The pandemic is a year old and has affected the global economy in countless ways, from lowering demand for oil to increasing demand for personal protective equipment. Supply chains in particular have been transformed, affecting businesses in all sectors.
During the initial months of the pandemic, lockdowns, immigration restrictions and other unforeseen challenges severely disrupted supply chains, particularly in manufacturing but by no means limited to that sector.
The pandemic will recede and restrictions will lift, but the crisis - along with recent US-China trade tensions and other factors - have exposed the fragility of global supply chains. Many organisations have been forced or incentivised by local tax authorities to: increase the domestic elements of their supply chains; re-map supply chains to be less reliant on producers based in a certain country (such as China); account for the new realities of a disbursed, remote workforce; and take other steps to reduce risks and vulnerabilities.
In short, supply chains will not revert to any pre-pandemic "normal," but will continue to evolve. Companies must adapt accordingly to remain compliant and competitive.
Transfer pricing compliance: Why companies need to act now
For multinationals, an essential step in adapting to our evolving global supply chain realities is updating transfer pricing assessments and documentation. While we're in a time of profound economic change, the need to comply with transfer pricing regulations - and to effectively manage all attendant risks - will remain constant.
Most multinational organisations are now finished with their fiscal-year-end process and will soon enter the corporate income tax return cycle. For good reason, companies traditionally use the current period to revisit their intra-group transfer pricing. Given the global economic changes and widespread supply chain disruptions of the past year, it's more important than ever for your organisation to use this time to review its transfer pricing assessments and documentation.
Transfer pricing requirements in light of the pandemic
An organisation's transfer pricing must be based on the OECD's arm's length principle, which seeks to ensure that associated enterprises (that is, enterprises under the same ownership) conduct cross-border transactions in ways that reflect market realities. An organisation must appropriately document its intra-group arrangements to provide evidence that its transfer pricing conforms to the arm's length principle.
As we've discussed, many - almost certainly most - multinational organisations have re-mapped their global supply chains in the past 12 months to account for the realities of the pandemic. These new realities include those related to internal staff working in new locations (including in some cases working from new countries), in addition to the kinds of changes we typically associate with supply chains, such as new manufacturing locations and third-party vendors.
Changes in organisational structures and supply-chain mapping have altered the fact patterns previously used by businesses to determine their intra-group cross-border arrangements and functional analyses. As an international tax practice, we've already seen certain tax authorities reviewing historic transfer pricing documentation against these new operational fact patterns. We're also aware of many other reviews being actively undertaken and in the pipeline.
Organisations should keep in mind that transfer pricing often involves benchmarking against third-party financial data. Because the pandemic has changed many elements of the global economic situation - think for example of the pandemic's effects on oil demand mentioned earlier - many previously established benchmarks are no longer accurate or "contemporaneous." As a result, many organisations' transfer pricing documentation is no longer representative of current arm's length pricing realities, which increases the risk of non-compliance.
In addition, some sectors - notably pharmaceuticals and technology - have experienced explosive growth over the past 12 months. As a result, many companies in these sectors have crossed country-specific transfer pricing documentation thresholds for the first time, including country-by-country reporting (CbCR) thresholds.
In a time of unprecedented change, it's critical to remember that global transfer pricing requirements - including adhering to the arm's length principle and fulfilling documentation obligations - are just that: requirements. Failure to comply can and often does result in double taxation and significant penalties that can run into the millions of dollars, as has been well reported in transfer pricing cases litigated in various courts. Moreover, if an organisation does not have its transfer-pricing house in order, even responding to the enquiries of tax authorities can carry significant administrative and financial burdens.
Tax authorities are investing in transfer pricing enforcement
For the past half dozen years or so, countries around the world have been implementing new transfer pricing reporting requirements that support the OECD's efforts to combat perceived base erosion and profit shifting. The transfer pricing regulatory and enforcement landscape continues to tighten. Tax authorities everywhere are well aware of our new economic and supply chain realities, and many are enforcing transfer pricing regulations in light of the changes.
To take an example, Singapore's tax authority - the IRAS- has invested significantly in cross-border enforcement, including transfer pricing enforcement. Last year alone it spent S$103 million (24 percent of its total budget) on international tax investigations.
The IRAS and other authorities expect these investments to generate good returns, and there are examples to support that expectation. In the five years leading up to 2018, the UK's HMRC raised £6.5 billion of additional tax by challenging the transfer pricing arrangements of multinationals, with an additional £1.5 billion raised in 2020 alone.
One recent ruling by a US court highlights the stakes involved and why it's critical for companies to regularly review and update their transfer pricing positions. The case focused on the IRS' assertion that Coca-Cola US had undercharged its foreign affiliates under its intercompany arrangements, effectively leaving taxable profits outside the US. Coca-Cola's transfer pricing in the early 2000s and beyond had been based on an IRS audit settlement relating to the 1987 to 1995 tax years. However, the IRS argued that facts and circumstances changed over time and what had been appropriate in the late 1980s and early 1990s was not applicable in the new millennium. In November, the court ruled that Coca-Cola "will remain on the hook for the bulk of a $3.4 billion IRS tax bill."
Protecting your organisation
Our changing global economic realities and increasingly strict transfer pricing requirements do not spell doom for multinationals organisations. There is no doubt that complying with transfer pricing obligations can be administratively burdensome, but all organisations must bear these costs. Moreover, the efforts of regularly reviewing your transfer pricing positions will not only lower your compliance risks and protect your reputation, they may also uncover opportunities to realise global tax savings.
It's also important to take a practical, risk-based approach to transfer pricing compliance. You should ensure that your organisation complies with its requirements while not "over-complying" by spending too much time and too many resources on relatively low-risk areas.
In the end, you need to map your relevant intra-group supply chains (including noting any changes since you last prepared transfer pricing documentation), understand your global transfer pricing obligations, and ensure that you have compliant documentation in place.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.