COVID-19: Transfer prices and permanent establishments

Effects of COVID-19 on transfer prices and permanent establishments

Due to the outbreak of the corona virus, multinational companies are often confronted with an immediate change in the economic environment, e.g. due to supply chain disruptions or stagnating sales. As a result, actions are required concerning the implemented classical business models and the corresponding transfer pricing systems.

Effects on typical principal structures

Many multinational corporations have implemented a typical principal structure. Within the value chain, individual functions are outsourced, for example, to contract research and development companies, contract manufacturers, and routine distributors (so-called LRD). These companies perform routine functions and, therefore, are only exposed to minor risks or are (financially) relieved of risks by the transfer price system implemented. Therefore, the routine companies receive only a low but stable remuneration. The residual profit, i.e. the difference between the sales to third parties minus the remuneration of the routine companies, remains with the principal. As a result, the principal benefits from rising group profits, but has to bear the (financial) risks within the value chain. For the principal, this means that it generally must bear the financial losses suffered by the routine companies as a result of the corona crisis. For the principal, this leads to a considerable burden on the income as well as the cash flow statement. In order to prevent the principal from getting into financial difficulties himself as a result of the corona crisis, possible adjustments of the prices and margins applied should, therefore, be examined.

There are various possibilities for (transfer) price or margin adjustments. Generally, an adjustment of the (transfer) prices and margins within the arm’s length range determined by benchmark studies can be made first. In addition, it is conceivable to make new benchmark studies in the near future and thereby determine a range that was achieved by routine companies in comparable recession periods. In order to ensure tax recognition, prompt action, and appropriate documentation is required.

Intra-group financing services

The liquidity needs of many companies triggered by the corona crisis cannot only be met by bank financing but also by intra-group loans. In this context, the interest rate applied must comply with the arm’s length principle, which avoids tax add-backs for the lender on the one hand and the borrower on the other. In Switzerland, the minimum and maximum interest rates stipulated by the FTA should be taken into account, unless a different interest rate can be proven by a third-party comparison (usually by a benchmark study). The support measures of the government and the corresponding interest rates applied can be taken into account as third-party prices as well.

The borrower must also ensure that the interest payments resulting from the debt financing can be claimed as expenses for tax purposes and that there are no restrictions on the deduction of interest.

Tax treatment of home office

In times of the corona virus many employees work from home. Particularly in areas close to the border (but also in inter-cantonal relations), the question arises whether the home office constitutes a permanent establishment. If this is the case, a corresponding tax assessment would have to be made.

The FTA has already commented on this issue. It has come to the conclusion that from today's perspective, an "enforced" home office is not geared towards permanent activity and, for this reason alone, does not constitute a permanent establishment. However, if the activity in the home office should last for a period of more than six months, the situation must be examined on an individual case by case basis. In most cases, however, even in the case of longer-term arrangements, the employer's power of disposal over the home office premises and the exclusive business use will be missing in order to qualify as a permanent establishment.

April 2020 | Authors: Thomas Linder, Dr. Hagen Luckhaupt, Simone Camenisch

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