In the issue entitled Guidance on the Transfer Pricing Implications of the COVID-19 Pandemic, the OECD emphasizes the importance of a comparability analysis in the transfer pricing of related-party transactions in accordance with the arm's length principle. The transfer pricing documentation guidelines offer a new concept of Contemporaneous Uncontrolled Transactions related to comparability analysis. It is intended to answer common questions about the use of comparable company data, the period of analysis years, to practical approaches related to changes in economic behavior due to the Covid-19 pandemic.
Contemporaneous Uncontrolled Transactions are information relating to the selection of the same period between controlled and uncontrolled transactions in the context of current information comparables. Because the information of contemporaneous uncontrolled transactions reflects how independent parties behave in an economic environment that is the same as or substantially similar to the economic environment of the controlled transaction. Thus, the information is reliable to be used in a comparability analysis during the Covid-19 pandemic period.
The current information on contemporaneous uncontrolled transactions can be obtained from publicly available commercial databases. This is the same as related-party transactions that taxpayers tend to get from the current information on potential internal comparables.
However, the concept of contemporaneous uncontrolled transactions will be more challenging as the application is confronted with the Transactional Net Margin Method (TNMM). If usually, taxpayers and tax authorities rely on historical financial information from commercial databases, this time they have to look for other alternatives. Because the financial information of unrelated parties in the 2020 fiscal year will only be published at least in the middle of the 2021 fiscal year.
Therefore, taxpayers will need to perform a comparability analysis for the 2020 fiscal year based on available prior year financial information and- depending on the facts and circumstances of each case, utilizing whatever current year information is available to support their transfer. This principle only applies to taxpayers who determine an arm's length price for related-party transactions on an annual basis.
Limitations of Data and Information
However, what must be considered is the lag in the data and information regarding contemporaneous uncontrolled transactions based on commercial databases. For this reason, it requires flexibility and assessment for both taxpayers and tax authorities in determining reliable results.
The following are some of the pragmatic approaches the OECD has introduced to address the issue of information deficiencies in contemporaneous uncontrolled transactions:
- The use of reasonable commercial judgment supplemented by contemporaneous information to set a reasonable estimate of the arm’s length price;
- Where feasible, allow for an arm’s length outcome testing approach; and
- The use of more than one transfer pricing method
Furthermore, the OECD does not recommend a comparability analysis based solely on financial information from the global financial crisis 2008/2009.
This is due to the fact that the conditions of the economic crisis at the time were not necessarily the same as the current pandemic situation. In principle, a comparability analysis should be performed by reference to the specific delineation of the controlled transaction including its actual economic circumstances faced by taxpayers. In addition, the principles outlined in the OECD Transfer Pricing Guidelines (TPG) regarding the use of multiple year data and average remain applicable.
In ordinary circumstances, it can be used as a means to mitigate the impact of accounting differences, appropriately measure the effects on profitability, and to evaluate other comparability factors. In doing so, it will increase the reliability in comparability analysis. Although, in the state of the COVID-19 pandemic, care should be taken to determine the financial data that may distort actual financial performance. For example, the impact of the closing of a taxpayer distribution facility for three months or other government assistance and intervention.
Not only multiyear data, but the OECD also reminds taxpayers not to override inclusion or exclusion of the use of loss-making comparables. Accordingly, loss-making comparables in a particular case should not be rejected.
Consequently, when performing a comparability analysis for the fiscal year 2020, it may be appropriate to include loss-making comparables when the accurate delineation of the transaction indicates that those comparables are reliable. For instance, the comparables assume similar levels of risk and that have been similarly impacted by the Covid-19 pandemic.
Lastly, The Covid-19 pandemic that has created economic conditions that differ from those of previous years allowed taxpayers to review the suitability of the existing comparables. In fact, if needed taxpayers may revise the set, based on updated search criteria. One of them is related to the geographic location of the comparable companies.
In addition, price adjustment can also be made. Of course, by considering the complexity of its application that can have implications for VAT and Customs Duty aspects.