COVID-19 and intra-group services – a transfer pricing perspective
Implementing emergency plans, trying to keep a positive cash flow, or monitoring the quick succession of legislative changes adopted in connection with the coronavirus pandemic – these have become corporate management’s daily bread. Remuneration models for intra-group transactions are an important piece in this puzzle.
Many companies receive a wide portfolio of services from their parent entities, usually referred to as management services. Others act as service providers, supplying support services to their group as a shared service centre.
The recent travel restrictions and changes in the quantity or nature of support that service recipients need, have given rise to many questions for group chain participants:
- Will the substance of some management services provided in connection with the pandemic meet the benefit test?
- If the demand for shared service centre services drops, who will pay for the unused capacity?
- How to support the arm’s-length basis, the economic reasons of the measures and any possible deviations from historically used remuneration models?
Benefit test and management services
The benefit test examines whether inputs – services or goods - purchased by a taxpayer have brought, or had the potential of bringing, economic benefits.
The benefit of a received service may be a cost reduction, access to special technology or know-how, a quality standard, etc. However, in the current pandemic situation, the need may arise for other support, such as assistance in the implementation of emergency plans, technical and legal support in connection with a production scale-down, finding additional financial sources, or the provision of alternative sales channels, such as dedicated e-shops or platforms such as Amazon.
Will these additional activities still constitute a service that brings or could potentially bring benefits to the recipient? Or will they fall under shareholders’ activities whereby the owners just maintain and protect their investment in post-crisis times? The distinction between these two categories will be very fine, and may not be the same for all business models. Even if management services meet the substance for which an independent enterprise would have been willing to pay, the question remains whether it would perhaps be appropriate to temporarily suspend billing to group companies that have been most affected by the crisis.
Even in these situations, the pragmatic language of tax laws demands economic reasons for such decisions. When looking for arguments, some judgements of the Court of Justice of the EU may offer a suitable precedent (e.g., the judgement in the Hornbach case of 31/05/2018, C-382/16).
Remuneration for shared service centre services
The remuneration of shared service centres acting as limited-risk entities is usually calculated using the cost-plus method. This approach should ensure that all justified costs incurred by the centres for the provision of their services will be compensated.
How to proceed if the need for support services provided by the centres drops due to the reduced demand for the group’s main products?
If these entities are to bear the costs of the (temporarily) unused capacity, their profitability will decrease. Is it appropriate to make efforts to support this lower profitability (or even loss) by preparing a new comparative analysis? If so, how to set the parameters for ‘comparable’ entities – will loss-making entities be acceptable, though they are otherwise usually not accepted by the tax authorities?
In a wider context, it will be necessary to answer whether the centres’ participation in a group’s lower profit/loss is acceptable from an arm’s-length perspective. The approach of some tax administrators indicates a certain flexibility, however, always within arm’s-length processes. Reference to acts by independent persons, e.g. when negotiating modified contractual terms and conditions, will most likely become a necessary component of transfer pricing documentation.
…and documentation, yet again
The above issues are just the notional tip of the iceberg of topics that will have to be addressed in (post)coronavirus times in connection with intra-group services. Management will have to concentrate on new models of cooperation introduced in response to the emergency measures, and their stabilisation. In a couple years’ time, tax officers may come knocking, armed with knowledge not available now. We recommend not underestimating the necessity of precise record-keeping and documentation that may serve as evidence of receiving or rendering a service, including comparative and other analyses to support the chosen remuneration models.