New methodological information of the GFD on the impact of Covid-19 on transfer pricing
In December, we informed you about the recommendations issued by the Organisation for Economic Co-operation and Development (OECD) in response to the impact of the Covid-19 pandemic on transfer pricing. At the end of March, the General Financial Directorate (GFD) issued methodological information summarising the most important guidelines in the OECD material from the perspective of the Czech financial administration.
The methodological information of the GFD focuses mostly on the pandemic's impact on the results of enterprises referred to as routine entities. These are enterprises that, within a multinational group, carry out their activities mainly based on orders from a superior entity. Routine entities are typically engaged in simple production or distribution activities and are not exposed to common market risks, such as the loss of a customer/supplier. Given the lack of decision-making power in the area of business strategy (e.g. product portfolio management, pricing, customer/supplier portfolio management), routine entities usually have long-term guaranteed terms on which they deliver.
In the context of a pandemic, the GFD acknowledges that even routine entities may suffer losses, but stresses the need for a thorough functional and risk analysis, which should be an integral part of the routine entity's local documentation. Losses should only be to the extent that they are attributable to the functions performed and risks borne. At the same time, it is always necessary to analyse how independent entities behave in similar conditions.
Benchmarking will continue to be used to analyse the behaviour of comparable independent entities in transfer pricing documentation. The way in which the benchmarking analysis is set up should correspond to the contractual terms based on which the remuneration of the routine entity was negotiated.
For example, a routine producer that has been guaranteed remuneration determined by the cost+ method under a production contract for a long period of time should continue to test the level of the arm's length profit premium on a regular annual basis, based on data available for comparable undertakings for the previous period (average of three to five years).
Commenting on the timing of the availability of data on the pandemic's impact on the results of companies doing business in the same sector as the routine entity, the GFD states that there will be a delay in making up for any declines in profitability by maintaining continuity in the compilation of comparative analysis based on historical data. In practice, this means that the operating results of routine entities will be tested for any tax base adjustments in the 2020 tax return based on data from 2017 – 2019, when no pandemic impact was experienced, while the 2021 results will be tested based on data from 2018 – 2020, when 2020 was already a pandemic year.
If the contractual arrangements for routine entity remuneration are set up in the short term in the group to allow flexibility to respond to the market situation, the GFD accepts the possibility of making comparability adjustments. The methodological information does not provide any specific example of a price comparability adjustment. Therefore, we can only assume that the development of price indices for the sector in the current year 2020 can be used as one of the possible criteria for such adjustments.
Please note that if the entity was a recipient of government support at the time of the 2020 pandemic, it will be necessary to reflect the costs that should have been compensated by the support, as well as the level of risk that the routine entity was actually exposed to in relation to incurring and covering those costs, for comparability adjustments.
The most important guidance contained in the GFD's methodological information, which is a binding methodology for all tax authorities, is the reference to the existing GFD Instruction D-34, according to which cumulatively loss-making companies are still to be excluded for the purposes of the comparability analysis. These are companies that have had a sustained negative operating result in previous periods (3-5 years).
We therefore recommend that the benchmarking analyses, which are part of the local documentation, continue to be updated on a regular basis once a year.