Credit crisis: impacts on transfer pricing

The current economic environment presents not only major commercial and financial challenges for many multinational enterprises but also increases the focus on transfer pricing arrangements. From a management perspective, the focus during this crisis is on managing the downturn of the entire enterprise. The measures available to management vary significantly with respect to their extent and range, from rather straightforward cost reduction approaches to a global realignment of the enterprise’s value chain. From a transfer pricing perspective, the challenge is to closely monitor and review the impact of these abnormal market conditions and the measures taken by management on the assumptions embedded in the transfer pricing systems.

The recent economic crisis does, however, provide a unique transfer pricing planning opportunity to revisit current arrangements and consider amendments for the future. The areas or intercompany transactions within this focus vary among different industries and multinationals. The following highlights some issues applicable to most industries.

Review of intercompany agreements

Intercompany agreements should be reviewed as to whether the terms and conditions still comply with the arm’s length standard, particularly intercompany loan agreements with respect to the interest rates. The recent increase in credit margins and the continued uncertainty of the credit market should be reflected in the interest rates and might require intercompany lender and borrowers to adjust their agreements.

In addition to the interest rate adjustments multinationals should consider changing their intercompany lending/borrowing policy, providing them with the necessary flexibility to cope with unpredictable financial market development in the future, e.g. agreeing on shorter terms or including early repayment clauses.

Managing losses – risk realignment

Profitability across all industries decreases during a recession while particular industries or enterprises may experience significant losses e.g. due to a sharp decline in customer demand. From a transfer pricing perspective, it is essential for the taxpayer to analyse and document the economic and/or commercial reasons for the drop in profits contemporaneously to prevent tax authorities scrutinising the transfer pricing policy. Because the taxpayer’s influence to minimize losses arising from overall economic developments is generally limited, managing the loss utilisation within the group becomes crucial. Managing losses effectively requires careful planning with respect to the jurisdiction the losses incur, the amount of losses and the possibilities to utilise these losses in the future.

The taxpayer might be required, in addition to preparing a contemporaneous transfer pricing documentation, to amend the risk allocation among entities. This could be the case if the decrease in the profitability of certain entities is due to the bearing of risks for which they are currently not being remunerated, e.g. local entities bear downsizing costs due to a decline in local demand. The taxpayer needs to ensure that the transfer pricing policy appropriately reflects the risk allocated to group entities, i.e. entities bearing certain risks have to be compensated for the assumption of these risks. Aligning the risk allocation might require the conversion of fully fledged entities in low risk entities or vice versa.

Transfer of intangible property

Multinationals may consider using the decrease in profitability to transfer intangible property (IP) among related parties. Transferring IP to an IP holding company in a favourable tax jurisdiction, or as part of a value chain restructuring in the current market conditions, could be beneficial in more than one way.

Firstly, the decrease in profitability leads to a lowered valuation of the IP compared to “normal” market conditions and hence, to a lower transfer price. Secondly, the lower valuation will equally affect the basis for the determination of capital gain tax in the location the IP was previously located, thus reducing potential capital gain or exit taxes payable. Lastly, the transfer of IP or an entire business function presents a tax planning opportunity for multinationals to utilise losses accumulated in a specific jurisdiction. The capital gain realised through the IP transfer or the taxation of a business function’s hidden reserves can offset losses previously incurred in this jurisdiction, while depreciation potential is created in the new jurisdiction.

Effectively managing the economic and transfer pricing challenges of the recent recession will be the focus of many multinationals in the short and medium-term future. Understanding the impact of the worsened economic conditions on existing transfer pricing arrangements and intercompany transactions is essential for multinationals to successfully manage the risks and exploit the opportunities.

Name:*				Company:
E-mail:*