Many transfer pricing policies use a form of one-sided profitability testing, where a routine entity’s result is benchmarked against the profitability of independent companies performing comparable activities (often in application of the so-called Transactional Net Margin Method). In normalized market circumstances, such transfer pricing policies result in a stable, rather low return for routine entities that is commensurate with (the value add of) the functions they perform and the risks they incur, whereas the entrepreneur or principal company is entitled to the residual profit or loss after remunerating the routine entity. Not often explicitly mentioned, but underlying such benchmarking and standard application of a transfer pricing method, is the division of normalized earnings levels and a rather non-exceptional materialization of risks. A simple thought to bear in mind is that a so-called ‘limited risk’ distributor for instance is not a ‘no-risk’ distributor.
Hence, as the COVID-19 crisis is an external exceptional materialization of risk, the question arises how the impact of the crisis, i.e. mainly decreased profits or overall losses, should be allocated within a multinational group and whether and to what extent routine entities should share in the deviation from the ordinary. We believe that there are good arguments (inspired by third party behavior) that in view of the arm’s length principle – where affiliates under the separate entity hypothesis are supposed to act in their own best interest in respect of their options realistically available – to reconsider the earlier agreed upon arrangements, at least temporarily.
If you have any questions on this subject, please contact the authors of this article:
Andy Neuteleers - Partner (andy.neuteleers@tiberghien.com)
Ben Plessers - Senior Manager (ben.plessers@tiberghien.com)