The global pandemic known as COVID-19 will undoubtedly continue to reverberate throughout the world economy. As businesses struggle to regain some modicum of normality, questions about business planning will naturally make themselves obvious. Particularly for multinational taxpayers with related-party transactions, the time to begin asking those questions is now.
Uniquely, COVID-19 compromises many facets of an established multinational tax strategy. Transfer pricing policy and documentation, inter-company loan and pricing agreements, and financial reporting thereof provide distinct areas of risk and opportunity for multi-nationals to proactively engage in a time of great uncertainty. While no article can realistically address all of these concerns, the following areas of consideration will empower forward-thinking professionals to explore optimal tax strategy and risk mitigation.
However beneficial the government-by-government response is to the global economic downturn, eventually nations will begin to seek out means to maximize tax revenue. One easy way to drive revenue is through transfer pricing enforcement. In an already complex transfer pricing world, taxpayers with U.S.-based trade or business are certain to see increased focus on intercompany (related-party) transactions.
Most multinational corporations already have complex, well-documented policies that address global transfer pricing rules. But what of those rules in a global economic downturn with very little insight into the future? Some of these changes are immediate. For example, multinational corporations may find themselves in a position to change intercompany agreements in real time. Changes to such agreements may be short term and others long term, some exceptionally so. Other corporations may be in a position to restructure the way it does business, either specific to one country or globally. Finally, cash needs may drive decision making on a global level not seen in many business cycles.
Most of these decisions must be made in real time, with very little guidance from tax authorities. Nevertheless, existing tax policy informs us that those decisions are not without consequence. The well-known arm’s length standard is here to stay, and businesses must proactively engage on all fronts to mitigate the risk of transfer pricing audits. Using intercompany agreements as an example, changes to such agreements have a significant impact on tax reporting and documentation requirements. Therefore, taxpayers must consider how changes to intercompany agreements reflect on existing documentation.
Related-party loans are another, more specific example of an intercompany agreement. Such agreements have weighty reporting and documentation requirements. Multinational entities must report related-party loans on U.S. tax returns, often times on schedules colloquially known as audit guides. Tax professionals refer to these schedules as audit guides, because in a transfer pricing audit the tax authority (or authorities) will request the loan agreements themselves, as well as supportive evidence and transfer pricing documentation that supports the intercompany rate. Absent this support, the taxpayer may be at risk.
Continuing with the related-party loan example, businesses may find themselves needing to quickly move cash around the world. Whether related-party loans are new or changing, taxpayers must ensure such loans are documented and that an arm’s length rate is established. Historical market data or existing benchmarking documentation may not accurately reflect economic reality, and the tax authorities will surely use this to their advantage. Consequently, taxpayers must actively engage with experts to ensure the day-to-day function aligns with written expectations.
Similarly, multinational corporations may find themselves renegotiating existing intercompany agreements, including back-office, sales, management, and product agreements. These negotiations may be the result of business-specific requirements, but such needs are not exclusive of the arm’s length standard. Non-related-party transactions are subject to the same economic pressure, and so—the tax authority would argue—should any related-party transaction. The data will reveal itself in time, but public information used to benchmark related party transactions will not be available until mid-year 2021—long after many taxpayers made the difficult decisions needed to maintain “business as usual.” We have found that multinational companies that proactively engage to research, document, and react to these changes fare better in the long run than those who do not.
There is no concrete method for allocating the right resources to perfect a global tax policy. However, we hope these practical considerations will aid multinational businesses in assessing the suitability of established transfer pricing policies. All facts and circumstances are relevant, and no two fact patterns are ever the same. If you have questions about these important international transfer price reporting and compliance issues, please contact us.