Transfer Pricing Therapy in a COVID-19 Downturn

by Andrew M. Bernard Jr., CPA, Kevin Kiyan, PhD, Andy Morris, and Disha Shah, JD | Sep 01, 2020

Businesses across the globe are struggling following a collapse in demand as the COVID-19 pandemic swept across country after country. Even among those businesses where demand had not declined as severely, disruptions to supply chains have been a devastating hardship. While there’s no certainty as to when the marketplace will “normalize,” businesses may be able to lessen the pandemic’s impact on their financial health by seeking remedies through transfer pricing mechanisms.

When market conditions are as universal as they have been, in many cases there is a corresponding impact on the numeric data which define arm’s length ranges. As a result, taxpayers should evaluate whether, and to what extent, transfer pricing can help preserve cash. Although a full discussion of all the transfer pricing mechanisms that could apply are beyond the scope of this article, the basic points here will be straightforward.

Routine Service Transactions

Nearly every transfer pricing structure includes “routine” service transactions of some sort.1 Compensation is typically defined as the service company’s costs plus an additional markup. The burden of compensating service companies falls on the entity serving as the group principal. In good times, operating profits are sufficient to cover the service fees.

In a severe downturn – as the current crisis certainly is – the arm’s length markup may not always require a positive result.

Given this possibility, taxpayers should consider the following steps:

  • Revisit intercompany agreements to evaluate how obligations are defined under extraordinary circumstances (i.e., is there a force majeure clause?).
  • Consider reducing the scope/scale of activity performed by the captive service provider.
  • Consider reducing the service fee (i.e., markup) if supported by benchmarking (see next section).
  • Evaluate the feasibility of applying another transfer pricing method.
  • Consider delaying payment of service fees.
  • Identify any transactions between the taxpayer and third parties for which the pricing terms have been revised downward. These may serve as useful references to support similar downward revisions to related-party transactions (if comparable).

Benchmarking Considerations

Given the unique circumstances of 2020, it would be prudent to identify/analyze third-party financial data that accurately reflects a taxpayer’s financial distress. This may include the following examples:

  • Use a single-year interquartile range rather than a three-year weighted average.
  • Adjust for certain one-time expenses in 2020 that were incurred because of COVID-19.
  • Include loss comparable companies as part of a benchmarking set.
  • Use partial-year financials for companies that may have shut down during 2020. This also helps alleviate some level of survivor bias that is natural during a recession.

Other Intercompany Transactions

For licensing transactions in which a royalty is typically benchmarked, a taxpayer could reconsider how the royalty is defined (i.e., sales versus profitability) or consider the feasibility of implementing a tiered royalty schedule.

For intercompany loan transactions, a taxpayer could consider applying the safe-harbor interest rate (100% to 130% of the appropriate applicable federal rate).2 Note that the loan must be denominated in U.S. dollars and the lender must not be in the trade or business of making loans to unrelated parties at the time the loan is made.

Importance of Documentation

Any deviation from a transfer pricing policy should be documented and supported by facts that explain the hardship endured by the taxpayer and the reasonableness of the positions taken. For example, the industry analysis section of a documentation report should show (and, if possible, quantify) how the pandemic has directly impacted the taxpayer’s business, including peers, suppliers, customers, etc. It is also important to quantify the financial strain implied if the taxpayer were to maintain the transfer pricing policy as it was defined prior to the pandemic. For example, how long would the taxpayer’s cash reserves be able to maintain monthly operating expenses without a significant turnaround in the economy?

Ultimately, taxpayers should turn the COVID-19 pandemic into an opportunity to revisit transfer pricing policies and not simply rely on what has been adopted in previous years. 

1 Routine transactions are those which can be quantified through a benchmarking analysis. They include, for example, sales and marketing, sourcing/procurement, transportation/logistics, customer service, back office/administrative support, among other services.

2 Pursuant to Treasury Regulation Section 1.482-2, care must be exercised if modifying an existing loan arrangement to avoid a significant modification that could result in a deemed disposition of the loan resulting in taxable gain (or loss) under Treasury Regulation Section 1.1001-3.


Andrew M. Bernard Jr., CPA, is managing director for Andersen in Philadelphia, and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at andrew.bernard@andersen.com.

Kevin Kiyan, PhD, is a managing director for Andersen in Los Angeles. He can be reached at kevin.kiyan@andersen.com.

Andy Morris is a senior manager for Andersen in Los Angeles. He can be reached at andy.morris@andersen.com.

Disha Shah, JD, is a director for Andersen in Los Angeles. She can be reached at disha.shah@andersen.com.

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