Comparability analysis is one of the focuses of the Organisation for Economic Co-operation and Development (OECD) in preparing the latest guidelines on transfer pricing documentation of related-party transactions in the midst of the Covid-19 pandemic.?
In the issue entitled Guidance on the Transfer Pricing Implications of the COVID-19 Pandemic, the OECD emphasizes that a comparability analysis is one of the important things that companies should consider in the transfer pricing of related-party transactions in accordance with the arm's length principle. The guidance is not intended as an extension or a revision of the OECD Transfer Pricing Guidelines (TPG), but it is considered an integral part.
The OECD sees that the unexpected economic and social conditions caused by the Covid-19 pandemic create unique challenges for companies and tax authorities in performing a comparability analysis. The key message is that both parties should take account of practical approaches that may be adopted to overcome information gaps. One of which is by making comparability adjustments.
In case of determining the arm's length price on related-party transactions on an annual basis, an adjustment to the comparability analysis in the fiscal year 2020 is necessary. The adjustment includes the economically relevant characteristics of the accurately delineated transactions. However, this adjustment does not solely apply to taxpayers who—before the fiscal year 2020 and valid for several fiscal years ahead—have entered into transaction agreements between related parties. As long as the facts and circumstances of accurately delineated related-party transactions do not change, an adjustment is not required.?
Furthermore, in order to conclude whether or not the changes exist, it is important for taxpayers to take account of the relevant economic characteristics. It includes the terms and conditions of the agreement. In addition, taxpayers at an arm's length condition must also determine whether independent parties will consider taking steps to renegotiate the terms and conditions of the agreement.
The Use of Contemporaneous Information
Basically, the OECD allows the use of any form of publicly available information on the effects of Covid-19 to ensure the application of the arm's length principle of taxpayers. Furthermore, the following sources of information can be used to support the determination through the comparability analysis, by estimating the effect of the Covid-19 pandemic on the related-party transactions being analyzed:
- An analysis of how sales volumes have changed during COVID-19, including whether the change is due to the use of other sales channels, and specifically compared to sales generated in previous fiscal years;
- An analysis of the change in the capacity utilization;
- Specific information on incremental and exceptional costs;
- An identification of accounting treatment and types of government assistance;
- Details of government assistance affecting the pricing and the performance of related-party transactions;
- Information on interim financial statements;
- Macroeconomic information such as data of Gross Domestic Product (GDP), industry indicators from central banks, government agencies, industry associations;
- Statistical methods, such as a regression analysis or variance analysis used to predict variations in the relationship between variables;
- A comparison of internal budget data and actual financial performance; and
- An analysis of the effects on profitability or behaviours of independent parties in previous recessionary periods or during the Covid-19 pandemic period.
A comparability analysis between the budget and the actual financial statements is one of potential approaches in transfer price setting due to the Covid-19 pandemic, for example, due to the reduced sales volume or increased operating expenses. The analysis includes:
- Preparation of a detailed analysis of the budget and the actual profit and loss report showing changes in revenue and expenses of taxpayers, along with an explanation for changes variances resulting from the COVID-19 pandemic;
- Preparation of a detailed profitability analysis showing the financial performance of taxpayers if the factors of performance increase or decrease caused by the Covid-19 pandemic are eliminated from the calculation, along with supporting evidence;
- The rationales and evidence related to an increase of allocation of costs or a decrease of sales in related-party transactions, by considering the function, asset, and risk profile of a taxpayer; and
- Any evidence related to government assistance obtained or affecting the taxpayer’s related-party transactions, along with its effect and accounting treatment.
Also, other similar reviews can be used to evaluate the context and factors that may influence the nature and price of related-party transactions that comply with the arm's length principle.