OECD Transfer Pricing Guidelines (2017)

OECD COVID-19 TPG paragraph 1

The impact of coronavirus (“COVID-19”) has been profound. The rapid spread of the virus has strained local medical infrastructures, led to restrictions on travel and social contact, and created unprecedented disruptions to the global economy.

OECD COVID-19 TPG paragraph 2

During the pandemic period, many enterprises have faced or continue to face significant cash flow constraints, requiring them to develop and implement strategies to conserve and generate cash. Enterprises have seen wide swings in profitability, both upward and downward. Enterprises across a variety of industries have faced disruption to their supply chains, including the curtailment of their operations and corresponding reductions in output, and have been forced to change how their business is conducted (e.g. working from home). In many jurisdictions, factories, mines, shops and restaurants have been forced to close, at least temporarily. In some industries, demand has completely collapsed, while in others it has merely shifted channels or even increased (e.g. the market for online videoconferencing services). In the presence of significant financial hardship, some enterprises have reviewed their contractual arrangements with third parties to ascertain whether they remain bound by them or have attempted to renegotiate key terms, including requesting discounts or deferred payment. Given the significance and speed of the economic impact of the virus, governments have adopted comprehensive policy responses to support the economy and protect people’s jobs and incomes.

OECD COVID-19 TPG paragraph 3

The arm’s length principle has been found to work effectively in the vast majority of cases,1 and this principle-based approach to assessing intercompany prices is equally robust for evaluating controlled transactions in the face of the COVID-19 pandemic. The OECD TPG are intended to help tax administrations and MNEs find mutually satisfactory solutions to transfer pricing cases2 and should be relied upon when performing a transfer pricing analysis under the possibly unique circumstances introduced by the pandemic.

1Paragraph 1.9 of Chapter I of the OECD TPG.

2 Paragraph 15 of the Preface of the OECD TPG.

OECD COVID-19 TPG paragraph 4

However, the unique and almost unprecedented economic conditions arising from and government responses to COVID-19 have led to practical challenges for the application of the arm’s length principle. For example, the pandemic may raise novel issues or exacerbate in complexity or magnitude the occurrence of certain transfer pricing issues (e.g. effect of government assistance or the availability of reliable comparable data). For taxpayers applying transfer pricing rules for the financial years impacted by the COVID-19 pandemic and for tax administrations that will be evaluating this application, there is a need to address these practical questions. Based on the responses to the questionnaires submitted to members of the Inclusive Framework and businesses, and conscious of the need to provide practical and timely guidance, this note addresses four priority issues:

(i) comparability analysis;

(ii) allocation of losses and the allocation of COVID-19 specific costs;

(iii) government assistance programmes; and

(iv) Advance Pricing Arrangements (“APAs”).

For ease of presentation, these issues have been presented as discrete topics, but it is important to emphasise that in performing a transfer pricing analysis, these topics may be interrelated and therefore should be considered together and within the analytical framework of the OECD TPG. For example, in order to determine whether an entity should be allocated losses during the pandemic under arm’s length conditions, the guidance in Chapter II of this document is relevant, but the guidance in Chapter I (as it relates to the results of the comparability analysis) and the guidance in Chapter III (if it receives government assistance) is also relevant.

OECD COVID-19 TPG paragraph 5

It is important not to lose sight of the objective to find a reasonable estimate of an arm’s length outcome, which requires an exercise of judgment on the part of taxpayers and tax administrations.3 Accordingly, this guidance focuses on how the arm’s length principle and the OECD TPG apply to issues that may arise or be exacerbated in the context of the COVID-19 pandemic. Thus, it should be regarded as an application of existing guidance under the OECD TPG to fact patterns that may arise commonly in connection with the pandemic, and it should not be regarded as an expansion or revision of the OECD TPG, either with respect to such pandemic-related fact patterns or more generally.

3 Paragraph 1.13 of Chapter I of the OECD TPG.

OECD COVID-19 TPG paragraph 6

This guidance acknowledges that the economic impact of the COVID-19 pandemic varies widely across economies, industries and businesses, which is a key factor when considering and interpreting its content. Therefore, in any transfer pricing analysis of the implications of the COVID-19 pandemic, businesses should seek to contemporaneously document how, and to what extent, they have been impacted by the pandemic.

