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April 23, 2020

Many countries have adjusted tax filing and payment deadlines as well as introducing economic stimulus and employment stabilization programs as a result of the worldwide outbreak of COVID-19. While COVID-19 has changed the short-term macroeconomic landscape, created many business uncertainties, disrupted supply chains, and negatively impacted short term profitability and the operational status quo for most business enterprises, the fundamental tax regulatory requirements and compliance documentation burdens remain unchanged. Thus far, there have not been any changes to U.S. transfer pricing regulations under IRC Section 482, nor to the penalty and documentation requirements under IRC Section 6662.


The typical standard in transfer pricing regulations worldwide (including under the auspices of the Organization for Economic Cooperation and Development (“OECD”) Base Erosion and Profit Shifting (“BEPS”), U.S. transfer pricing regulations and case law, and the domestic laws in most foreign countries) is for compliance documentation of transfer pricing practices to be complete at the time of the taxpayer’s filing, and we do not expect this to change. While deadlines for tax payment and filing may be delayed, we continue to advise clients to begin work on their transfer pricing compliance documentation as soon as financial data for the prior fiscal year is available, in order to ensure timely completion of reports.

There is far too much uncertainty to reliably predict the future of transfer pricing enforcement activity or policy development in the immediate aftermath of the COVID-19 pandemic. Economies and markets have been disrupted worldwide, and supply chains which were already strained have been (and likely will continue to be) further tested. Many of our clients have already felt significant effects of the COVID-19 pandemic on their businesses and the lives of their employees, and we anticipate that many more are likely to experience disruptions in the coming weeks. While we do not anticipate a significant ramp-up in enforcement following the pandemic (especially as governments and economies worldwide enter into recovery mode), we also do not anticipate significant changes to the arm’s length standard and other longstanding principles that have historically underpinned transfer pricing regulations.

Obviously, the COVID-19 pandemic is an extraordinary event, which has had, and will continue to have, a profound effect on the operations of businesses globally. It will have many unique implications for multinational enterprises, given the disruptions to international travel, global markets, points of entry, interest rates, and cooperative international organizations and efforts. The most important thing a business can do to prepare for its future transfer pricing compliance is to properly document the impact of current operating conditions and extraordinary circumstances, while continuing to do its best to adapt in a difficult and rapidly changing situation. We remind everyone to prioritize the health and safety of their employees and their families in this difficult time.

No one knows for certain how long the disruption from the COVID-19 pandemic will last. What we do know is that transfer pricing regulations worldwide are the result of decades of collaborative development by the international community. When the COVID-19 outbreak has been controlled, we fully expect this collaborative development to resume (even if remotely over video-conferencing for a time), for the ongoing debate of topics such as taxes on digital services to be taken up again, and for the ongoing implementation of BEPS actions to continue.

None of the COVID-19 Stimulus measures, thus far, change anything from a transfer pricing regulatory, technical, or enforcement perspective. However, taxpayers always need to be cognizant that transfer pricing regulations and the application of the arm’s length standard are often used by tax authorities to test the validity of FTCs, BEAT calculations, and the appropriate attribution of entrepreneurial risk and any resulting NOLs.

From a transfer pricing perspective, an NOL may be nothing more than an artificially created or inflated tax “asset” for the purpose of inappropriately shifting loss from one entity to another.  During these uncertain times, and with what are likely to be very aggressive goals for tax collection over the next decade, it will be more important than ever to have a supportable transfer pricing policy and robust transfer pricing documentation to defend and support the tax positions taken, including any use of NOLs.  An NOL is not a “get out of jail free card.” Tax authorities will continue to question whether NOLs meet the arm’s length standard, and whether the taxpayer has adequate documentation to support and defend the use of the NOLs.

The COVID-19 pandemic and resulting short term macro-economic turbulence may also be a unique opportunity to undo or “do-over” supply chain operations, economic behavior, royalty payments, interest charges, and implicit or explicit contracts or related party agreements. From a transfer pricing perspective, the current economic challenges may provide planning opportunities – or even business necessities – to modify or shift functions, change  or “turn off” royalty payments, pursuant to the U.S. IRC Section 482 commensurate with income standard in place of the arm’s length standard, or to reallocate risk-bearing and entrepreneurial behavior, such as related party services. We strongly recommend that companies review their current transfer pricing policies to identify potential opportunities to take advantage of changes, and to help mitigate future exposure to tax and transfer pricing risk.

For example, under contract law, the considerations for modifying or unwinding transactions between parties, is called “rescission.”  Allowing parties an opportunity for a “do-over” when there is a misunderstanding – or unanticipated economic events, such as a global pandemic – may have tax advantages for many taxpayers. Under Revenue Ruling 80-58, a successful tax rescission has two criteria that should be addressed when contemplating a redo of related party agreements and engagement in arm’s length economic behavior: one, the parties to the transaction must be returned to the status quo ante (to before the transaction occurred); and two, the restoration to the status quo ante must be accomplished within the same tax year as the original transaction.

It is important to note, that since Revenue Ruling 80-58 was issued, the IRS has issued numerous private letter rulings confirming the effectiveness of numerous rescissions. However, whether or not the concept of “rescission” will be effective (or even necessary) under U.S. IRC Sections 482 and 6662, is an open question. It is somewhat comforting to know that rescission as a legal concept recognizes a business or economic need to redo contracts or agreements under certain defined conditions. Nevertheless, U.S. taxpayers with existing related-party transactions may want to consider adjusting or terminating certain of them that may not make economic or business sense, given the current business climate and resulting supply chain disruptions from the pandemic. The U.S. transfer pricing rules, based on the arm’s length standard, allow taxpayers to report arm’s length prices that have been adjusted from those originally charged (although, typically, it is recommended that this be done on an original, timely submitted tax return, particularly if the adjustment reduces U.S. taxable income). Lastly, other non-U.S. jurisdictions may not respect a rescission or related-party adjustment, depending on their own laws, policies, and regulations.

Transfer pricing planning, forecasting, implementation, risk mitigation and the drafting of related party agreements must be managed, especially in the context of a global catastrophe with historical repercussions. The eventual economic recovery will likely bring an aggressive focus on tax revenue and enforcement of transfer pricing, not only by the IRS, but by tax authorities worldwide.

Please contact your Mazars USA LLP professional for additional information.


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