The novel coronavirus has been spreading worldwide since December 2019 and is increasingly leading to quarantine situations for employees, business partners and customers. This has resulted in exit restrictions, border closures, production stoppages, retail closures, redundancies, short-time working, logistical stagnation and import restrictions. The pandemic has had a significant impact on the supply chains of multinational corporations since March 2020 at the latest. Optimistically, the associated effects will gradually diminish, but when this will be the case is currently unclear and varies greatly from region to region.

It is already foreseeable that the coronavirus crisis will have a massive impact on financial results and will very quickly place a considerable strain on the liquidity of multinational groups, including all subsidiaries. Companies must therefore take the necessary and appropriate precautions as quickly as possible and analyse and, if necessary, readjust transactions with affiliated companies in order to remain capable of acting.

We currently see an urgent need for action in relation to transfer pricing, particularly in the following areas

  • Group financing and liquidity management,
  • Control of extraordinary profit and loss situations,
  • Suspension of individual transactions,
  • short-term restructuring of business models and
  • Staff recalls and secondments.

A. Ensuring liquidity

In some cases, liquidity problems arise at very short notice due to the failure to achieve planned sales targets. Fixed and variable costs cannot always be reduced immediately.

In order to avoid liquidity bottlenecks, we recommend preparing further financial planning in various scenarios and gaining a precise understanding of market fluctuations and changes in supply, dynamically assessing the liquidity requirements of the subsidiaries and providing financial support in good time with the help of the following measures:

    • Group financing

Intra-group financing is the most direct form of financial support. However, not only issues such as the level of interest rates, tax burdens and proportional deduction restrictions must be taken into account, but also, for example, low capitalisation in the case of intra-group financing. Interest actually paid by the company to its affiliated entities that exceeds the specified equity/funding ratios (China 5:1 for financial companies and 2:1 for other companies) may not be deducted for the current period or in subsequent years unless the company can provide information and evidence that such a transaction complies with the arm's length principle. It should be noted that guarantee fees paid to affiliated companies for loans borrowed from third-party financial institutions may also be subject to the above limitation on the equity ratio if guarantees are provided for the loans from affiliated companies.

    • Measures to offset losses

Loss compensation is another option for supporting the liquidity of a subsidiary. The correct procedure for this compensation must be carefully analysed from the perspective of both countries and accompanying documents must be created as soon as possible to ensure that the payment is also tax deductible for the paying part of the company. As such payments usually take place independently of supply and service transactions, customs and VAT may also need to be considered in order to avoid risks at this point or at least to be aware of them.

For some countries, it is recommended that relevant contracts and documents are agreed in advance with the local bank and, if applicable, the state foreign exchange authority (in China, for example, the "SAFE") in order to ensure smooth processing of the relevant payment.

If a company has established an operational transfer pricing system ("price setting" vs. "profit checking"), it is advisable to change the frequency of the monitoring process from quarterly to monthly in order to become aware of loss situations and any necessary transfer price adjustments as early as possible.

    • Adjustment of the terms of delivery and payment

Extending the payment terms can help to reduce the pressure on the liquidity of subsidiaries. Here, too, it is advisable to prepare accompanying documents in order to be able to substantiate potential challenges from the tax and customs authorities at a later date.

    • Application for tax deferrals

Check with your advisor the local options for (interest-free) deferral of tax (advance) payments due or the reduction of advance payments in accordance with the above-mentioned measures. The Federal Ministry of Finance published a letter on 19 March 2020 which regulates the adjustment of advance payments, deferral applications, etc. in relation to the current situation (s. BMF of 19 March 2020) and on trade tax the decree of 19.03.2020; see also TAXGATE News from 16/03/2020.

    • Terminate or temporarily suspend I/C transactions

Another way to create liquidity, at least for the time being, is to temporarily suspend inter-company transactions that are not directly related to the manufacture and/or sale of products. These can be, for example

- Licence payments,

- Payments for Group services,

- Repayments of Group loans.

