Supreme Administrative Court – from a certain perspective, the greatest danger for the taxpayer is the taxpayer himself or the policy of the group. This applies to the situation of presenting not well considered contractual and evidential documentation that does not correspond to reality in the course of the tax procedure.

According to the OECD, entities may post losses only to the extent that pertains to them according to the performed functions and the risks born. The company must also control the given risks and have sufficient financial capacity, which will enable covering the given risk. The attitude of the OECD to selected priorities was discussed at a workshop organised by Grant Thornton on 20 April 2021, where representatives of the OECD were present.

It is possible to read between the lines of the OECD Guidance as well as understand from a statement of OECD representatives that the effects of the pandemic should be assessed very individually, and it is necessary to approach them in this way when documenting the impact on a specific entity as well. At the same time, the OECD is calling on tax entities as well as financial administrations for flexibility in terms of finding a suitable approach to transfer pricing at the time of the pandemic, the effects of which will not influence the years 2020 and 2021 alone, but probably the following years as well.

We strongly recommend not to underestimate the given area and to consult it with experts on the given field, because a number of changes in pricing within a group have a long period of application and retroactive adjustments usually cannot be considered relevant for the given period. A warning arises from discussions with representatives of the Czech state administration that any potential changes for the crisis years will need to be reflected in the future transfer pricing setup in the periods after the crisis has ended.

Long-term impact therefore calls for thorough analysis and evaluation of the consequences of adjustments of transfer pricing methods, for a good consideration of the new setup and especially for reckoning with the fact that the endeavour to deal with the consequences of economic lapse by means of a sudden adjustment of the transfer pricing model may lead to increased interest of the tax administrators in auditing the tax base for the crisis and post-crisis periods in future. The fiscal requirements of the state budget presented in the media, as well as the historical experience from the first half of the previous decade, when the profit (or rather loss) impact of the financial crisis was allocated from group headquarters to production companies on a massive scale, also suggest this trend. The fact that the Financial Administration is more than prepared for such a situation is illustrated for example by the common press release of the Finance Ministry and the Financial Administration published on 22 April 2021, from which it is clear that between the years 2014–2019 the Financial Administration performed some 2182 audits focusing primarily on transfer pricing and the increase of tax base for this period alone reached more than CZK 39bn.

Last but not least, it needs to be mentioned that the issue of transfer pricing does not only apply to the tax liabilities of an entity, but increasingly more also to its statutory bodies from the perspective of due managerial care and diligence, or disputes between shareholders of companies. We focus on these situations, too, and we can offer their efficient solutions or coverage of risks. We suppose that more than ever, the risk of additional tax assessment for the above-mentioned reasons may be shifted to the statutory bodies of companies, which will be actively trying to manage the impact of the pandemic with regard to the preferences of corporate headquarters.

If you have any questions regarding the above-mentioned issue, please, do not hesitate to turn to the Transfer pricing team of Grant Thornton Tax & Accounting s.r.o., which is prepared to answer any questions you may have and also to provide professional assistance.