Country-specific guidance on the transfer pricing implications of the COVID-19 pandemic

A number of countries, among them Australia, Canada, and Singapore, have put forth guidance on the appropriate transfer pricing treatment for governmental subsidies related to the COVID-19 pandemic, as well as guidance on the appropriateness of single-year vs. multi-year transfer pricing analysis.  It may be helpful for businesses to consider such guidance for transfer pricing purposes in the COVID-19 pandemic environment.

 The main issues are^[1]:

• Would affiliates of multinational enterprises (MNEs)’ be able to reflect in their financial statements, for transfer pricing purposes, the financial aid they may have received from governments due to the COVID-19 pandemic? That is, should MNEs treat a government subsidy as an adjustment above the line?This would reduce the TP adjustment, but it may result in a company passing on the benefit back to the Principal/Parent.Or should MNEs treat this as an adjustment below the line?This would mean the Principal/Parent will continue to support the margin and the government assistance will be taxable locally.  This question is particularly relevant because many affiliates may be challenged to meet target financial returns in the current economic environment.
• Would MNEs’ affiliates be able to test transfer pricing results on a multi-year basis (ie, tested party results) in order to smooth out the impact of the COVID-19 pandemic?

In this alert, we summarize our observations regarding country-specific guidance in Australia, Canada, China, Singapore, the Netherlands and the United States.

AUSTRALIA

Treatment of COVID-19 governmental subsidies

On July 15, 2020, the Australia Taxation Office (ATO) issued a statement that provides basic guidance on the treatment of JobKeeper payments for transfer pricing purposes.  Australia’s JobKeeper program provides financial support to employers that have been materially affected by the Covid-19 pandemic. 

The statement indicates that the ATO expects Australian entities to retain the benefit of the JobKeeper payment received.  ATO intends to review transfer pricing arrangements wherein the JobKeeper payment resulted in a change to the transfer prices to offshore related parties.  The statement from the ATO outlines two simplistic “cost plus” examples to illustrate the correct transfer pricing treatment of JobKeeper payments in the ATO’s view.  Presumably, the JobKeeper support should be adjusted out of a taxpayer’s financial results in transfer pricing analyses in order for taxpayers to comply with the spirit of the statement.

Single-year vs. multi-year analysis

Multi-year testing, such as across a five-year period, is generally acceptable by the ATO.  In practice, based on experience with the ATO, the ATO has been challenging cases in which a number of low-profit / loss making years are combined with higher-profit years to achieve an overall weighted average result within the interquartile range of comparable companies’ financial results.

CANADA

Treatment of COVID-19 governmental subsidies

The Canada Revenue Agency (CRA) has published administrative guidance suggesting that COVID-19 governmental subsidy amounts should be excluded from transfer pricing computations and that the full benefit should remain in Canada, unless the taxpayer can provide that arm’s-length parties would treat such government support differently.

During the TaxCoop 2020 World Tax Summit on October 14, 2020, Alexandra MacLean, Director General of the CRA’s International and Large Business Directorate, acknowledged that the governmental COVID-19 assistance to businesses raises important tax considerations: making sure that Canadian governmental assistance stays in Canada and isn’t shifted out of Canada using transfer pricing or other methods, and making sure taxpayers’ income and losses are being measured accurately, taking into account amounts received from the government.”  Further, MacLean indicated that the CRA is now in the middle of running phase one of auditing of the Canada emergency wage subsidy.  The agency intends to complete the audit work for the wage subsidy as close to real time as possible and bring lessons from that experience back to the income tax auditing program.

Single-year vs. multi-year analysis

Single-year testing is generally required.  Multi-year data are considered by the CRA in advance pricing advancement negotiations.

 CHINA

Treatment of COVID-19 governmental subsidies

Since China has not issued specific guidance on the treatment of governmental subsidies for transfer pricing purposes, one can look to the general guidance contained in the OECD Guidelines^[2] (Chapter I, D.4) regarding the effect of government policies.  The key issue associated with governmental assistance programs, such as revenue tax relief, social security relief, or rent relief, centers around the comparability analysis.  As part of comparability analysis, Chinese taxpayers should assess and potentially adjust the impact of governmental COVID-19 support programs in different jurisdictions and across various industries to determine comparable companies’ profit level or pricing information under the arm’s-length standard.