Check the contractual agreements on which these transactions are based for possible short-term termination. A termination of such contracts contrary to the contractual basis (e.g. immediate cancellation vs. notice period of 6 months to the half-year) can be interpreted as a transfer of functions in accordance with OECD TP Guidelines or national regulations and entail the risk of a compensation payment. At this point, you should also draw up records promptly to document your approach, actual alternative courses of action and the economic background.

B. Change in functional and risk profiles

In order to maintain supply chains on the sales side or to maintain or increase production activities in less affected regions, a short-term change in function or risk profiles may be necessary, which can have a fundamental impact on the amount of remuneration and/or also lead to a tax-relevant event such as a relocation of functions. In this case, it is also important to prepare records promptly in order to document your approach, actual alternative courses of action and the economic background.

C. Loss analysis and preparation of documentation

Even if a well-defined and controlled transfer pricing policy is applied, the coronavirus crisis temporarily leads to returns for group companies that do not match their functional and risk profile, particularly in the case of subsidiaries with routine profiles or cost centres. The tax regulations of most countries worldwide generally provide for low but stable and positive returns for subsidiaries with this profile, which correspond to the functions assumed, risks borne and assets utilised.

Such companies are very likely to be scrutinised by their local tax authorities after the crisis if they generate too low returns or even losses. In this case, one option would be to make transfer pricing adjustments to ensure that companies with routine functions in the value chain can generate adequate profits while the headmaster absorbs the residual result, i.e. acts as the profit equalising entity in the group. It should also be discussed whether the losses of subsidiaries with routine functions that arise as force majeure due to insufficient productivity and weak market demand as a result of the crisis must be borne by the principal/entrepreneur/strategy holder, which performs central key functions, or whether such losses in this exceptional situation should not also be borne by routine companies and whether they should therefore also exceptionally assume risks in the value chain.

In order to mitigate the potential transfer pricing risks for all entities involved, we recommend distinguishing the losses incurred at different stages (e.g. before and during the crisis and during the recovery phase after the crisis) and preparing appropriate documentation to explain which entity has to bear the losses and in what amount.

D. Staff recalls and secondments

In the event of short-term repatriation of personnel in the event of illness or to avoid later restrictions and delays when returning to a home country, you should check existing contractual bases to see to what extent they contain passages that must be observed in the current situation and ensure that the "disconnect" takes place with as little risk as possible. In the event of a deviating procedure or emergency decisions that can no longer be reviewed in a timely or complete manner from a legal or tax perspective, we also recommend documenting the situation and circumstances promptly for any discussion with the tax authorities at a later date.

If, in the current situation, you urgently need to post personnel at short notice, you should still structure, check and regulate these as usual from the perspective of the sending and receiving countries in order to avoid tax risks.

E. Internal communication and prompt documentation are crucial

We strongly recommend that you proactively communicate all of the above issues with your affiliated companies abroad and consistently prepare the necessary documents as completely as possible in order to be able to prove the appropriateness of decisions and the distribution of profits (losses) to the group companies during the crisis at a later date. Actively approach your units abroad and do not wait until decisions can only be made under pressure and with limited room for manoeuvre. Include any transfer pricing issues that may arise in the regular dialogue with your financial managers abroad that is now required anyway.

At present, it is particularly important to collect as much information and background material as possible for your decisions: e.g. current official orders that have a direct or indirect impact on your business activities or records with customers (e.g. order cancellations, late payments).

The format of these records is initially of secondary importance and can, if necessary, be prepared later in the correct form. Handwritten notes, file notes, emails, screenshots of reports on the Internet, telephone notes, press articles, etc. may be decisive.

The better you can document the current exceptional situation and justify and substantiate your decisions later with the basis for the decision that existed at the time of the decision, the greater the chances and lower the risks if you are confronted by a tax authority at a later date.

Our team remains at your disposal both in Stuttgart and in the partner regions via the TPA Global network! Stay in good spirits and, above all, stay healthy!

Carsten Schmid