OECD COVID-19 TPG paragraph 7

The significance of risk is particularly relevant in the current economic climate for the four issues discussed in this note. The COVID-19 pandemic, which constitutes a hazard risk, has led to unusual outcomes of other risks for some taxpayers, including:

(i) marketplace risk, as demand for some products and services has collapsed;

(ii) operational risk, as the pandemic has disrupted supply chains and inhibited production; and

(iii) financial risks, as borrowing costs for some industries have spiked and customers have delayed or defaulted on payments.4

4 Paragraph 1.72 of Chapter I of the OECD TPG.

OECD COVID-19 TPG paragraph 8

Against this background, taxpayers and tax administrations should carefully follow the guidance on the accurate delineation of controlled transactions in Chapter I of the OECD TPG to identify with specificity the economically significant risks and to determine the specific economically significant risks that each party to a controlled transaction assumes.5 Therefore, the interplay between the COVID-19 hazard risk and other economically significant risks should be evaluated when considering risk assumption in a particular controlled transaction. In undertaking this analysis, it may be determined that a party to a controlled transaction cannot influence the hazard risk associated with a pandemic, but nevertheless assumes other risks that have materialised as a result of COVID-19. Care must also be taken to determine how the associated enterprises and the group as a whole respond to the manifestation of hazard risks and its subsequent effects on the other economically significant risks identified in the controlled transaction. (See paragraphs 1.34 and 1.35 of Chapter I of the OECD TPG). In particular, the widespread effects of the COVID-19 pandemic in an industry or within an MNE group do not suffice to claim that a member of an MNE group has to bear the consequences of risks materialising as a result of the COVID-19 pandemic without an analysis of how the outcome of the economically significant risks controlled by the member of the group has been affected by the pandemic.

5 Paragraphs 1.59-1.60 of Chapter I of the OECD TPG.

OECD COVID-19 TPG paragraph 9

The unprecedented change in the economic environment following the outbreak of COVID-19 creates unique challenges for performing comparability analysis. The pandemic may have a significant impact on the pricing of some transactions between independent enterprises and may reduce the reliance that can be placed on historical data when performing comparability analyses. This may require taxpayers and tax administrations to consider practical approaches that can be adopted to address information deficiencies, such as comparability adjustments. Such practical approaches regarding the performance of comparability analyses should be consistent with the transfer pricing policy of the taxpayer over time.

OECD COVID-19 TPG paragraph 10

The challenges associated with performing a comparability analysis may vary depending on the impact of the COVID-19 pandemic on the economically relevant characteristics of the accurately delineated transaction. For example, if a controlled transaction is covered by a pre-existing intercompany agreement (for example, if in 2018 it was determined that at arm’s length a party should receive an agreed fixed return for five years, and that parties at arm’s length would remain bound by that agreement), there may be no need to perform a comparability analysis for Financial Year (“FY”) 2020 provided that the facts and circumstances of the accurately delineated controlled transaction have not changed. In reaching this conclusion, it is important to consider any changes in the economically relevant characteristics, including the terms and conditions of the agreement, and whether at arm’s length, unrelated parties would have tried to renegotiate those terms and conditions.6 In contrast, where the arm’s length price of a controlled transaction is determined on an annual basis, it will be necessary to perform a comparability analysis for FY 2020.

6 See also the discussion in paragraphs 42 to 46 in this regard.

OECD COVID-19 TPG paragraph 11

In principle, any form of publicly available information regarding the effect of COVID-19 on the business, industry and controlled transaction may be relevant in ascertaining the arm’s length nature of an enterprise’s transfer pricing policy implemented for FY 2020. The following sources of information may support that determination through the comparability analysis, generally by estimating the effect of the COVID-19 pandemic on the controlled transactions under review:

  • An analysis of how sales volumes have changed during COVID-19, including whether the change is due to the use of other sales channels, and specifically compared to sales generated in pre-COVID years;
  • An analysis of the change in capacity utilisation relevant for the MNE group and the controlled transaction7, and/or transactions with independent parties;
  • Specific information relative to incremental or exceptional costs borne by parties to the controlled transaction (either with associated or unrelated parties) or by the MNE group as a whole;
  • The extent to which government assistance has been received and, if so, quantifying the effect and identifying the type of the assistance and its accounting treatment;
  • Details regarding government interventions that have affected the pricing and performance of controlled transactions;
  • Information from interim financial statements such as quarterly SEC filings or earnings releases;
  • Macroeconomic information like country specific GDP data or industry indicators from central banks, government agencies, industry or trade associations to the extent useful in understanding the context of the controlled transaction;8
  • Statistical methods such as regression analysis or variance analysis that are used to predict the extent to which a certain variable will vary with reference to other variables under certain specific conditions (e.g. the response of corporate profits in certain industries to GDP movements);
  • A comparison of internal budgeted/forecasted data relating to sales, costs and profitability, compared to actual results; and
  • An analysis of the effects on profitability or on third party behaviour observed in previous recessionary periods or using any data available in the current year, even if partial.

