In this first article of our new Transfer Pricing Insights series, we turn our lens to an urgent issue that has arisen from Covid-19 crisis: cash flow.
This Insight takes you through some short-term actions to preserve cash flow a multinational enterprise may take as a reaction to Covid-19. We discuss how these actions can have a direct impact on the transfer pricing policy within the Group. Vice versa, changes in the transfer pricing policy may boost cash flows and help companies survive this crisis.
Observe market behavior
Daily cash flow planning and cash management has quickly become the most critical management issue for companies impacted by Covid-19.
As changes in the economic environment occur, parties are seeking to amend the terms and conditions of existing trade agreements, both third-party and intercompany. In order to create much-needed cash resources, they are looking to take various measures such as: deferring cash outflows in respect to taxes and payables, obtaining lower interest rates on loans, and obtaining access to cash through government subsidies. While amendments to third-party agreements are constrained by existing contracts and the relative market positions of each party, changes to intercompany arrangements are, or course, subject to the (almost) global arm’s length standard and the transfer pricing regimes of each country involved.
Given that group companies are expected to enter into intra-group transactions in a manner consistent with the way they deal with third parties (arm’s-length principle), it may be possible to renegotiate intra-group arrangements as a result of Covid-19 disruptions. Companies may consider a number of alternatives including: reducing management fees due to reduced cross-border services being provided (or increasing them due to extraordinary crisis management costs); prepaying, postponing or cancelling royalty payments or support service fees; or renegotiating interest rates on loans and/or prepaying or deferring interest payments. Intra-group factoring might be affected. Consideration should be given to whether certain banking arrangements or covenants may be impacted by a change in the debt to equity ratio.
However, while amending intra-group transactions and policies may seem like a rather quick fix to free up cash and improve liquidity, it is imperative to fall within the framework of the arm’s-length principle. For the first time and quite recently in February 2020, the OECD has issued Transfer Pricing Guidance specifically focusing on Financial Transactions, emphasizing the importance of detailed analyses of a Group’s intercompany financing arrangements to ensure that they meet the arm’s length standard.
Nonetheless, existing intra-company funding arrangements may no longer be effective, and now may be the time to re-examine them. Revisions may involve, for example: changes in payment terms (prepayments or deferrals); changes in interest rates; amendments to maturity or repayment clauses; or changing other relevant terms and conditions. Analyze intra-group agreements to consider whether they provide for a change in payment terms, what the financial implications of any changes are, and whether Intercompany agreements can and / or need to be amended. And, when revising funding arrangements, any changes must be consistent with the functional and risk profiles of the various companies in the Group.
If there are intra-group guarantees, consider what securitization options are available to lower funding costs. Explore market behavior between third parties to adjust payment terms in line with the arm’s-length principle.
Regarding cash pools, care should be taken when moving funds raised through government measures cross-border by means of a cash pool. Before taking any cash out, the implications involved must consider local country requirements and the local legal framework.
When creating new arrangements, consider checking the other tax jurisdiction’s country-specific rules, safe harbour rules, withholding taxes, customs requirements, in conjunction with the overall economic situation of the Group.
Where to start
Start by verifying the funding needs of both the Group as a whole and of the individual members. Determine if there is need to raise new capital or whether it is enough to reallocate capital within the Group. In order to do so, collect financial and operational data as evidence to be able to compare it with third party market data, and to support decisions that are taken now (ex-ante). Seek support from governments through subsidies, tax deductions or exemptions, delay for tax declaration filings, and other fiscal and financial support measures related to Covid-19 provided by governments throughout the world.
For more information visit our Global Transfer Pricing webpage or get in touch with one of the team directly.