Navigating transfer pricing during Covid-19

MAY 22 — 2020 certainly started out in a tumultuous fashion, with no one anticipating just how Covid-19 would change our lives so drastically. Social distancing has become a common practice, out of pure necessity, to curb the spread of the virus. With many countries still on some form of lockdowns due to the pandemic, most businesses have been affected badly as they grapple with navigating a “new normal” in doing business.

This is truly an unprecedented time for everyone, with things likely to remain uncertain until at least the end of the year. The International Monetary Fund paints a bleak picture for 2020, with the global economy predicted to sharply contract by 3 per cent.

During this difficult period, many businesses are trying to find ways to mitigate business risks to stay afloat. Corporate groups may also consider if pricing for related party transactions can be reviewed or changed, whether for sale of goods/services, licensing of intellectual property, etc.

However, as Malaysia has transfer pricing rules which require transactions among group companies to be carried out at arm’s length, businesses may wonder if there are transfer pricing implications arising from changes in their related party transactions during this period.

Transfer pricing is a tax concept which requires group companies to transact with one another at market prices, similar to transactions between independent companies. Transfer pricing documentation needs to be maintained by companies to demonstrate arm’s length nature of intercompany transactions.

Let us look at some typical challenges faced by businesses due to Covid-19 in terms of transfer pricing.

Intercompany borrowing and lending

A group company may provide loans, advances or make payments on behalf of another group company which is currently struggling with cash flow issues and requires funds to cover their operational costs. You may see this as an ordinary business transaction but the Inland Revenue Board (“IRB”) views this differently.

Based on Malaysian transfer pricing rules, a group company lending funds to another group company has to charge market interest rates. In short, it cannot be an interest-free arrangement.

However, charging of interest brings about an additional challenge for businesses as the borrowers are cash-strapped and presumably cannot repay the funds and interest expenses anytime soon. As such, businesses need to consider the potential approaches which can be adopted in this case.

In the short run, businesses should carefully evaluate the amounts required and determine appropriate interest rates. As a longer-term solution, if charging interest is not preferable, businesses can consider injecting equity instead.

Business losses — can they be justified?

The IRB typically scrutinises business losses incurred by companies. Right now, many businesses suffer from losses due to poor market demand and economic conditions. The main challenge in a tax audit, however, lies in convincing the IRB of legitimate commercial and business reasons behind the losses, and that losses are not due to transfer prices entered into by businesses, particularly for those with significant related party transactions.

This include exceptional expenses during the pandemic and post-pandemic period, such as cleaning/sanitation and retrenchment expenses.

A robust transfer pricing documentation may come in handy in this case, to document and quantify the impact of such costs on the company’s financial results and how these expenses ordinarily would not be incurred under normal operating conditions.

In short, businesses need to prove that the losses were not incurred in relation to their related party transactions.

However, this might be more difficult to prove if your company is a contract manufacturer or limited risk distributor. The general principle is that the higher the risks borne, the higher the return which should be earned.

Limited risk entities perform limited functions and bear limited risks for which they earn a routine (i.e. fixed) margin. These entities do not bear significant economic risks such as market and operational risks.

As such, businesses should consider whether there is a need to revise transfer pricing policies and/or transfer pricing adjustments so that limited risk entities do not bear the brunt of losses arising from extraordinary events such as pandemics, and whether losses should be shared across the group instead.

Discounts provided — anything to consider?

A group company may provide discounts to related companies to help ease their financial burden. For example, a group company sells products or sub-leases part of the office premises to related companies and it decides to provide a discount on the product selling prices or rental charged.

Businesses should consider how the discounts can be justified from a commercial perspective. In developing such justifications, businesses need to be able to demonstrate that the same discounts would be provided to external parties under the same circumstances.

There is no “easy fix” or “one-size-fits-all” approach in transfer pricing, unfortunately. After all, transfer pricing is not an exact science and a suitable approach for one company may not be suitable for another. As such, asking these difficult questions upfront can help you to identify the most suitable approach for your business and mitigate transfer pricing risks.

This understandably is a daunting task, but as it is with other global crises, we will need to weather this storm until the pandemic eventually comes to a natural end. In the meantime, keep calm and stay safe!

Source: Malay Mail

About the Author:

For more information, please contact:

Celine See
Tricor Services (Malaysia) Sdn Bhd
Director, Business Development

Tel: +6 03 2783 9191

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