Transfer Pricing Global Taxation

Transfer pricing & APA considerations during an economic disruption

Mark Kirkey of Gowling WLG on transfer pricing in the new economic reality

Author: Mark Kirkey
Mark Kirkey
Now is the time to ensure your company's transfer pricing policies align with the new economic reality, says Mark Kirkey of Gowling WLG.

OTTAWA – At times like this, when health and safety are at the forefront of everyone's mind, tax planning, including transfer pricing, understandably, is generally put aside. However, in light of the potential economic downturn arising from the COVID-19 pandemic, it would be prudent for Canadian companies to consider transfer pricing matters at this time. A review of your current tax and transfer pricing structuring could reveal options for both temporary and permanent improvements in cash flow and tax savings.

As most corporations during these times must be conscientious regarding unnecessary or non-urgent business expenditures, simple practices can now prove cost effective. Companies can arrange an internal meeting within their tax group, or an informal call with its transfer pricing service provider, to look at ways of navigating through unprecedented challenges.

Here are a few things companies should be aware of at this time that may involve no costs, or minimal costs, to execute.

Annual Transfer Pricing Documentation Requirements

Although there is no legal requirement to prepare transfer pricing documentation, most companies prepare their documentation annually. This is because, in the absence of such documentation, should Canada Revenue Agency ("CRA") adjust a company's transfer prices, penalties, equal to 10% of the upward adjustments, could apply. While many companies prepare detailed transfer pricing reports annually, the requirement to meet the "reasonable efforts" standard and avoid potential penalties can be much less involved. Assuming that the 2018 transfer pricing documentation was prepared meeting all of the "reasonable efforts" requirements, if in 2019 there were no substantive business changes in the year, a full blown transfer pricing report is not required.

A shorter internal memorandum discussing any minor business and economic changes could be prepared explaining that the same facts applied to the 2019 taxation year and thus the same methodology and comparables were used. One issue that may need to be addressed is how, or whether, to update the comparables. If nothing material has changed in the business and the functions of the tested party are deemed routine, existing comparables could still be considered appropriate. 

CRA's transfer pricing policy requires that transfer prices fall within the "full" range of the comparables, which allows for a broad interpretation of a reasonable transfer price. Assuming the 2019 transfer prices fall between the 25th and 75th percentile (1st and 3rd quartiles) of the 2018 comparables range, it is unlikely that the updated comparable margins would put the transfer prices offside unless there was a material economic event during the year.

Where there were only minor functional or economic changes in 2019 in respect to a company's business, it is likely the "reasonable efforts" reporting standard could be met at a significantly lower cost. Given a comparables analysis is often done to test the margins of the least complex party, without major business or economic changes we would not expect routine activities to see much of a change. Below, we will discuss this issue in respect to the impact of the COVID-19 economic crisis on 2020.

Review of Existing Transfer Pricing Policies

2020 Review

At times of financial distress companies need to, more than ever, revisit their tax and transfer pricing structures to ensure they are as tax effective as possible (e.g. future losses are not lost, more appropriate and tax effective sharing of profits and losses). Companies are now being tasked to find more savings that can be used for operations. If current transfer pricing policies call for fixed margin or cost plus payments to related parties, these policies should be reviewed to ensure they continue to represent arm's length pricing. Creating huge losses in one company while another is very profitable is not tax efficient and changes may be possible. Again, any revisions to intracompany pricing should reflect how unrelated parties would transact.

Most transfer pricing analysis relies on comparable data to establish an arm's length range of returns. Comparable data is most often taken from public databases which compile the reported results of public companies. The majority of the 2020 data will only be available in the second half of 2021, after the requirement to file 2020 tax returns and report transfer prices. 

This lag in data availability makes it impossible to use current year comparable data and leaves us with unreliable prior year data to establish prices, which can create a significant problem in a quickly deteriorating economic environment.  Accordingly, determining what are arm's length results in 2020 will take serious consideration and should be done as soon as possible to limit overpayments, and the need for compensating adjustments at a later date, which could also involve customs duty and indirect tax implications. Given the absence of current economic data, the taxpayer should write a qualitative memo or analysis explaining the company's performance. This should be done immediately in order not to lose facts that the passage of time may obscure.

