If multinational groups were now to incur losses because of the Covid-19 crisis, corporation tax payments in countries where they are only active through so-called routine group companies, i.e. companies with a low functional and risk profile, could put an additional burden on their economic situation. Per definition, a routine company is, for example, a contract manufacturer or a so-called low-risk distribution company. [Reference is made to para. 47 of the Austrian Transfer Pricing Guidelines (ATPG)] This is true since tax authorities usually expect routine group companies to generate a moderate, but stable profit.
Also, para. 3.64 of the OECD Transfer Pricing Guidelines (OECD TPG) states that simple or low risk functions in particular are not expected to generate losses for a long period of time. However, this does not imply that loss-making transactions can never be admissible. Every case is therefore to be assessed on an individual basis. According to para. 7.35 pp. OECD TPG (or para. 80 ATPG), there are circumstances in which an independent enterprise may not realise a profit from the performance of services. Therefore, it does not always need to be the case that an arm’s length price will result in a profit for an associated enterprise performing an intra-group service.
The Austrian tax authorities (see Macho/Steiner/Spensberger, in Verrechnungspreise kompakt, Case Study 2) refer in this respect to para. 18.104.22.168a of the German Administrative Principles Procedures (“Verwaltungsgrundsätze-Verfahren“). Accordingly, a small but stable profit shall be achieved "in the normal course of business". It can be derived that losses may be incurred "in the case of unusual business developments", i.e. in exceptional cases. Considering the bargaining power and negotiation dictate of the principal, reductions in profit margins, respectively profit mark-ups of routine companies, may in certain cases also be considered appropriate. Such procedures are also conceivable among third parties during times of economic recession. An essential requirement for the recognition of such "adjustments" is an appropriate and comprehensive documentation that reflects the negotiation process. The assumption of losses by a routine company due to a total loss in the group might be appropriate if this is compensated by higher chances of profit in the future. A de facto risk-free production unit would only have a positive function; economic fluctuations (sales crises) would basically only have to be borne by the entrepreneur, not by the routine company. The acceptance of the reduction of the profit mark-up to zero as an "economically existential contribution to the restructuring of the survival of the entrepreneur" could enable the economic survival of the routine enterprise.
In the current Covid-19 crisis, the following measures may thus be taken:
Price adjustment due to the Covid-19 crisis
The coronavirus does not only cause a "normal" economic downturn, whose negative economic effects can be compensated by the regular economic high. Corresponding growth is not necessarily to be expected in the future. Due to the current exceptional situation, reducing the profit mark-up of de facto risk-free routine group companies to zero seems appropriate, whilst precisely describing the particular hardship for the group and the negotiations of the exceptional circumstances between the parties to the contract.
Another option may be to adjust the transfer prices or profit margins agreed with the routine company in the short term to the lower end of the interquartile range (provided that the transfer price has been determined on the basis of the transactional net margin method).
The participation of routine companies in losses is viewed very critically by parts of the Austrian tax authorities. In view of the risks in future tax audits, we would therefore not recommend such an approach.
Necessary contract adaptations and documentation obligations
Even if the existing intra-group contracts do not include a so-called price adjustment clause, such a price adjustment can be made if there is corresponding detailed documentation. This should be done in writing, with a detailed explanation of the planned period of validity, the exact economic circumstances that led to such a short-term adjustment of transfer prices, and a description of the relevant negotiation process.