7 Paragraph 2.76 of Chapter II and illustration 3 in Annex I to Chapter II of the OECD TPG.

8 Paragraph 3.7 of Chapter III of the OECD TPG.

OECD COVID-19 TPG paragraph 12

Another potential approach to utilise in setting transfer prices is to compare budgeted or forecast financial results to those actually achieved, to approximate the specific effects of COVID-19 on revenues, costs and margins. The financial outcomes that taxpayers within a controlled transaction would have achieved ‘but for’ the impact of COVID-19 may provide useful information, particularly when assessing the financial impacts from COVID-19 (e.g. reduced sales volume or increased operating expenses) and determining, in light of contractual terms and risk assumption of the parties, any appropriate resulting impact on intercompany prices. This analysis may include:

  • The preparation of a detailed profit and loss analysis showing changes in revenue and expenses, with an explanation for variances resulting from COVID-19 – this may include a variance analysis of budgeted (pre-COVID) versus actual results;
  • Details of profitability, adjusted to where the outcome would have been if COVID-19 had not occurred – this should consider all factors that have a positive or negative impact on the profits of the taxpayer to a controlled transaction and should be supported by evidence;
  • The rationale and evidence for any increased allocation of costs or a reduction of sales (and subsequent changes in operating margins) to the tested party in the controlled transaction, taking into consideration its function, asset and risk profile; and
  • Any evidence of any government assistance provided or affecting the tested party in the controlled transaction, its effect and its accounting treatment.

OECD COVID-19 TPG paragraph 13

Such a review may be performed as part of a more general set of approaches utilised to evaluate the context and the factors that may impact the arm’s length nature of prices.

OECD COVID-19 TPG paragraph 14

Information relating to the conditions of comparable uncontrolled transactions undertaken during the same period as the controlled transaction (“contemporaneous uncontrolled transactions”) is the most reliable information to use in a comparability analysis. Such information reflects how independent parties behave in an economic environment that is the same as or substantially similar to the economic environment of the controlled transaction.9

9 Section B of Chapter III of the OECD TPG.

OECD COVID-19 TPG paragraph 15

In some instances, comparability analysis can be performed using contemporaneous (or near contemporaneous) uncontrolled transactions. For example, publicly available commercial databases typically have current or recent information on financial transactions between unrelated parties, which may provide reliable information on which to base comparability analyses under current economic conditions. Similarly, taxpayers are more likely to have current information on potential internal comparables, where these can be used to price related party transactions.

OECD COVID-19 TPG paragraph 16

In other instances, it may be more challenging to use contemporaneous uncontrolled transactions as part of a comparability analysis, notably in the application of the transactional net margin method (“TNMM”). When applying the TNMM, taxpayers and tax administrations typically rely on historical information from commercial databases in order to set and test prices. FY 2020 information will typically not be available until mid FY 2021 at the earliest because commercial databases use publicly available information derived from financial statements and these financial statements tend to be lodged only after several months after the period to which they relate. This suggests that in these circumstances taxpayers will need to perform a comparability analysis based on available prior year financial information and, depending on the facts and circumstances of the case, utilising whatever current year information is available to support their transfer prices.

OECD COVID-19 TPG paragraph 17

However, not every application of the TNMM will in principle require contemporaneous information for FY 2020. For example, a long term arrangement covering FY 2019 through FY 2022 may be in place, including an arm’s length price based on comparables contemporaneous with the negotiation of the arrangement, that insulates the tested party from risks that the tested party does not assume like those that play out during the pandemic. See also paragraph 10.

OECD COVID-19 TPG paragraph 18

As the economic circumstances caused by the pandemic are continuing and evolving over time, taxpayers may encounter difficulties in determining arm’s length conditions due to the lag in time between the occurrence of controlled transactions and the availability of information regarding contemporaneous uncontrolled transactions.

OECD COVID-19 TPG paragraph 19

Data from independent comparable transactions or companies from other time periods, such as average returns in preceding years, may not provide a sufficiently reliable benchmark for the current period without considering the specific impact of the pandemic on the controlled transactions under review.


OECD COVID-19 TPG paragraph 20

The discussion below provides several pragmatic approaches to this issue. Tax administrations could consider these pragmatic approaches in an attempt to minimise disputes where taxpayers are making good faith efforts to determine arm’s length prices in the context of the information deficiencies associated with the COVID-19 pandemic. However, these approaches would not be appropriate in cases where taxpayers seek to use the circumstances attached to the COVID-19 pandemic to manipulate their pricing strategies in a way that is inconsistent with the arm’s length principle.

OECD COVID-19 TPG paragraph 21

The difficulty posed by the delayed availability of contemporaneous data on comparable companies or transactions may have been exacerbated by the COVID-19 pandemic. Taxpayers and tax administrations should be mindful that determining a reliable arm’s length outcome requires flexibility and the exercise of good judgment.10 Difficult transfer pricing issues that arise as a result of the COVID-19 pandemic could give rise to a large number of mutual agreement procedure (“MAP”) disputes that could severely strain the resources of tax administrations. As such, tax administrations are encouraged to keep these complexities in mind when performing risk assessments, evaluating transfer pricing positions on audits and considering the support and documentation taxpayers provide that might demonstrate reasonable efforts and care when trying to comply with the arm’s length principle. Taxpayers should undertake reasonable and appropriate due diligence in evaluating the likely effects of the COVID-19 pandemic and in implementing appropriate changes in their transfer prices. MNE groups should document the best available market evidence currently available, which may be in the form of internal comparables, external comparables, or other relevant evidence of the economic impact of the COVID-19 pandemic (see paragraph 11), including its effects on the level of demand for goods and services, and on production and supply chains in particular sectors of the economy.

