COVID-19 Crisis: Impact on international business models

8. April 2020 | Reading Time: 5 Min

The Corona virus pandemic has triggered a worldwide crisis not only of health systems but also an economic crisis of a number of business models and industries. The shockwaves which are tearing through supply chains both on the supply as well as demand side are massive:

  • Lockdowns and contact restrictions threaten the existence of businesses particularly in gastronomy and hotel business, retail, travel and event planning industry.
  • Shutdowns of manufacturing facilities because of virus incidences or reduced capacities trigger interruptions in the procurement of raw materials and components.
  • Lockdowns and shutdowns result in sales drops to zero or change consumer behaviour (online shopping).
  • Home office recommendation or obligation mean that employees no longer work from the office but from their residency.
  • In project-based businesses – particularly structural and civil engineering – there are interruptions of the projects or shutdowns of building sites.

Particularly in an international context these disruptions of daily processes and workflows may have a tax impact. Here is a summary of some of the major aspects which should be considered in order to mitigate tax risks and costs.

1. Consider adjustments of the transfer pricing system to the economic conditions

The changed economic conditions must be considered in the transfer pricing system. The existing pre-corona system should be reviewed in light of these market changes. The pivotal question is: What is the impact of the crisis on the group entities and is there any need for adjustment?

COVID19 crises: Corona Transfer Pricing TPA News

Some of the relevant questions regarding the transfer pricing set up are summarised here:

Value chain and people functions

  •  Are there changes in the value chain? Particularly,
    • regarding the value drivers,
    • regarding the risk allocation between the business units,
    • regarding the decision making functions,
    • regarding the relevance of intangibles (f.e. customer stock))?
  • Which entity bears the risks and costs of the crisis, particularly from sales drops, loss of efficiency, unused capacity and under-utilisation as well as from additionally necessary liquidity?
  • Which entity bears the costs of a strategic reorientation or adjustment of the business model?
  • How does remote working affect the allocation of functions (e.g. employees who previously worked locally at subsidiaries)?

Intercompany legal framework

  •  Do existing IC agreements need to be amended or renegotiated?
  •  How do third parties act on the market or industry? How do external customers or suppliers react?
  •  Do payment terms have to be amended or renegotiated?
  •  Do existing price lists or contractual calculations have to be redefined?
  • Do price adjustment clauses have to be suspended?

Documentation & benchmarking

  •  What is the effect on “limited risk” or “routine” entities within a group?
    •  Should they still achieve positive results or do they have to carry losses?
  •  Are the existing benchmarks still applicable or do they have to be adjusted? Are there any internal benchmarks?
  •  Which financial data should be used for current ex-ante pricing?
  •  How should shareholder loans currently be remunerated (which credit rating should be assumed and which financial data should be used)?

The impact of the current crisis and thus the need for changes in the respective transfer pricing systems will vary between different industries. In any case, we recommend a review of the existing TP framework.

2. Consider transfer pricing aspects of intra-group liquidity solutions

With regard to the partial or total loss of sales, it is of utmost importance for companies to ensure liquidity during the crisis. In case of a group entity’s need for liquidity, the following measures may be considered:

  •  Prolongation of internal payment terms
  •  No charge of default interest for late payments
  •  No charge of / deferral of payment for management fees or royalties,
  •  Higher limits for debit balances in existing cash pooling arrangements
  •  Internal sales of current assets (goods, raw material, etc.)
  •  Internal factoring
  •  Additional shareholder loans

It is important to take such measures in line with the arm’s length principle and to ensure a proper documentation of such transactions.

With regard to the current business situation and in particular in light of the new OECD Transfer Pricing Guidance on Financial Transactions, it is recommended that all intra-group financial relationships and the respective contractual framework should be reviewed and adjusted (if necessary).

3. Consider permanent establishment issues in international project business

In international project business, cross-border deployment of employees may result in the constitution of a permanent establishment due to the exceeding of business site or construction deadlines or longer-term work on site.

Due to the Corona crisis, many employees are not able to perform the daily work as usual or at the usual location, at least for a certain time. In some sectors, such as the construction sector, current projects are suspended or “on hold”.

In cases where the constitution of a permanent establishment depends on time (such as PEs in the construction sector), the relevant period of usually 12 months (but depending on the specific rules in applicable treaties) is always calculated from the start of the project (arrival of the first employee at the construction site) until the project is handed over. Interruptions to on-site work generally do not result in an interruption of the deadline! Exceptions to this basic rule are only possible under limited conditions.

Hence, corona-related interruptions may lead to a retroactive constitution of a permanent establishment in many cases.

This can have significant tax implications:

  •  Registration of a permanent establishment retrospectively from project start
  •  Local corporate tax liability for (third-party) profits that have to be allocated to the PE
  •  Additional administrative effort in connection with local tax compliance (PR profit determination, documentation, etc.)
  •  Employees can no longer use the 183-day simplification rule and are liable to tax in the country of the construction site with their pro rata income

It should therefore be checked in a timely manner whether any international construction projects are at risk of exceeding deadlines due to delays. Additionally, it should also be checked for the specific case as to whether an interruption of the deadline can be argued after taking appropriate measures (deduction of all employees, corresponding correspondence with the client, documentation of official measures) (e.g., for projects in the Austria-Germany relationship).

4. Permanent establishments through home office or place of management

The (permanent or repeated) work by employees in a home office may lead to companies establishing a permanent establishment abroad. For more details, please refer to our newsletter HERE.

The constitution of a permanent establishment by managing directors or executives can be particularly tricky, as this may also lead to a foreign place of effective management.

In our opinion, however, a temporary work performance in the home office that only lasts a few weeks or months due to the crisis should not be considered sufficiently “sustainable” to actually trigger a permanent establishment for the company. This is also in line with the OECD information which was just published. In practice, such PEs usually require more than six months of work; therefore, from a current perspective, the “remote” work of employees should not trigger any significant issues relating to a permanent establishment. Nevertheless, monitoring is recommended if the corona-related restrictions last longer than currently expected.

However, the crisis-related additional home office activity may be decisive in “borderline-cases” that have already existed before. Such cases should therefore be checked carefully.

Stay healthy!

CEE/SEE Tax Desks


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