The economic changes which caused by the COVID-19 pandemic, creates challenges to the comparability analysis. This pandemic may have a significant impact on transactions between independent firms and may reduce the reliance on historical data when conducting comparability analysis. It may require taxpayers and tax administrations to consider practical approaches that can be adopted to address comparability adjustments.

The OECD has prepared several practical approaches regarding comparability analysis. The followings are some of the questions that are likely to be frequently asked in the preparation of the TP Documentation during this pandemic.

  1. What sources of information that can support the comparability analysis applicable for the Financial Year of 2020?
  • An analysis of how sales volumes have changed during COVID-19 by comparing with the analysis in pre-COVID years.
  • Information relating to outstanding costs caused by either with related or unrelated parties or by the whole MNE group, including the government assistance that has been received and its accounting treatment.
  • Details regarding government interventions that have affected the pricing and controlled transactions.
  • Information from interim financial statements.
  • Macroeconomic information like country GDP data or other economy indicators from central banks, government agencies, industry or trade associations.
  • Statistical methods such as regression analysis or variance analysis to analyze the response of corporate profits in certain industries to GDP movements.
  • A comparison of budgeted/forecasted data and actual results relating to sales, costs and profitability.
  • A comparison of analysis of the effects on profitability in previous periods and in the current year.

  1. Can budgeted financial information be used to support the setting of arm’s length prices?

Another potential approach to utilize in setting transfer prices is to compare budgeted financial results to actual results in order to find out the effects of COVID-19 on revenues, costs and margins.

The financial outcomes with the impact of COVID-19 may provide useful information, particularly when assessing the financial impacts from COVID-19 whether there has been a reduction in sales volume or increment in operating expenses, and determining the contractual terms and risk assumption of the parties. This analysis may include:

  • The detailed profit and loss analysis showing changes in revenue and expenses, with an explanation resulting from COVID-19.
  • Details of profitability including factors that have a positive or negative impact resulting from COVID-19 on the profits of the taxpayer and should be supported by evidence.
  • The evidence whether there is any increased allocation of costs or a reduction of sales in the controlled transaction by also taking into consideration its function, asset and risk analysis.
  • Any evidence of any government assistance affecting the controlled transaction and its accounting treatment.

  1. Any challenges in using contemporaneous uncontrolled transactions?

According to OECD, information relating to the conditions of comparable uncontrolled transactions undertaken during the same period as the controlled transaction (“contemporaneous uncontrolled transactions”) is the most reliable information to use in a comparability analysis. Such information shows how independent parties behave in an economic environment that is more or less the same as or similar to the economic environment of the controlled transaction.

In other instances, it may be more challenging to use contemporaneous uncontrolled transactions as part of a comparability analysis, especially in the application of the transactional net margin method (“TNMM”).

When applying the TNMM, taxpayers and tax administrations rely on historical information from commercial databases. Apparently, the information of the Financial Year of 2020 will not be available until Financial Mid-Year of 2021. This suggests that in these circumstances, taxpayers will need to perform a comparability analysis based on available prior year financial information and utilizing whatever current year information is available to support their transfer prices.

  1. How to address information deficiencies?

Taxpayers may encounter difficulties in determining arm’s length conditions due to the availability of information regarding data from independent comparable transactions. Data from other time periods may not provide a reliable benchmark for the current period due to the pandemic.

OECD provides several pragmatic approaches to this issue. Tax administrations could consider these pragmatic approaches to minimize disputes particularly when taxpayers are showing efforts to determine arm’s length prices in the context of the information deficiencies during the COVID-19 pandemic.

  1. Tax administrations are encouraged in performing risk assessments, evaluating audits and considering the documentation that taxpayers provide as reasonable efforts on which they are also trying to comply with the arm’s length principle. Taxpayers should also provide analysis and reasonable explanations in evaluating the likely effects of the COVID-19 pandemic and in implementing appropriate changes in their transfer prices.
  2. Tax administrations could provide flexibility to allow adjustments to the Financial Year of 2020 tax returns if transfer prices are set on an arm’s length basis and using available information. Also, given the potential for double taxation that may arise as a result of unilateral adjustments, Tax Administration may consider to:

a) Allow “compensating adjustments” before the tax return is filed in order to allow for any available information to be evaluated by taxpayers and tax administrations to clarify if the arm’s length prices can be reliably established; or

b) Ensure access to the MAP (Mutual Agreement Procedure) or to some alternative procedure where the issue could be addressed to avoid double taxation.

  1. The application of more than one transfer pricing method may be useful to confirm the arm’s length price of a controlled transaction.

  1. How might the period of data used to evaluate arm’s length pricing be established to support a comparability analysis?

The principles outlined in Section B.5 of Chapter III of the OECD TPG regarding the use of multiple year data and averages remain applicable. It can be used as a means to learn the impact of accounting differences, the profitability effects for the tested party based on its business, and to assess the reliability of the comparables.

The use of combined periods which include both years that are impacted by the pandemic and years that are not impacted, may improve reliability. This approach would bring out the financial results of the Financial Year of 2020 with more normal results of prior years in order to test the arm’s length nature of the transfer pricing policy applied in the Financial Year of 2020.

In addition, government intervention can affect business activity performance. In some cases, government intervention can allow business activities to continue or even force to stop due to the pandemic. This aspect is also relevant in performing the comparability analysis. Let’s assume when government intervention forces a taxpayer to close its distribution facilities for three months. In undertaking a benchmark analysis, it is preferable to verify that comparable enterprises also have faced similar conditions. Otherwise, it might be necessary to adjust the period by excluding the economic data corresponding to the three months where the taxpayer was unable to operate.

  1. Would price adjustment mechanisms be appropriate?

Price adjustment mechanisms is one potential solution according to OECD, in order ro maintain an arm’s length outcome especially during this uncertainty period which caused by the COVID-19 pandemic.

A price adjustment mechanism which is consistent with Arm's Length principles would address the problem of a lack of information about comparability or evidence in response to the pandemic. This will give taxpayers and tax administrators the flexibility in ensuring compliance with Arm’s Length Principles.

However, given the scope of potential adjustments, Taxpayers and Tax Administrators have to pay attention the effect of any payments that may have on the comparability analysis for the Financial Year of 2021, and the potential VAT/GST and import duty implications.

  1. What actions may be taken to evaluate the set of comparable companies or transactions used?

The COVID-19 pandemic has brought significant changes to economic conditions. It may be necessary to review the suitability of those existing comparables, by revising the criteria. For example, assume that geographic comparability is considered as the most relevant factor given the effects of COVID-19 in a particular market. In these circumstances, in order to obtain reliable data, it is important to focus based on that criteria.

8.    Can loss making comparables be used?

Comparables that suffer losses which qualify the comparability criteria in a particular case should not be rejected just because that they suffer losses during the COVID-19 pandemic.

When performing a comparability analysis for the Financial Year of 2020, it may be appropriate to include comparables that suffer losses especially when the comparables are reliable (for example, the comparables have similar levels of risk and that have been similarly impacted by the pandemic).

Direktorat Jendral Pajak bkpm

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