10 Paragraphs 1.13 and 2.74 of Chapter I and Chapter II of the OECD TPG.

OECD COVID-19 TPG paragraph 22

The OECD TPG describe two approaches to identify and collect data required to undertake a transfer pricing analysis. The first is a “price-setting,” i.e. an ex-ante approach, which uses historical data updated to reflect any change in economic conditions through the date of the contract. The second is an “outcome-testing” approach, which may incorporate information that becomes available after the close of the taxable year to determine arm’s length conditions and report results on the taxable year to determine arm’s length conditions and report results on the tax return. According to the OECD TPG, both approaches, or a combination of these approaches, are found among OECD member countries.11

11 Paragraph 3.71 of Chapter III of the OECD TPG.

OECD COVID-19 TPG paragraph 23

Where possible, and on a temporary basis during the pandemic, tax authorities that otherwise use the price-setting approach could consider allowing taxpayers, for those controlled transactions affected by the pandemic, to take into account information that becomes available after the close of the taxable year in filing their returns (where legally permissible and properly described in the transfer pricing documentation). Tax administrations could provide flexibility to allow amendments to FY 2020 tax returns such that transfer prices are set on an arm’s length basis and using available information. Also given the potential for double taxation that may arise as a result of unilateral adjustments, consideration may be given by tax administrations to:

    • Provide for flexibility in the allowance of “compensating adjustments” to be made before the tax return is filed, where it is legally permissible, in order to allow for any available contemporaneous information to be better evaluated by taxpayers and tax administrations such that arm’s length prices can be reliably established12; or
    • Ensure access to the MAP, or to some alternative applicable procedure, where the issue could be addressed between the respective tax administrations and early certainty could be obtained, to avoid double taxation, noting that through MAP or alternative procedures tax administrations can address issues in a non-adversarial proceeding, often achieving a negotiated settlement in the interests of all parties.

12 Paragraphs 4.38 and 4.39 of Chapter IV of the OECD TPG.

OECD COVID-19 TPG paragraph 24

In the specific circumstances of the COVID-19 pandemic, the application of more than one transfer pricing method may be useful to corroborate the arm’s length price of a controlled transaction. In this context, it is important to note that the arm’s length principle does not require the application of more than one method and that the use of more than one method should follow the guidance in paragraphs 2.2 and 2.12 of the OECD TPG.

OECD COVID-19 TPG paragraph 25

A comparability analysis that is solely based on financial information from the global financial crisis 2008/2009 would raise significant concerns (despite the obvious superficial similarities between that crisis and the current pandemic), given the unique and unprecedented nature of the COVID-19 pandemic and its effect on economic conditions, as well as the variability of the impact by business sector of the 2008/2009 crisis. In all cases, a comparability analysis should be performed by reference to the specific delineation of the controlled transaction, including its actual economic circumstances.

OECD COVID-19 TPG paragraph 26

The principles outlined in Section B.5 of Chapter III of the OECD TPG regarding the use of multiple year data and averages remain applicable. In ordinary circumstances, the use of multiple year data and multiple year averages for comparability analyses may have certain advantages. For example, it can be used as a means to mitigate the impact of accounting differences, appropriately measure the effects on profitability for the tested party based on its business and product life cycles, and to evaluate the same for the comparables, such that the reliability of the comparison is increased.13

13 Paragraph 3.77 of Chapter III of the OECD TPG.

OECD COVID-19 TPG paragraph 27

As a pragmatic means of addressing divergent economic conditions in the pre- or post-pandemic period, and when the pandemic was in effect and its effects on economic conditions were material, it may be appropriate to have separate testing periods (and periods considered for price setting) for the duration of the pandemic or for the period when certain material effects of the pandemic were most evident. This may be appropriate, so long as the data from independent comparables can be measured over a similar period in a consistent manner. Care should be taken to ensure the financial data of years affected by the pandemic do not unduly distort results from pre- or post-pandemic periods. In addition, government intervention in a market may materially affect the performance of activities. For example, in certain situations, the activities that otherwise normally would have occurred absent the pandemic may not occur in the same manner (or at all) during the period that the government intervention is in place. Also, in some cases a government intervention may permit activities to proceed that otherwise would have been curtailed or stopped by the pandemic. The accurate delineation of a controlled transaction will determine the effect, if any, of such intervention on the price or form of any controlled transaction associated with such activities.

