Transfer pricing disputes may be on the rise due to Covid-19 disruptions

Diligent record keeping of decision-making during this period is vital.
The significant impact of the pandemic on the pricing of transactions may have tainted third party comparability, which is the foundation of the arm’s length principle. Image: AdobeStock

The global Covid-19 restrictions on the movement of people and goods have disrupted long-standing intercompany commercial arrangements and impacted normal pricing arrangements.

This may well result in increased transfer pricing disputes between taxpayers and revenue authorities, experts warned during the 10th Africa Transfer Pricing summit hosted by the South African Institute of Taxation (Sait).

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Multinational companies have, in the past two years, faced challenges they have never encountered before, with disrupted supply chains, faltering economic demand and increased unemployment, said Chantel Venter, MD of Impact Transfer Pricing.

As a result, transfer pricing compliance was not high on the priority list. Intercompany transactions which were previously conducted in accordance with the arm’s length principle have been modified in an attempt to survive.

The principle of arm’s length pricing is fundamental to intercompany pricing arrangements: the transfer price should be similar to the price that would be charged if the product were sold to or bought from an unrelated party.

Consequences

Cabrini McCarrick, transfer pricing partner at Regan van Rooy, said disruptions led to an increase in intercompany lending, ranging from interest-free loans, advances or even discounted prices and delayed payments.

All of this will have transfer pricing consequences, she said.

Groups experienced volatility in terms of profit- and loss-making entities and changes to the functional profiles of companies. “Any changes that occurred, whether it was additional transactions or a change to the risk function of an entity within the group, will trigger an automatic transfer pricing review.”

Venter remarked that due to global disruptions, third party comparability – the foundation of the arm’s length principle – has been compromised.

“Entities failed to honour certain of the terms and conditions in the intercompany agreements in an attempt to minimise the negative impact of the pandemic,” she said.

Comparability

The Organisation for Economic Cooperation and Development (OECD) has issued guidelines on how challenges with comparability analysis could be faced. However, Patrick McLennan, associate director at BDO, says the guidance is not really “groundbreaking”.

It really only covers what companies would have considered in another “extraordinary circumstance”.

McLennan said the pandemic had a significant impact on the pricing of transactions which may have tainted third party comparability.

“We do not know what these comparable companies experienced themselves during the pandemic.” Publicly-available information about comparable companies is not always as available in Africa as in the rest of the world, he remarked.

Adjustments

Mazars senior manager Charl Hall noted that while some companies struggled to survive, others in online retailing and distribution excelled during the pandemic.

“They now have to consider how to treat these increased profits from a transfer pricing policy perspective … A group needs to evaluate potential transfer pricing adjustments that it may have made. It has to be documented carefully to prevent future disputes with revenue authorities.”

Companies need to create a “narrative” around what happened to the business during the pandemic, Venter advised. “It will be tricky to recreate what happened a few years down the line.

“It is better to act proactively by recording and retaining information about the commercial rationale behind business decisions during the pandemic.”

Documentation retention

Companies are advised to keep supporting documents that relate to pre- and post-Covid budgets, diligently record changes to transfer pricing policies, and keep documentation that will illustrate any restrictions on the movement of people and products.

Kerry Watkin, attorney at TRM Tax Attorneys, emphasised the need to archive transfer pricing documentation digitally. Paper and personnel become risky in the long term. “Staff members resign, retire, emigrate or die and paper gets lost, wet, destroyed, misplaced.”

The absence of records presents a massive risk.

“A taxpayer can be squeaky clean, but because they cannot discharge the burden of proof they may find themselves in a very unenviable position,” she remarked.

Venter said it is vital to demonstrate how restructuring costs were treated during the pandemic and to keep any information relating to changes in sales volumes, government assistance and macro-economic information.

On the rise

The pandemic has affected tax collections in many countries and revenue authorities are hard pressed to fill empty coffers.

It appears that transfer pricing adjustments, audits, disputes and even litigation may be on the rise.

Watkin said the power of the audit process should not be underestimated. It can actually go a long way in resolving issues before it comes to disputes or expensive litigation.

If there is a risk in the company’s transfer pricing landscape it must be acknowledged, as opposed to trying to dodge the inevitable bullet.

Okkie Kellerman, independent consultant, agreed that risks should be addressed upfront. The South African Revenue Service (Sars) is not going to be scared away by a four-page aggressively worded letter.

“We tend to believe that we can prove everything, but sometimes the policy is grandly designed but hardly ever implemented in practice. Sometimes you will find a mismatch between the policy and what you can actually prove.”

In some instances, the policy may be deficient and then technical issues should take a back seat when responding to queries from Sars, Kellerman advised.

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