Duff & Phelps Experts Discuss Transfer Pricing Methods for Multinationals During COVID-19

This article was first published in Law360 on June 4, 2020.

Fabian Alfonso, Matt Billings and Justin Radziewicz, Managing Directors in Duff & Phelps' Transfer Pricing practice, recently published an article for Law360 titled, “Multinationals Should Review Their Transfer Pricing Methods”. The authors wish to thank Salim Vagh, Director in the firm’s Transfer Pricing practice, for his contributions to this article.

The COVID-19 crisis is significantly disrupting multinational corporations and will lead to unexpected – and for most, unfavorable – group profit outcomes in 2020. From a tax perspective, this disruption may be magnified by traditional transfer pricing models and the relatively simple ways they allocate group risk and profit between jurisdictions.

Tax directors are already faced with difficult questions as to whether their existing transfer pricing models remain appropriate in times of such extreme crisis and how to benchmark arm's-length outcomes in such an environment. 

In times of crisis, cash preservation often becomes a higher priority for multinationals, and taxes represent a significant type of cash outlay that could be strongly affected by transfer pricing. 

Many groups have relied on one-sided transfer pricing methodologies, such as the transactional net margin method (TNMM) or comparable profits method (CPM), that provide a target level of profit to limited risk group members in certain jurisdictions. By construction, such a one-sided model leaves any residual profit or loss to be reported by related entities in other jurisdictions. 

The practical limitations of these one-sided transfer pricing models become more evident in times of crisis, raising questions about its appropriateness. Notably, its allocation of positive profits to specific jurisdictions if the shock is expected to create substantial operating losses for the overall group. 

The impact of the COVID-19 crisis on financial accounting returns for samples of comparables and for taxpayers are hard to predict. This makes efforts to comply with the arm's-length standard under CPM/TNMM and residual profit split approaches particularly challenging for 2020.¹

Tax directors relying on these pricing methods, therefore, face challenges in predicting what the arm's-length benchmarks and associated profit ranges for 2020 will be, and how to implement internal pricing policies intended to hit such profit targets. Questions facing tax departments operating under these methods include:

• Should profit targets be revised midyear, in anticipation of benchmarks shifting for 2020?
• How should differences in forecasted versus actual revenue levels, idle production assets, inventory obsolescence, intragroup services that are temporarily not provided, etc., be addressed?
• Can loss-making companies be reliable comparables, even for limited risk taxpayers?
• Are geographic, industry and product comparability factors worth reconsidering and reevaluating now?

This article will focus mainly on the TNMM/CPM, considering how commonly they are used and how sensitive they can be to economic shocks that affect operating profit levels.

Read the full article here.

_Sources
^1.By contrast, the comparable uncontrolled price method, resale price method, cost plus method and other forms of transactional profit split methods do not directly consider the operating profitability of comparable companies, nor the operating costs of the taxpayer, and so are relatively less sensitive to changes in operating costs or sales volumes.