OECD COVID-19 TPG paragraph 28

This aspect is also relevant in performing the comparability analysis. For instance, assume government intervention forces a taxpayer to close its distribution facilities for three months. In undertaking a benchmark analysis, care should be taken in verifying that comparable enterprises have faced similar restrictions or conditions. Otherwise, it might be necessary to adjust the period over which the comparison is performed (e.g. excluding the economic data corresponding to the three months where the taxpayer was unable to operate). Taxpayers and tax administrations should determine on a case-by-case basis the extent to which these adjustments are necessary in circumstances where the potential differences may not have a material impact on the comparability. In this respect, the guidance in paragraphs 3.50 to 3.52 of the OECD TPG is relevant.

OECD COVID-19 TPG paragraph 29

As with other analyses under the OECD TPG, numerous considerations may come into play, including the availability and choice of potential transfer pricing methods and comparables, and the interrelationship among them and the parameters of the testing periods (e.g. a transaction-based method may have a different time frame from a profit-based method). Just as it may improve reliability to use separate or more carefully circumscribed testing periods (or price setting periods) in some fact patterns (see paragraph 27), in other fact patterns the use of combined periods (that include both years that are impacted by the pandemic and years that are not impacted) may improve reliability.14 This approach would aggregate the financial results of FY2020, which may be exceptional, with the more normal results of prior years in order to test the arm’s length nature of the transfer pricing policy applied in FY2020.

14 Paragraphs 3.75 and 3.79 of Chapter III of the OECD TPG.

OECD COVID-19 TPG paragraph 30

One potential solution to the uncertainty caused by the COVID-19 pandemic would be to allow for the inclusion of price adjustment mechanisms in controlled transactions. This may provide for flexibility while maintaining an arm’s length outcome. In particular, this approach to the extent permissible by domestic law would allow the adjustment of prices relevant for FY2020 through adjusted invoicing or intercompany payments effectuated in a later period (likely FY2021), when more accurate information to establish the arm’s length transfer price becomes available. In jurisdictions that use the outcome-testing approach, price adjustment mechanisms to reflect updated information relevant to determining an arm’s length price are often used. A jurisdiction that temporarily allows the outcome-testing approach could also temporarily allow the use of price adjustment mechanisms for that purpose and the taxpayer would be expected to describe the application of the price adjustment mechanism in its transfer pricing documentation. Such price adjustment mechanisms (provided that they are consistent with the arm’s length principle in the particular facts and circumstances) would address the issue of the lack of contemporaneous information on comparables or other direct evidence of arm’s length behaviour in response to the pandemic. This would give flexibility to taxpayers and tax administrations while also ensuring ultimate compliance with the arm’s length principle; however, given the scope of the potential adjustments, care would need to be taken with their appropriate characterisation, any effects that the payment may have on the comparability analysis for FY2021, and their potential resultant VAT/GST and customs duty implications (which are not the subject of this chapter or guidance).

OECD COVID-19 TPG paragraph 31

The COVID-19 pandemic has created economic conditions that often differ from those of previous years. In these circumstances, where a taxpayer rolls forward an existing set of comparables to cover FY2020, it may be necessary to review the suitability of these existing comparables and potentially in some cases, it may be useful to revise the set, based on updated search criteria.

OECD COVID-19 TPG paragraph 32

For example, assume that geographic comparability is deemed as the most relevant comparability factor given the nature of the effects of COVID-19 in a particular market. In these circumstances, in order to obtain reliable data from a particular market it may potentially be necessary to relax other comparability criteria, and then refine the sample.

OECD COVID-19 TPG paragraph 33

In general, there is no overriding rule on the inclusion or exclusion of loss making comparables in the OECD TPG.15 Accordingly, loss-making comparables that satisfy the comparability criteria in a particular case should not be rejected on the sole basis that they suffer losses in periods affected by the COVID-19 pandemic.16 Consequently, when performing a comparability analysis for FY 2020, it may be appropriate to include loss-making comparables when the accurate delineation of the transaction indicates that those comparables are reliable (e.g. the comparables assume similar levels of risk and that have been similarly impacted by the pandemic).

15 Paragraph 3.64 of Chapter III of the OECD TPG.

16 Paragraph 3.65 of Chapter III of the OECD TPG.

OECD COVID-19 TPG paragraph 34

During the COVID-19 pandemic, many MNE groups have incurred losses due to a decrease in demand, inability to obtain or supply products or services or as a result of exceptional, non-recurring operating costs.17 The allocation of losses between associated entities can give rise to dispute and hence is an issue that requires consideration given the probable increase in the frequency and magnitude of losses in the current economic environment. When considering the issue of losses and the allocation of COVID-19 specific costs, three issues warrant specific discussion.

