Tax Articles

TRANSFER PRICING AMIDST COVID-19

By: Atty. Jomel N. Manaig

Almost two years on and the world is still reeling from the effects of the Covid-19 pandemic. To give some perspective, the International Monetary Fund expects global economic growth in 2021 to be at 5.9% with further declines to 4.4% and 3.8% in 2022 and 2023, respectively. The slow global growth is the product of the disruptions brought by Covid-19 which contributed to increase in poverty, sharp reduction of remittances flows, and volatile commodity prices, among others.

Global trade was likewise not spared. Along with the effect on basic economic circumstances, Covid-19 presented a complex hurdle on the determination of the arm’s length principle. With the BIR’s renewed vigor to implement transfer pricing audits to test the compliance of related party transactions to the arm’s length principle, taxpayers must make significant strides to justify their pricing mechanisms amidst the backdrop of Covid-19.

Compliance to the arm’s length principle relies heavily on comparability analysis. Basically, this involves the gathering of historical data from comparable transactions and/or entities to determine whether a related party transaction adhered to the arm’s length principle. However, historical data may not accurately reflect current economic realities or may have skewed figures due to the economic impairments caused by the pandemic.

In a bid to guide taxpayers and tax administrators, the Organization for Economic Co-operation and Development (“OECD”) provided for practical approaches regarding the performance of comparability analyses to address the information deficiencies on the impact of Covid-19.

Comparability analysis may be supported by a separate analysis on the changes in certain key metrics from the pre-Covid-19 years against the present. Such key metrics may include sales volume, capacity utilization, Covid-19-related incremental or exceptional costs, government assistance and interventions, and macroeconomic information. A comparison of budgeted/forecasted data against the actual results may also be used in assessing the financial impacts of Covid-19. These analyses are aimed to explain to tax administrators the “should be” financial outcomes of the taxpayer had it not been for Covid-19.

The analyses prepared by taxpayers should be based on reliable information preferably from publicly available historical data. However, the problem with publicly available historical data is that it may not accurately represent the current economic circumstances due to the lag in time between the occurrence of the transaction and the availability of information regarding that transaction. As such, use of the said data may not provide a sufficiently reliable benchmark without considering the specific impact of the pandemic.

Considering the said limitation, the OECD advises tax administrators to take into consideration certain practical approaches in order to minimize disputes where taxpayers are making good faith efforts to determine arm’s length prices despite the information deficiencies associated with the Covid-19 pandemic.

One of these practical approaches is the use of reasonable commercial judgment supplemented by contemporaneous information to set a reasonable estimate of the arm’s length principle. Here, taxpayers, after exerting reasonable and appropriate due diligence, must be allowed to evaluate the likely effects of the Covid-19 pandemic and implement appropriate changes in their transfer prices. Taxpayers must also document the best available market evidence currently available to complement its evaluation.

Another practical approach is for tax administrators to allow for an “outcome-testing” approach where taxpayers are allowed to incorporate information that becomes available after the close of the taxable year to determine arm’s length conditions and report results on the tax return. However, local application of this approach may require the BIR to issue related guidelines since it may ultimately lead to significant amendments in the tax returns. Without said guidelines, taxpayers may shy away from amending their tax returns considering the fines and penalties attendant to such amendment.

Lastly, the OECD also recommends the use of more than one transfer pricing method to corroborate the arm’s length price of a related party transaction.

In addition to changes in the comparability analyses, the OECD recommended the use of price adjustment mechanisms to provide for flexibility while maintaining an arm’s length outcome. The use of price adjustments would address the issue of information deficiencies. However, given the scope of the potential adjustments, extreme care should be practiced.

Evidently, timely and accurate information is key in transfer pricing. While taxpayers may gather the necessary information on its own, it is highly recommended to consult your transfer pricing expert in order to give you insights on all the intricacies and complexities in transfer pricing, especially in the time of Covid-19.