Corporations operating in almost every country are struggling to cope with repercussions of the COVID-19 pandemic sweeping the globe. While most companies try to figure out how to manage the swift decline – or sometimes even complete halt – in production of goods and consumer sales, multinational organizations face an additional challenge: these corporations must also consider the reasonability of the pricing strategies being utilized for their intercompany purchases and sales of goods and services.
Transfer pricing regimes look to determine whether related companies are purchasing and selling goods to one another in arm's-length transactions. That is, are related companies buying and selling goods and services to and from each other using the same pricing mechanisms and strategies that two nonrelated companies would employ when purchasing and selling goods to one another?
The answer to this question is not simply yes or no. In fact, many corporations spend a lot of money and resources determining how to build and maintain their intercompany pricing strategy to comply with this arm's-length standard. Pricing strategies are often driven by the risk each party takes on in the relationship, as well as the costs and revenues associated with the manufacture and sales from one entity to another. In a perfect – well, at least a normal – world, various risks, costs and revenues are things that can be budgeted and forecasted with some level of confidence on a quarterly or annual basis.
So what happens to our thoughtfully crafted transfer pricing strategies when a pandemic happens and everything we planned for is no longer possible? This is the question we’ll need to continue to answer in the coming months. It largely depends both on how risk is defined from a legal perspective, as well as how we as accountants and analysts quantify the financial and economic impact of such an unprecedented situation on pricing strategies.
If we put on our lawyer caps for a moment, we can start to work through questions that focus on determining which of our related parties bear the ultimate risks associated with profits and losses. It’s those companies that are truly bearing the risks that should be recognizing profits and losses. We might also ask which companies should be exempted altogether from the transfer pricing policies due to force majeure clauses in their related-party contracts? If exempted, these companies would not need to worry about deviating outside of "acceptable ranges" and could report their financials as is, with relatively low risk.
Switching to our accountant hat, we ask slightly different questions, such as should companies be working to change their pricing strategies now, or documenting their financial operations within previously established transfer pricing policies while waiting for operations to go back to "normal?" Also, if a company is able to quantify the periods for which COVID-19 has had an extraordinary impact on its business, what does an acceptable alternate analyses look like? Finally, and maybe the most complicated to answer, how does one identify comparables – a principle feature in any transfer pricing study – in a world that’s been virtually shut down for almost a month (potentially longer for companies operating in China, Italy and other countries that have been feeling the impact of COVID-19 since January)?
For many of these questions, like so much else right now, only time will yield the appropriate answer. Due to the subjective nature of transfer pricing, the approach for how to best deal with these questions within your own organization will likely be unique to your business structure and industry. No matter the business or industry, however, there will be a crucial need for multinational companies who have faced a change to their business due to COVID-19 to document those abnormalities in the coming year.
If you’d like to discuss the impact COVID-19 may be having on your current transfer pricing policy, or your current transfer pricing strategy in general, the SD team would love to hear from you!
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.