17 For example, this might include expenditure on personal protective equipment, on IT infrastructure required to implement a “test and trace” system, measures to reconfigure office space to implement physical distancing requirements, or on other health-related safety equipment.

OECD COVID-19 TPG paragraph 35

First, it is important to emphasise that the allocation of risks between the parties to an arrangement affects how profits or losses resulting from the transaction are allocated at arm’s length through the pricing of the transaction.18 Hence, the existing guidance on the analysis of risks in commercial or financial relations will be particularly relevant for determining how losses are allocated between associated parties.

18 Paragraph 1.58 of Chapter I of the OECD TPG.

OECD COVID-19 TPG paragraph 36

Second, it will be necessary to consider how exceptional, non-recurring operating costs arising as a result of COVID-19 should be allocated between associated parties.19 These costs should be allocated based on an assessment of how independent enterprises under comparable circumstances operate. Separately, as extraordinary costs may be recognised as either operating or non-operating items, comparability adjustments may be necessary to improve the reliability of a comparability analysis. It is important to keep in mind that the treatment in a transfer pricing analysis of “exceptional,” “non-recurring,” or “extraordinary” costs incurred as a result of the pandemic will not be dictated by the label applied to such costs, but by an accurate delineation of the transaction, an analysis of the risks assumed by the parties to the intercompany transaction, an understanding of how independent enterprises may reflect such costs in arm’s length prices, and ultimately how such costs may impact prices charged in transactions between the associated enterprises (see OECD TPG paragraph 2.86, for example). Financial accounting standards should be considered in the comparability study, as they contain relevant and potentially helpful concepts in identifying the nature of costs. However, it should also be noted that even under those financial accounting concepts, there can be uncertainty as to whether particular costs are properly characterised as exceptional or extraordinary costs.

19 Depending on the duration of COVID-19 and the broader effects of the pandemic, the question may arise what constitutes an “exceptional, non-recurring” operating cost and when should such costs no longer be considered “exceptional” or “non-recurring”. As the effects of the pandemic vary by industry, business model or market, it is likely that this question can only be answered through a careful analysis of the specific costs under consideration.

OECD COVID-19 TPG paragraph 37

Finally, the COVID-19 pandemic has created conditions in which associated parties may consider whether they have the option to apply force majeure clauses, revoke or otherwise revise their intercompany agreements. This may impact the allocation of losses and COVID-19 specific costs between associated parties, and therefore also requires specific consideration in the current economic environment.

OECD COVID-19 TPG paragraph 38

When performing transfer pricing analyses, the activities performed by an entity may lead it to be characterised as “limited-risk” where it has a relatively lower level of functions and risks. 20 Though the term “limited-risk” is commonly used, since the term is not defined in the OECD TPG, the functions performed, assets used and risks assumed by “limited-risk” entities vary, and therefore it is not possible to establish a general rule that entities so-described should or should not incur losses. It should also be noted that neither the mere labelling of activities as “limited-risk” nor the fact that an entity receives a fixed remuneration means by itself that an entity operates on a limited risk basis in a controlled transaction.21 Further, no supposition should be made regarding the most appropriate transfer pricing method to apply in any set of circumstances without first undertaking a full and accurate delineation of the transaction, which then will help inform the choice of method made when performing the appropriate comparability analysis.

20 Paragraph 9.2 of Chapter IX of the OECD TPG.

21  Paragraph 1.81 of Chapter I of the OECD TPG.

OECD COVID-19 TPG paragraph 39

In all circumstances it will be necessary to consider the specific facts and circumstances when determining whether a so-called “limited-risk” entity could incur losses at arm’s length. This is reflected in the OECD TPG which states that “simple or low risk functions in particular are not expected to generate losses for a long period of time”,22 and therefore holds open the possibility that simple or low risk functions may incur losses in the short-run. In particular, when examining the specific facts and circumstances, the analysis should be informed by the accurate delineation of the transaction and the performance of a robust comparability analysis. For example, where the losses incurred by third parties reflect a level of risks that is not comparable to the one assumed by the taxpayer in its controlled transaction then such a comparable should be excluded from the list of comparables (see paragraph 3.65 of the OECD TPG).

