The word "unprecedented" seemed to adequately capture the general sentiments surrounding the COVID-19 pandemic and its impact on the global economy. The importance of COVID-19 cannot be overstated. There is no doubt that this global pandemic created unique and diverse challenges and business conditions for all businesses and industries. As a result, it is not surprising that, in December 2020, the Organization for Economic Cooperation and Development (OECD) issued a document titled "Guidance on the Transfer Pricing (TP) implications of the COVID-19 pandemic" (the COVID-19 guidelines), which aimed to provide much needed clarity to taxpayers in analyzing the accounting periods.
As businesses prepare TP documentation for the first fiscal year (FY) impacted by COVID-19, it is only fitting that we revisit the COVID-19 guidelines in order to distill key aspects that will be useful in objectively reporting financial outcomes. The COVID-19 guidelines address the following priority issues in order to ensure that the arm's length principle is consistently applied as the core of TP during the COVID-19 pandemic:
1. Comparability Analysis: As is frequently stated, the arm's length principle is based on a comparability analysis. The effective application of the principle overriding TP is dependent on obtaining financial information from companies that are thought to perform similar activities to the entity whose compliance with the arm's length standard is being evaluated. Given the impact of the pandemic on this period, the COVID-19 guidelines seek to address the challenges and likely adjustments that may arise while selecting appropriate comparables for 2020 or 2021 FY, as the case may be.
2. Costs and losses associated with COVID-19 are allocated as follows: MNEs faced a number of challenges as a result of the COVID-19 pandemic. One of the most difficult challenges is the generation of losses, which can occur as a result of a drop in product demand or the complete shutdown of business operations. The COVID-19 guidelines answer questions that may arise as a result of these losses. These questions include whether limited risk entities can sustain losses, how operational or exceptional losses should be allocated, and how to account for exceptional COVID-19-related costs in a comparability analysis.
3. Government Assistance Programs: While most governments focused on mitigating the spread of the corona virus and providing adequate health care services to their citizens, governments also aided businesses that were harmed by the pandemic. Government assistance includes, but is not limited to, tax relief, loan deferrals, and direct financing. The assistance provided by the government makes it difficult to identify comparable companies that received comparable government assistance. As a result, taxpayers must accurately determine the nature, substance, and duration of any government assistance they receive, as well as the implications of this assistance in their local market, as well as the reduced risks borne by the entity, which will invariably affect the arm's length price.
4. Advance Pricing Arrangements (APA): An APA is a contract between the tax authorities and a taxpayer that specifies the TP method for analyzing the taxpayer's future transactions with related parties. To reach a consensus position during APA negotiations, a set of criteria/conditions under which the APA would apply must be defined. APAs typically include key assumptions concerning the economic and operational conditions likely to impact the transactions covered by the APA.
The COVID-19 pandemic has created significant uncertainty in the treatment of previously agreed-upon transactions by both tax administrators and taxpayers, contradicting the primary purpose of an APA. As a result, taxpayers are encouraged to be open about the impact of COVID-19 on any agreed-upon transaction with tax administrators and to work together to find the best solution to any issues that arise. Given the economic uncertainty, it is not surprising that taxpayers and tax administrators are hesitant to file new APA applications or renew existing APAs. In the case of Nigeria, where the APA provisions in the TP Regulations have yet to take effect, the uncertainty may cause the Federal Inland Revenue Service to postpone the implementation of APAs.
Finally, the OECD guidelines on COVID-19 have provided the clarity and specific guidance needed to address the challenges involved in ensuring that the arm's length principle is applied in testing related party transactions as a result of the COVID-19 pandemic. However, due to the uniqueness of each transaction and the varied impact of the pandemic across industries and jurisdictions, the guidance allows for some degree of flexibility. It would also be beneficial for tax administrators to issue relevant notices and guidelines in advance to address any additional challenges that may arise due to the unique situation in each jurisdiction.
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