COVID-19 | Impacts of the greatest economic crisis of the modern era on the development and transfer pricing policies of multinational groups

The Covid-19 emergency is causing unprecedented political and economic stress capable of producing a planetary crisis that will last over time. With rare exceptions, the resulting economic slowdown will not spare even multinational groups, called today to question how this unexpected discontinuity will impact on their value chains and therefore on transfer pricing policies. Will it therefore be plausible to expect a planned rise in compliance risks to the benefit of the survival of companies?

The pandemic spread of Covid-19 is globally generating a situation similar to that of a "war economy" with closed factories, suspended or contingent activities and industrial conversions aimed at giving strength to the efforts of the various governments to deal with the emergency. Even in this painful battle against an invisible but ruthless enemy, like other wars, public intervention in supporting people and businesses becomes decisive. However, the only welfare measures are not sufficient to guarantee the continuity, but also only the survival, of companies. And for once, the dimensional factor will certainly not be a guarantee of greater strength and, therefore, of acquired "immunity" to negative external factors, even the most severe. All companies, even large international groups, are at risk of suffering substantial losses, which may even "become chronic", and result, in the worst cases, in default.

And to worsen the above picture there is the absolutely unprecedented circumstance in the post-industrial economy that the crisis is not sparing even a corner of the planet with the disarming consequence that normally "comfortable" decisions to take, such as geographical diversification with entry into new markets, this time may not be effective or in any case sufficient to improve the destinies of companies.

International private operators will then have to assess whether, due to the pandemic, there is no need to make urgent and substantial changes not only to their business model but also to the management of transfer prices.

With regard to the first point, changes may be necessary in the supply chain, leading multinationals to review the current geographical distribution of their functions, risks and assets within the group. Reasons in this direction could for example derive from prolonged closing periods of production plants in one particular country or from lasting changes in consumer behavior in another. Certainly, in many cases, it will be appropriate to resort to a renegotiation of the intercompany contractual terms to make the supply chains suitable to mitigate, in line with what is happening in the respective national markets, the consequences of the crisis, so that once more it is thought not to only to regulatory compliance but also and above all, to avoid dangerous financial and / or economic defaults, which would inevitably trigger chain reactions within the entire group. And more than ever, in this period, nobody should forget that a national gross product is made from the sum of the results of the individual companies operating in the respective territory. Responsibility and foresight are therefore required from the tax authorities who will have to accept the sacrifice of revenue in the short term, to ensure revenue, hopefully increased, in the coming years.

Similar changes are consequently to be considered reasonable also for the transfer pricing policy, called to consider the changes in context that occurred. The main issue is to establish how to distribute the risks within the group keeping in mind that the OECD considers that they must be attributed to those who control them and to those who have the financial capacity to support them. But there is no doubt that the risks associated with the pandemic cannot be controlled. So is the approach of distributing them among the various entities valid?

The theme assumes a certain relevance for multinational groups operating in different countries through routine entities. Typical examples are the figures of low risk distributors and routine producers who, performing routine functions, present a limited exposure to risks if compared with that typically associated with the group principal. In this sense, the dilemma as to who within the group must bear the risk of the pandemic and the related negative economic consequences entails assessments of the margins to be recognized to these entities, which normally due to the routine nature of the activities carried out receive remuneration consistent with the low level of risk inherent in these functions.

As regards the economic analysis aimed at assessing the arm's length nature of the intercompany conditions, there are several general considerations that emerge.

Covid-19 is creating a series of extraordinary occurrences to consider for the purposes of comparability analysis and the economic ones that derive from it. It is therefore evident that the economic conditions, and in particular the characteristics of the markets, are becoming more relevant today than ever. Factors such as different lock-down policies and public assistance intervention between individual EU countries will make the conduct of pan-European analyzes challenging. These differences will also become relevant from an intra-national perspective. In this sense, just think of the different temporal incidence of the "red zones" on Italian territory.

For operators who have internal comparables, for which a comparison of the intercompany conditions with those negotiated with third parties is therefore easily operable, the comparability exercise will be more immediate and "reassuring" as well as less nebulous the resulting framework of actions will result. In these contexts, therefore, not only the economic parameters but all those conditions that are directly related to the epidemic will fall (e.g. renegotiation of contracts, deferment of payments, etc.).

In the event that the method applied is that of the external Transactional Net Margin Method ("TNMM"), it will be necessary to identify what is to be considered an acceptable positioning in light of the negative economic situation in progress. The topic assumes relevance for those who will have to compare the evidence relating to their margins for 2020 (e.g. return on sales, return on costs) with the evidence of benchmark studies based on data concerning previous years (normally the previous three years). In this regard, reflections should be made about the opportunity to include loss-making companies in the arm's length range in order to reflect the actual market conditions and make further reflections on the time span to be considered, without misleading alterations of reality. Other considerations are those relating to the use of adjustments for the set of comparable companies or, more simply, to different positions in the range (e.g. lower quartile rather than median).

Avoiding generalizations and remembering that each case may be different from any other, it seems useful to point out the usefulness of identifying the costs incurred due to the Covid-19 epidemic, isolating both those due to the emergency itself (e.g. closure of the plants ), and those deriving from the economic consequences that will influence commercial performance once the emergency is over. And the advice is to highlight it in the transfer pricing documents in order to limit the impacts of possible future assessments made by the tax authorities. In fact, it is plausible to expect in the post Covid a resurgence of the tax audit on transfer prices aimed at recovering the chasm of revenue that will inevitably originate. And we want to believe that the tax authorities will take into due consideration that companies are operating in conditions far from those typically associated to a market economy.

Francesco Gerla 
International Managing Partner

Matteo Coppola              
Transfer Pricing Manager - Milan  


Francesco Gerla
Managing Partner

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