22  Paragraph 3.64 of Chapter III of the OECD TPG.

OECD COVID-19 TPG paragraph 40

In determining whether or not a “limited-risk” entity may incur losses, the risks assumed by an entity will be particularly important. This reflects the fact that at arm’s length, the allocation of risks between the parties to an arrangement affects how profits or losses resulting from the transaction are allocated.23 For example, where there is a significant decline in demand due to COVID-19, a “limited-risk” distributor (classified as such, for example, based on limited inventory ownership – such as through the use of “flash title” and drop-shipping – and therefore limited risk of inventory obsolescence) that assumes some marketplace risk (based on the accurate delineation of the transaction) may at arm’s length earn a loss associated with the playing out of this risk. The extent of the loss that may be earned at arm’s length will be determined by the conditions and the economically relevant characteristics of the accurately delineated transaction compared to those of comparable uncontrolled transactions, including application of the most appropriate transfer pricing method and following the guidance in Chapter II of this note and Chapters II and III of the OECD TPG. In the example provided in this paragraph, the TNMM or potentially the resale- minus method depending on the more detailed facts and circumstances, might be used as the most appropriate method to test the arm’s length nature of the return, and third party comparable distributors might in these circumstances earn a loss, which may, for example, arise if the decline in demand means that the value of sales is insufficient to cover local fixed costs. It should be noted that the comparables chosen should be suitable in light of the accurate delineation of the transaction, in particular with reference to the risks assumed by each of the counterparties to the transaction. However, it will not be appropriate for a “limited-risk” distributor that does not assume any marketplace risk or another specific risk to bear a portion of the loss associated with the playing out of that risk. For instance, a “limited risk” distributor that does not assume credit risk should not bear losses derived from the playing out of the credit risk. For this reason, when determining whether an entity operating under limited risk arrangements can sustain losses the guidance in Chapter I of the OECD TPG, particularly as it relates to the analysis of risks in commercial or financial relations,24 will be particularly relevant.

23 Paragraph 1.58 of Chapter I of the OECD TPG.

24  Paragraphs 1.56 -1.106 of Chapter I of the OECD TPG.

OECD COVID-19 TPG paragraph 41

When considering the risks assumed by a party to a controlled transaction, tax administrations should carefully consider the commercial rationale for any purported change in the risks assumed by a party before and after the outbreak of COVID-19 (and taking into consideration the accurate delineation of such purported change). In particular, concerns may arise where before the outbreak of COVID-19 a taxpayer argues that a “limited-risk” distributor did not assume any marketplace risk and hence was only entitled to a low return, but after the outbreak argues that the same distributor assumes some marketplace risk (for example, due to changes in risk management functions) and hence should be allocated In this scenario, consideration should be given to re-examining whether prior to the outbreak of COVID-19 the “limited-risk” distributor genuinely did not assume any marketplace risk, whether after the outbreak the “limited risk” distributor did not actually assume any marketplace risk, and/or whether the assumption of this risk following the outbreak of COVID-19 is a result of a business restructuring. If a prior risk allocation is recognised under an accurate delineation, in order for a reallocation of that risk to be recognised under a subsequent updated accurate delineation, such new risk allocation must be supported by an analysis of all the facts and circumstances and relevant evidence should be obtained and documented to substantiate the position. In this respect, the guidance in Chapter IX of the OECD TPG may be relevant. In general, consideration should be given to whether a taxpayer is taking inconsistent positions pre- and post- pandemic and, if so, whether either position is consistent with the accurate delineation of the transaction.

OECD COVID-19 TPG paragraph 42

In response to the COVID-19 pandemic, independent parties could seek to renegotiate certain terms in their existing agreements.25 Associated parties may also consider revising their intercompany agreements and/or their conduct in their commercial relationships. Tax administrations should therefore review the agreements and/or the conduct of associated enterprises, in light of the guidance in section D of Chapter I of the OECD TPG, together with observations of relevant behaviour of independent parties and this guidance, in order to ascertain whether any such renegotiation should be respected under the OECD TPG. The accurate delineation of the controlled transaction will determine whether the revision of intercompany agreements is consistent with the behaviour of unrelated parties operating under comparable circumstances.

25  Part 1, Section F of Chapter IX of the OECD TPG.

OECD COVID-19 TPG paragraph 43

Given the current economic environment, it is possible that independent parties may not strictly hold another party to their contractual obligations, particularly if it is in the interest of both parties to renegotiate the contract or to amend certain aspects of their For example, unrelated enterprises may opt to renegotiate a contract to support the financial survival of any of the transactional counterparties given the potential costs or business disruptions of enforcing the contractual obligations, or in view of anticipated increased future business with the counterparty. This behaviour should be considered when determining whether or not associated parties would agree to revise their intercompany agreements in response to COVID-19.

OECD COVID-19 TPG paragraph 44

For example, assume that Distributor X purchases products, the controlled transaction, from a related party Company Y, and sells these products to third party customers. Further assume that a major customer of Distributor X does not pay for products purchased within its standard 30-day term, and that this causes a cash flow issue for Distributor X, who bears credit risk under the accurately delineated transaction. Under these circumstances, Distributor X may seek to renegotiate its payment terms on a temporary basis with Company Y. The determination of whether this renegotiation is arm’s length should be based on what independent parties would do under comparable circumstances and if there have been situations at arm’s length where contractual terms have not been enforced, or have been amended, this may form reasonable evidence for taxpayers to justify revised terms in intra-group agreements where the situations are comparable.

