6 Ways Transfer Pricing Can Improve Your Cash Position During the Covid-crisis
The world is currently facing the worst economic crisis since the Great Depression due to the COVID-19 pandemic. Companies are facing entrepreneurial risks unimaginably big compared to only a year ago. With the crisis far from over and a quick recovery being unlikely, many companies are struggling to keep cash within the company.
Transfer pricing is not the first thing that would spring to mind when considering your cash management, but it definitely helps. The earlier you find time to look into it, the better the results will be. Below we’ve listed six ways that transfer pricing can improve your cash position during the COVID-19 crisis.
1. Review the terms and conditions of your intercompany contracts
The COVID-crisis has led some companies to review and revise the terms and conditions of the contracts that they have with their suppliers and/or customers. The arm’s length principle, the leading principle in transfer pricing, states that: where conditions are made or imposed between the two associated enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, that should be adjusted.
If independent enterprises are reviewing and revising the terms and conditions of their contracts, then the ‘at arm’s length’ thing to do would be to also review and revise your intercompany contracts in a similar way.
2. Review and adjust the results of your benchmark studies and other economic analyses
To support your transfer pricing you may have had a benchmark study performed. Usually these studies need to be updated periodically to (better) reflect the present market conditions. But even the newest benchmark studies will not yet accurately reflect the current bizarre market conditions.
During a bad crisis, you do not want to determine an at arm’s length profit by referencing the market conditions of last year or the years before. The market has completely changed. We can help you to report (lower) profits that are better aligned with current market conditions and use that as a support towards the tax authorities.
3. Analyze the effects of extraordinary events on your worldwide profit allocation
In an extraordinary crisis such as this one, extraordinary things happen. Perhaps important customers or suppliers have gone into default or supply chains have been heavily disrupted by the lockdown measures implemented by countries worldwide. As a result of these measures some companies within your group may have been heavily impacted.
We can help you analyze these effects and help you decide where in the group these effects should land. Realize that where these losses initially accrue, is not necessarily where they should accrue at arm’s length and that deciding not to change anything about the initial place where the losses accrued is just as much a decision as making a deliberate choice.
Making a deliberate choice based on a careful analysis may prevent your group from unnecessary reporting of profits or unrecoverable carry-forward losses and could prevent future disputes with tax authorities.
4. Adjust your provisional tax returns
The COVID-crisis and implementing some of the previously mentioned measures may lead to differences in forecasted profits. By timely adjusting your provisional tax returns you may be able to get overpaid pre-paid taxes refunded. In case the currently forecasted profits are too low, it may also be wise to adjust the provisional tax return accordingly to avoid paying interest.
5. Monitoring your transfer pricing throughout the year may save you VAT or customs duties
Monitoring your transfer pricing throughout the year is generally advisable, even without a crisis. If you have not done so yet, now may be a good time to start a good habit.
Monitoring your intercompany prices throughout the year, also called operational transfer pricing, may save you VAT or customs duties in certain situations.
A VAT impact may exist, in situations where goods or services are transferred between related parties, if one of the parties involved is not allowed to fully deduct input VAT. Year-end adjustments can often not be charged with VAT because the adjustment is not retraceable to individual products.
The same applies to customs duties. Year-end adjustments for transfer pricing will generally not lead to an adjustment of the price for customs purposes. If, in hindsight, the price for customs purposes was set too high, you are unlikely to be able to recover overpaid customs duties.
Adjusting your prices accordingly may therefore prevent unrecoverable VAT and customs duties.
6. Review the effects of government support on your transfer pricing
Although this won’t save you cash directly, it will save you trouble. Which can in itself prevent expensive advisory fees and penalties as well.
Our advice is that you carefully consider the effects of your transfer pricing policies in light of any government grants that have been provided. More specifically you need to make sure that any government grants received are not exported abroad as a result of your transfer pricing policy.
This point is clarified based on the example of X.B.V. below.
X B.V. is a routine distributor and is part of a multinational group that is severely impacted by the COVID-19 pandemic. The group’s transfer pricing policy is to remunerate X B.V. with an EBIT equal to a 5% return on sales.
When applying this transfer pricing policy, you should make the adjustment as if the government grant was not provided. Because if you do not exclude the government grant from your transfer pricing analysis, you will end up exporting your grant abroad. The below numerical example highlights this effect.
|X B.V.||2020 (no grant)||2020 (grant)|
|Sales||€ 7,000,000||€ 7,000,000|
|Total Costs||€ 8,600,000||€ 7,600,000|
|EBIT||€ -1,600,000||€ -600,000|
|Transfer pricing adjustment|
|Transfer pricing adjustment amount||€ 1,950,000||€ 950,000|
|Adjusted EBIT (5% of return on sales)||€ 350,000||€ 350,000|
In the left column we see the effect without the grant. The company is bound to make a loss of € 1.6 million. To ensure that X B.V. reports a 5% return on sales, a transfer pricing adjustment of € 1.95 million is made.
In the situation in the right column, a grant has been provided by the government, lowering the costs of X B.V. by € 1 million. This lowers the loss, prior to the transfer pricing adjustment to € 600,000. If the grant is not taken out of the equation prior to calculating the needed transfer pricing adjustment, the effect is that the transfer pricing adjustment is also lowered by € 1 million.
This is likely to cause problems, especially when the company providing the adjustment is not located in the same country. From the local government’s perspective, taxpayer’s money has now been spent to effectively subsidize a foreign company. Government authorities will likely find this to be an undesirable outcome and will combat it. Therefore, it is good practice to take any government grants out of the equation prior to making transfer pricing adjustments.
These are just a few tips that you can apply to hopefully avoid more cash leaving your business than what is strictly required. Please note that many of these tips are generally good practices of operational transfer pricing, also outside of an (economic) crisis.
If you found these tips valuable and want to know more, please feel free to contact the transfer pricing specialists at Crowe Peak without any obligations.