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OECD releases guidance on the transfer pricing implications of COVID-19 - Australian considerations

5 February 2020 

In brief

On 18 December 2020, the Organisation for Economic Co-operation and Development (OECD) issued guidance to provide policy recommendations on the transfer pricing implications of the COVID-19 pandemic (OECD guidance). The OECD Guidance, which represents the consensus view of the 137 members of the Inclusive Framework on Base Erosion and Profit Shifting (BEPS), is intended to help address the transfer pricing challenges faced by taxpayers in years impacted by the pandemic. Please refer to PwC’s Tax Policy Alert for a full summary of the key takeaways.

Taxpayers may recall in June 2020, the Australian Taxation Office (ATO) released its own guidance on the transfer pricing implications of the COVID-19 pandemic as well as a separate notice highlighting the intention to review changes to related-party arrangements that may be deemed to result in certain tax advantages (ATO guidance). This guidance was supplemented with specific ATO guidance on the interaction of JobKeeper and transfer pricing outcomes.

For taxpayers with international related-party dealings (IRPDs) and impacted by COVID-19, it will be important to understand the OECD and ATO Guidance when supporting their transfer pricing positions for the COVID-19 impacted income year. It is worth noting that such impact is not limited to the economic and financial effects of COVID-19. It extends, and is not limited to, changes in the Australian entity's functional profile, its bearing and control of risks, supply chain, intercompany transactions and business strategies. These changes may mean that historical transfer prices may no longer appropriately reflect value creation and/or mean that existing comparables are no longer comparable.

In detail

Common themes between OECD and ATO guidance

In both sets of guidance, there is strong emphasis on the need for taxpayers to appropriately consider the impact of COVID-19 on their transfer prices, contemporaneously document their transfer pricing positions and substantiate these positions with evidence. The level of transfer pricing analysis to be undertaken will vary on a case by case basis but, at a minimum, this should include:

  1. an accurate delineation of the transaction to identify, with specificity, the economically significant risks borne by each party to the IRPD;

  2. a detailed analysis of the economic impact of COVID-19 risks on the taxpayer, the industry and geographic market in which the taxpayer operates (including the impact of Government incentives such as JobKeeper). This should include a similar assessment of the comparables; and

  3. consideration of the internal and external evidence available to support the conclusions and whether there are any evidentiary gaps might impact the robustness of the positions taken.

This analysis will then allow taxpayers to properly consider key issues, such as whether:

  • The comparables remain appropriate or should a fresh comparables analysis be undertaken?

  • Testing should occur for separate periods within the year?

  • Accurate delineation suggests adjustments to pricing or that independent parties would be expected to renegotiate terms? If so, whether there is sufficient comparable evidence to support such adjustments?

  • Secondary transfer pricing methods should be considered to improve transfer pricing documentation?

  • Certain costs are 'exceptional’ or ‘non-recurring' due to COVID-19, or whether these reflect the ‘new normal’?

  • Losses are appropriate for Australian distribution entities?

  • Force majeure clauses might be expected to have been enforced and what is available to support this?

  • JobKeeper or other Government incentives have been claimed and how these impact the analysis, including the comparables relied upon?

Given the complexity of transfer pricing challenges caused by COVID-19, it is recommended that the transfer pricing documentation process commences earlier than in prior years.

For taxpayers that decide not to undertake this further analysis and seek to roll-forward existing transfer pricing documentation (for example, because a view is formed that COVID-19 has not affected their business, industry or comparability analysis), there may be an increased risk that the transfer pricing outcomes on either side of the transaction are not arm’s length.

Differences between OECD and ATO guidance that may have implications for taxpayers

While the two sets of guidance share similarities, there are differences. The OECD has adopted a detailed and principle-based approach which seeks to link with the commentary in the OECD Transfer Pricing Guidelines (an approach also conducive to achieving timely consensus). This is important as the 2017 OECD Transfer Pricing Guidelines are prescribed material under the Australian transfer pricing rules (i.e. the Australian transfer pricing rules should be read to best achieve consistency with the OECD Transfer Pricing Guidelines).

The ATO guidance outlines the practical approaches taxpayers may take in supporting their transfer pricing positions. However, the guidance does not focus on the delineation of the transaction and identification and control of risks (albeit, functions, assets and risks will be taken into consideration by the ATO). Instead, the ATO suggests taxpayers focus their efforts on the before and after impact of COVID-19 without explaining how the arm’s length principle ought to apply in assessing an arm’s length outcome. The guidance is intended to be practical rather than technical and gives taxpayers clear focus areas on the evidence expected by the ATO and the ‘standard’ of analysis the ATO expects.

The ATO guidance is also intended to flag the ATO’s perceived level of risk of certain facts and circumstances. The key scenarios flagged by the ATO include: 

  • changes to transfer pricing outcomes that may result in an Australian tax advantage;

  • changing intercompany agreements; and 

  • the treatment of Government incentives with the ATO outlining more prescriptive guidance (particularly relating to JobKeeper, adopting the view that the benefit of Government Incentives should not move offshore through transfer pricing). 

The OECD guidance, on the other hand, encourages an analysis of the facts to determine how Government incentives should be treated. Clearly, to the extent that this analysis supports the non-Australian entity sharing in the benefits of Government incentive payments taxpayers should be aware of the strong guidance issued by the ATO which states “Independent parties acting in a commercially rational manner would not share the benefit of the government assistance”.

Similarly, the ATO have stated they do not intend to revise the distributor EBIT margin zones in Practical Compliance Guide PCG 2019/1 which may mean that a larger number of taxpayers will fall into the ‘high risk’ zones (these risk ratings will be disclosed to the ATO in the Reportable Tax Position Schedule for those taxpayers that are required to submit this schedule with their income tax return). As a result, taxpayers can expect an increased prospect of review and, as seen with other ATO reviews, will be required to explain why EBIT margins fall into high risk zones.

Taxpayers will need to be aware of these differences in the guidance and their implications, including the ATO’s perceived risk profile of certain facts and circumstances. For example, where taxpayers more closely follow the OECD guidance and the resulting transfer pricing outcome falls within one of the ATO’s perceived higher risk scenarios, despite being an arm’s length outcome, then it is important that contemporaneous documentation and evidence is prepared and obtained.

For taxpayers with IRPDs that are not impacted by COVID-19, it is expected that there will be a heightened level of review activity by the ATO particularly during COVID-19 impacted income years. While these taxpayers may require a lesser degree of work to support their transfer pricing positions, other non-COVID-19 related transfer pricing enquiries may ensue as a result of this heightened activity.

The takeaway

COVID-19 has caused significant economic and financial disruptions to many businesses which taxpayers will need to account for in their transfer pricing analysis and documentation. This will create challenges for taxpayers. The release of OECD and ATO guidance will assist taxpayers in overcoming these and, in the case of the latter, help taxpayers understand scenarios the ATO perceives as higher risk. 

Crucially, taxpayers will need to start their transfer pricing documentation processes earlier, address the guidance provided, work through the analysis in greater detail than would be the case in a ‘business as usual’ year, and ensure robust contemporaneous documentation is prepared and substantiated with evidence.

Contact us

Michael Bona

Global Tax Leader

Tel: +61 7 3257 5015

Jenny Elliott

Partner, PwC Australia

Tel: 613 8603 3753

Hamish McElwee

Partner, PwC Australia

Tel: +61 (8) 9238 3571

Nick Houseman

Australian Transfer Pricing Leader, PwC Australia

Tel: +61 2 8266 4647

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