Companies with cross-border affiliates that are considered limited risk — and therefore don't typically incur losses — can contend that the pandemic caused short-term losses for these entities, according to Mayra Lucas, a senior transfer pricing adviser at the Organization for Economic Cooperation and Development. At the same time, companies should be aware that this argument could open the door to profit reassessments for earlier years, she said, speaking during a panel at the American Bar Association tax section's annual conference on U.S. and European trends, held online.
"I think it's very important to raise a flag here to taxpayers, especially when you're trying to argue that a limited-risk entity should be bearing part of the losses arising as a result of COVID for the affected years," Lucas said. COVID-19 is the respiratory ailment caused by the coronavirus.
If companies claim that limited-risk affiliates incurred losses in 2020 because of the economic impact of the pandemic, then maybe the risk allocation wasn't accurate for previous years, according to Lucas. If the entity was assuming greater risks than what was reported, it might need to see its profits increase for the years before 2020, she said.
"It's a matter of being consistent between your analysis for COVID years and the pre-COVID years," Lucas said.
In December, the OECD published long-awaited guidance about the pandemic's impact on transfer pricing. The advisory document included a discussion of companies with transfer pricing structures designed to limit risk — and income — to some group members.
Large corporate groups often place routine operations such as distribution, manufacturing or services in high-tax countries, attributing minimal profits to them for tax purposes. In these structures, the bulk of the group's income is often earned by a so-called entrepreneur set up in a low-tax jurisdiction, which bears most of the risk. The routine operations, which bear little risk, are rewarded with a steady but small stream of income.
According to the OECD's guidance from December, when tax administrations are examining the risks assumed in an intercompany transaction, they should "carefully consider the commercial rationale for any purported change in the risks assumed by a party before and after the outbreak of COVID-19."
In particular, concerns may arise when a company argues a distributor didn't assume any marketplace risks before the pandemic and then, after the outbreak, contends the distributor assumes some risk and should be allocated losses, according to the guidance. In this case, tax administrations should consider whether "prior to the outbreak of COVID-19 the 'limited-risk' distributor genuinely did not assume any marketplace risk," the guidance said.
For these situations, the guidance recommended an analysis of facts and circumstances to support any new risk allocation. The guidance also noted that "in general, consideration should be given to whether a taxpayer is taking inconsistent positions pre- and post-pandemic and, if so, whether either position is consistent with the accurate delineation of the transaction."
--Additional reporting by Molly Moses. Editing by Neil Cohen.
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