Travel restrictions to curb the spread of the new coronavirus pandemic could upend multinational companies’ business models and their tax positions if they don’t take preemptive measures.
The outbreak of the respiratory disease Covid-19 has propelled countries, including the U.K., Italy, Spain, the U.S., and Canada, to issue some form of temporary travel restrictions across borders, including suspending flights. If prolonged, the limitations to travel could affect the way companies within a multinational group charge each other for goods and services, and even break preexisting agreements with tax authorities, tax advisers warned.
Travel restrictions could affect how companies justify the prices they set for transferred assets if their intercompany arrangements require certain kinds of people and functions to be in a certain jurisdiction, tax practitioners said. For example, a company could rely on a unit in another country to conduct marketing across a specific region. If employees can’t travel to carry out that function, that sudden change could either trigger a taxable presence in a different country or raise questions from tax authorities in the future.
“As soon as you start to get towards five to six months and longer, and you are relying on people traveling to a location to provide special value-adding functions, then you are going to get problems,” said Vicki Bales, transfer pricing director at DLA Piper’s London office.
Changes to Functions
Multinational companies follow transfer pricing rules that require them to value assets they buy and sell between their related parties in the same way unrelated parties would, also known as the arm’s length standard.
Companies carry out a functional analysis as part of their transfer pricing documentation in many countries, which describes the functions performed, assets used or people employed, and risks assumed by the parties to the transaction as a way to demonstrate that the prices charged meet the arm’s length standard.
Because travel limitations could be in place for many more months, as countries predict the peak of the virus outbreak is still weeks away, companies should keep track of where key functions like sales, marketing, and research and development are being provided, Bales said. They could be asked to prove to tax authorities that those functions are actually happening at the place their operating model says they are, she said.
Companies will also need to ensure they can explain temporary changes to their transfer pricing arrangements that could lead to disputes with tax administrations, Justin Breau, a tax partner at Ernst & Young LLP in Denmark, said.
For example, a parent company might provide a management service to a subsidiary that tax authorities view as having low risk. But these arrangements could be compromised if they require the parent company to send management to the jurisdiction where the subsidiary is based, Breau said.
Tax authorities often require proof, such as travel documents or visa stamps, so that they can see services are being provided in the country in question, he said.
“If there are long-term travel restrictions to an area, then it could become difficult for a parent company to demonstrate the oversight of a limited-risk entity,” Breau said.
Companies will also need to be able to explain to tax authorities, perhaps years from now but without the benefit of hindsight, that they took reasonable actions during the crisis to curb these issues, Sandy Bhogal, a partner at law firm Gibson Dunn & Crutcher LLP in London, said.
“It should be enough to say, ‘I can’t travel because of coronavirus,’ but it will be interesting to see if tax authorities accept that the specific situation is appropriately unforeseen and unavoidable,” he said.
In the meantime, companies should keep contemporary reports of why certain decisions are made in the context of their transfer pricing arrangements, Bhogal said.
In some cases, restrictions to travel could cause issues to arise over which country can tax an activity.
“If the travel bans last long enough there might be a real effect on the strength of tax positions, as companies are able to have economic activity in a country remotely and this could cause issues of territoriality,” said Jeff VanderWolk, a former OECD official who is now a partner at Squire Patton Boggs in Washington.
For example, a sales director could be contracted to perform a function in one country, but might not be able to leave another country to carry out that function because of a travel restriction. Some companies may opt to operate remotely, but by doing so, the sales director could create a taxable presence in the country they are working from, VanderWolk said.
“People will be prevented from flying and that will force them to get used to virtual or telephone meetings, which could disrupt, or be inconsistent with, transfer pricing planning a business has done that assumes a particular person that performs a particular function traveling around,” he said.