OECD COVID-19 TPG paragraph 45

Determining whether a renegotiation of a commercial arrangement (including pricing under the arrangement going forward and any potential compensation for the renegotiation itself) represents the best interests of the parties to a transaction requires careful consideration of their options realistically available26 and the long-run effects on the profit potential of the parties.27 For example, an entity may agree to restructure a transaction if the alternative option is losing a key customer or supplier, where it considers that the restructuring will maximise its profits in the long-run. Consideration should also be given to whether the economic impact resulting from the renegotiation may require indemnification (as defined in OECD TPG paragraph 9.75) of the harmed party.28

26 It should be noted that in an uncontrolled transaction one party might attempt to force a renegotiation by threatening to violate the terms of an existing agreement, believing that the other party will not find it worthwhile to seek judicial enforcement of the agreement, whereas this course of action may not realistically be available in the context of a controlled transaction.

27 Paragraphs 9.78-9.97 of Chapter IX of the OECD TPG.

28 Paragraphs 9.78-9.97 of Chapter IX of the OECD TPG.

OECD COVID-19 TPG paragraph 46

The above analysis outlines the factors that should be considered when determining whether associated parties may at arm’s length consider revising their intercompany agreements and/or their conduct in their commercial relationships as a consequence of the COVID-19 pandemic. However, it is important to emphasise that in the absence of clear evidence that independent parties in comparable circumstances would have revised their existing agreements or commercial relations, the modification of existing intercompany arrangements and/or the commercial relationships of associated parties is not consistent with the arm’s length principle. Accordingly, such modifications should be treated with caution and well-supported by documentation outlining how the modification is in line with the arm’s length principle.

OECD COVID-19 TPG paragraph 47

As a result of the COVID-19 pandemic, many enterprises have incurred exceptional, non-recurring operating costs relevant to differing operating conditions for the pandemic period. These include expenditure on Personal Protective Equipment (PPE), reconfiguration of workspaces to enable physical distancing, IT infrastructure expenses relating to test, track and trace obligations and to implement teleworking arrangements. In determining how these costs should be allocated between related parties, it will be important to consider how these costs would be allocated between independent parties operating in comparable circumstances.

OECD COVID-19 TPG paragraph 48

Allocation of operating or exceptional costs would follow risk assumption and how third parties would treat such costs. Thus in order to determine which associated enterprise should bear exceptional costs, it would be first necessary to accurately delineate the controlled transaction, which would indicate who has the responsibility for performing activities related to the relevant costs and who assumes risks related to these activities. For example, if a cost directly relates to a particular risk, then the party assuming that risk would typically bear the costs associated with that risk. Furthermore, the party initially incurring an exceptional cost may not be the party assuming risks associated to that cost at arm’s length, and consequently such costs may need to be passed on to parties that do assume such risks. Thus a thorough analysis should be performed before concluding whether all or part of the operating or exceptional costs should be allocated between related parties.

OECD COVID-19 TPG paragraph 49

Further, it should be noted that certain operating costs may not be viewed as exceptional or non- recurring in circumstances where the costs relate to long-term or permanent changes in the manner in which businesses operate. For example, certain costs relating to teleworking arrangements may become permanent if working from home became more common as a result of the pandemic. Consequently, if the expense is viewed as neither being exceptional nor non-recurring and reflects more common means of doing business, then it should be treated as such when delineating the transaction to which the costs pertain and in undertaking the comparability analysis. Furthermore, it should also be noted that for certain businesses the COVID-19 pandemic has led to reduction in or elimination of certain costs that were typically incurred prior to the COVID-19 pandemic. These will differ depending on the underlying facts and circumstances, but might include expenses on rent, the day-to-day running expenses of a physical office, and travel related expenses, among others. Expenses that relate to substitutes to the means of conducting business activities would likely be treated as operating costs, depending on the underlying facts and circumstances. If teleworking costs, or any other costs pertaining to remote working facilities, are centrally borne by one entity of the MNE group, it may be appropriate to charge out such expenses to parties that benefit from the underlying product or service to which the expense relates.

OECD COVID-19 TPG paragraph 50

At arm’s length, exceptional costs may or may not be passed on (wholly or partially) to customers or suppliers depending on who has the responsibility to bear such costs and (including in cases in which such responsibility is not expressly provided for) the consequences of the accurate delineation of the controlled transaction (including risk assumption) and the comparability analysis. For example, which party ultimately bears such costs might be influenced by the competitiveness of the industry within which the activity occurs and how demand responds to changes in price. For example, a manufacturer in a highly competitive market, with undifferentiated products, may be unable to pass on exceptional costs to its customers, without experiencing a decline in demand for its services (unless its competitors are passing on similar costs). However, a similar manufacturer that produces differentiated products in a comparatively uncompetitive industry may be able to pass on these costs to its customers, at least partially, without experiencing a decline in demand.

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