For comparable companies or transactions located in the same jurisdiction of the tested party, the governmental support programs may have limited impact to warrant comparability adjustments.  For comparable companies situated in a different jurisdiction than the tested party, this may not be the case.  Therefore, careful assessment and consideration of appropriate adjustments to address the impact of governmental support programs on comparable companies across different countries are required in order to enhance the reliability of data.

Single-year vs. multi-year analysis

The Chinese transfer pricing regulations do not specify comparison rules regarding the use of single-year versus multi-year data. The main article relevant in Circular 6 provides that “when analyzing and evaluating whether the related-party transactions of an audited enterprise are conducted in compliance with the arm's length principle, tax authorities may choose among statistical methods such as the arithmetic method, weighted average method or quartile method, depending on the actual situation, to calculate the mean value or the interquartile range of profit or price of comparable enterprises on a year-by-year basis or on a multiple-year average basis as the comparable profit level or comparable price.”  In an audit context, the Chinese tax authorities have frequently preferred a single-year analysis approach by comparing the single-year tested party data against the comparable companies’ results for the same period or for a multi-year period, citing Article 25 of Circular 6 which provides that tax adjustments in an audit setting are made to the individual audit years.

Accordingly, in our DLA Piper transfer pricing documentation for China, we use single-year tested party’s results to compare against three-year results for the comparables.  In some instances – eg, the tested party’s results for one year are especially low due to market factors – it is acceptable to use three-year tested party’s results.  In this case, as a best practice, the transfer pricing documentation should elaborate further on the rationale for the selected testing approach, such as, external economic environment factors.

SINGAPORE

Treatment of COVID-19 governmental subsidies

The Inland Revenue Authority of Singapore (IRAS) expects details relating to any COVID-19 specific government assistance that the taxpayer has received, as well as, details relating to government regulations imposed on the taxpayer that have an impact on its operations, to be documented in the transfer pricing documentation to substantiate the arm’s length nature of the transfer pricing outcome.

Single-year vs. multi-year analysis

The IRAS has indicated willingness to accept term testing (ie, test of the related party transaction over a multi-year period) for the Year of Assessment 2021 due to the Covid-19 impact, without prior consultation with the IRAS, under certain circumstances.

NETHERLANDS

Treatment of COVID-19 governmental subsidies

The Netherlands has not issued specific guidance on the treatment of governmental subsidies for transfer pricing purposes. As such, the general guidance contained in the OECD Guidelines (Chapter I, D.4) regarding the effect of government policies can be followed. Paragraph 1.132 recognizes that while there are some circumstances in which a taxpayer will consider that an arm’s length price must be adjusted to account for government intervention (eg, price controls, price cuts, interest rate controls, anti-dumping duties), as a general rule, these government interventions should be treated as conditions of the market in the particular country, and in the ordinary course they should be taken into account in evaluating the taxpayer’s transfer price in that market.  Therefore, governmental subsidies are ultimately a comparability factor that has to be taken into account in a transfer pricing analysis.

Single-year vs. multi-year analysis

Multi-year analysis is preferred and commonly practiced. Specifically, when assessing a transaction, it can be useful to consider data covering several years.  The use of multi-year data can prevent corrections being made in a particular year, while the group receives a payment over a number of years that is in accordance with the arm's length principle. The Netherlands Transfer Pricing Decree provides for the following system:

1. First, it is tested whether the fee for the transaction to be assessed falls within the arm's length range that has been determined for the year in question (ie, single-year analysis).  If the compensation falls within the annual range, no correction will be made.
2. If the remuneration falls outside the annual range, such a test is then repeated on the basis of (moving) averages over a number of years (ie, multi-year analysis).  The length of the period that is included will partly depend on the length of the life cycle of the product.  If the average fee for the transaction to be assessed falls within the multi-year range, no correction is made.
3. If the consideration to be assessed falls outside the arm's length annual range, as well as, outside the arm's-length multi-year range, an adjustment is made.

UNITED STATES

Treatment of COVID-19 governmental subsidies

The US has not issued specific guidance on the treatment of governmental subsidies for transfer pricing purposes in the context of the COVID-19 pandemic. The general principles around comparability standards when considering the circumstances of the tested party versus the comparables used to test a given transaction contained in both the OECD Guidelines and the US transfer pricing regulations apply.

Single-year vs. multi-year analysis

Multi-year analysis is preferred over single-year analysis for both the comparables data and the tested party.

Please also see our Global Tax Alert, Understanding the OECD’s guidance on the transfer pricing implications of the COVID-19 pandemic. 

To learn more about this issue, please contact the authors or your usual DLA Piper contact.

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