Many multinational enterprises (“MNEs”) are providing new forms of financial, technical, or other support to group members facing COVID-19-related business issues such as plant (temporary) closures or supply chain disruptions. This support may in some cases give rise to a transfer of value, such as the knowhow of a seconded employee. It may also involve a transfer of assets coupled with the ability to perform certain functions and assume certain risks. Such transfers could be viewed as a “business restructuring” as defined by the Chapter IX of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2017) (the “OECD Guidelines”) and may trigger transfer pricing and tax consequences.
Under Chapter IX of the OECD Guidelines, a “business restructuring” refers to the cross-border reorganization of the commercial or financial relations between associated enterprises. Business restructurings often give rise to compensable transfers of value (e.g., transfers of tangible or intangible assets or activities). In order to evaluate such transfers that may arise in connection with a business restructuring, taxpayers should examine the allocation of risks between associated enterprises before and after the restructuring by: (1) identifying the transactions that result in a potential transfer of value; (2) performing a functional analysis that seeks to identify the economically significant activities and responsibilities undertaken, assets used or contributed, and risks assumed before and after the restructuring by the parties involved; and (3) determining whether the conditions of such restructuring differ from those that would be made between independent enterprises. Under the OECD Guidelines, arm’s length remuneration is required for all transfers of value that would be remunerated between independent parties in comparable circumstances.
If a business restructuring is not structured to remunerate impacted group members at arm’s length, tax administrations may assert transfer pricing adjustments to ensure that any profits which would have accrued between independent enterprises are included in profits of one of the associated enterprises and taxed accordingly. In addition, financial, technical or other support payments realized as part of the transfer of value may be classified as base erosion payments or as payments for an outbound transfer of intangibles and may be subject to withholding taxes or trigger deductibility limitations, even if such payments reflect arm’s length prices. For example, in the context of Covid-19, transfers of value from a US corporation to a foreign related party that are treated or reclassified as a cross-border payments requiring compensation under transfer pricing rules could unexpectedly fall within the scope of Code § 59A – US base erosion and anti-abuse tax (“BEAT”). This tax is in addition to any other US tax imposed at the corporate level.
Documentation is key. MNEs should be prepared to explain to tax authorities the business reasons behind the restructuring as well as the economically relevant characteristics taken into account by the associated enterprises in reaching the conclusion that there was no option realistically available.