Companies instructing employees to work remotely, in all levels of the organization, should consider whether there is an opportunity, or even necessity, to relocate or increase/reduce, functions assets and risks in one jurisdiction to obtain a more effective tax structure. Where material functions, assets or risks change because of this pandemic, it is very likely that the transfer pricing will also have to change. In some cases companies will not welcome the change. 

Take the situation of technical people having returned to their home country for extended periods of time and continuing to work on valuable intellectual property. This raises important questions: 

  • Are unintended tax profits created in those countries?  
  • Does the economic ownership of the IP now move to where these employees are working from? 
  • What if key decision makers are unable to attend meetings in person and are working in different countries than contemplated by the tax and transfer pricing plan, due to travel restrictions? 

Some of these questions are difficult to answer and each tax authority will likely have its own view on the matter. However, these questions, along with many others, should be considered sooner rather than later.

2019 Review

Filing season for the 2019 taxation year is still a few months away and companies should be revisiting the accuracy and validity of their current transfer pricing models. Although retroactive tax planning in the transfer pricing world is a concern with tax administrations, many companies have been utilizing the same transfer pricing policies for years and in many cases these policies have not been updated to reflect the new OECD transfer pricing guidelines. There may be opportunities for companies to change their tax policies in a principled manner (i.e. in accordance with the arm's length principle), which could result in a more tax effective structure going forward, especially with the economic downturn that could arise in these uncertain times.

Impact of the Current Economic Crisis on Advance Pricing Arrangements

An advance pricing arrangement ("APA") is an agreement between a taxpayer and one or more tax authorities to set the price of a covered transaction into the future, usually for five years. Most APA's will include critical assumptions that if breached require notification of the relevant tax authorities within limited time periods. Accordingly thought should be given to whether the significant changes in the economy impact any critical assumptions in existing APAs. In many cases the answer is likely yes.

It is not uncommon for APAs to have wording to the effect that, where major business or economic disruptions occur, the terms of the APA will have to be revisited. If you currently have an APA that includes 2020 as a covered year, you will want to check the wording of the critical assumptions. This does not mean that existing APAs would be considered null and void, but rather the terms will need to be reviewed and potentially amended. Take for example an APA that provides a fixed profit level to one party using comparables from prior to the pandemic. If the overall business was hard hit economically, it could be reasonable for both parties to share the financial impact. This of course would need to be negotiated between the governments and taxpayer involved.

What if you are in the middle of APA negotiations? Be prepared for the negotiations to be delayed, once the government gets back to their offices, to a period where all parties will have a better understanding of the actual impact of COVID-19.  In some cases, it may be wise to consider withdrawing your APA request, or having it held in abeyance, for the time being. In many cases, an APA can take years to negotiate and what was supposed to be forward looking ends up being negotiated on actual data. This typically happens because no government wants to be seen as giving up too much. With so much unknown at this time, it is possible that governments may be reluctant to agree to any type of fixed payment transfer pricing methodology until all parties get a grasp of the true economic impact from COVID-19.


Clearly the COVID-19 crisis has, and will continue to have, a material impact on the way we do business.  However, one thing that will not change is transfer pricing. Profit and loss allocations will continue to be allocated based on the functions, assets and risks of the parties involved. 

In this period of potential financial distress, now is the time to ensure your company's transfer pricing policies align with the new economic reality. While the CRA has been instructed to reduce most activities, including audits, during this period of physical distancing, the CRA will be back examining all tax matters in the near future, including transfer pricing, which is open to review for extended periods of time. The review of your existing transfer pricing polices does not necessarily have to be extensive or costly, but some basic consideration of the matter now, rather than later, could substantially reduce a company's global tax costs over the long term.

By Mark Kirkey, a partner in Gowling WLG's Ottawa office, practising in the Transfer Pricing and Competent Authority Group; Jim Wilson, a partner in Gowling WLG's Ottawa office, practising in conjunction with the firm's Tax Group; and Jamal Hejazi, a senior member of Gowling WLG's Transfer Pricing and Competent Authority team as well as the firm's China Group. Read the original article on by Elchinator from Pixabay.

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