Pandemic Disruptions Could Throw Tax Agreements into Limbo

Companies forced to change their business structures in the wake of the coronavirus pandemic may find it harder to renegotiate their agreements with tax authorities, potentially opening them up to future disputes and audits.

Tax rulings or written agreements from administrations are sought by multinational companies to lock in the tax treatment for their domestic and offshore arrangements, granting them safety from potential audits.

But new supply chains and business structures could alter existing agreements and make it harder to renew expiring ones. That’s especially the case as tax authorities take different approaches to help companies, while others turn their attention to other virus-related issues, leaving companies in limbo.

Companies must be proactive, said Vicki Bales, transfer pricing director at DLA Piper’s London office. That “is the only way you are going to have a chance of success in convincing tax authorities to accept changes to these agreements,” she said.

Countries like New Zealand, the U.S., Australia, and U.K., have indicated they will assist companies in managing pandemic-related impacts on advance pricing agreements—contracts companies sign with governments to pre-approve their transfer pricing arrangements over a set period of time. But they urge companies to start discussions as soon as possible.

Companies with existing or expiring agreements should approach governments with specific issues now because tax authorities might not be as lenient after the world emerges from the crisis, tax professionals said.

“Right now these governments are doing whatever it takes to help businesses, but don’t expect them to be this understanding forever,” said Sandy Bhogal, a partner at law firm Gibson Dunn & Crutcher LLP in London.

Expect Delays

Companies shouldn’t expect a quick response from tax authorities as they focus on tackling more urgent issues during the pandemic, practitioners warned.

“The main thing is to expect delays on getting tax rulings,” Fabian Sutter, an associate at Loyens and Loeff in Zurich, said. “From the administrations I talk to, their focus is on helping the businesses affected by the virus, and they are all saying, ‘Don’t expect the same swift reply.’”

Canada is operating on reduced capacity and giving priority to critical services, such as benefits administration, so companies may experience delays, a Canada Revenue Agency spokesperson told Bloomberg Tax.

The Hong Kong Inland Revenue Department has also been providing limited services during the virus outbreak since March 23, and “understandably the special work arrangement during the Covid-19 period would delay the process of case review and negotiation,” said Victor Zhang, director of transfer pricing and tax at Deloitte Hong Kong.

The revenue department didn’t immediately respond to requests for comment.

Possible Violations

Companies forced to make business decisions as a result of the coronavirus, such as adding or discontinuing a business line in a jurisdiction, could be violating a “critical assumption” clause in their advance pricing agreement, or APA. The clause requires that any critical assumptions made by both the company and government when negotiating the agreement must be maintained or the APA will be void.

“If for example, you are sourcing a part from China and the whole country is in lockdown so you are unable to source it from there and you instead opt to use a subsidiary in Hungary, you could end up violating the critical assumption clause in your APA,” said Steve Wrappe, national technical leader of transfer pricing at Grant Thornton LLP in Washington.

The Internal Revenue Service Advance Pricing and Mutual Agreement Program in the U.S. wants companies to consult with it first about challenges before making decisions.

“We very much prefer that taxpayers talk with us about what they’re facing, rather than, in a sense, taking unilateral action on their own,” John C. Hughes, director of the IRS program, said April 6. “In that vein, we are being contacted by taxpayers mentioning the kinds of challenges they’re facing and we stand ready to talk with them about those challenges.”

Companies with possible technical violations may not have to renegotiate their agreements, however, if they correctly assess the situation and find their tax position from the transactions remains largely the same, Wrappe said.

Under normal circumstances, “you can contact the tax authority, usually via email, to let them know that you have made a change that could technically violate the agreement, but that you feel it doesn’t change the outcomes,” he said.

Some Flexibility

New Zealand’s Inland Revenue offered flexibility to companies and said they won’t need to consult with the authority when making business decisions that result in an APA breach, according to the agency’s March 24 email to tax professionals shared with Bloomberg Tax.

New Zealand advised companies to refer to its Annual Compliance Report and said it anticipates circumstances where arrangements may not follow the arm’s-length standard—the bedrock of transfer pricing that requires units within a multinational group to transact the way third-parties do.

“At this stage, we do not know how significant the disruption will be or how long it will last and there will be considerable variations between sectors and types of businesses. It is only after the dust has settled that we will be able to reset the likes of APAs but we do recognise these rulings will need to be reconsidered in light of this global upheaval,” the agency’s email said.

Where a technical breach results from factors that are pandemic-related and outside a taxpayer’s control, the Australian Taxation Office will work with the taxpayer “with the aim of agreeing on an outcome that allows the taxpayer to continue to have the benefit of the APA,” an agency spokesman told Bloomberg Tax April 8.

The U.K. tax office, Her Majesty’s Revenue and Customs, “is always responsive to changes in the commercial environment and by their nature, transfer pricing challenges always take market conditions into account,” a spokesperson said, without offering concrete details.

Renegotiating Terms

The tax authority in India should also be open to renegotiating APAs terms, said Mukesh Butani, managing partner at BMR Legal Advocates in New Delhi. He said he already has had one client ask what to do about “an APA that was negotiated back in the rosy days when some critical assumptions existed that now do not.”

The law that governs APAs in India doesn’t have a provision allowing for revisions, however. Typically, an APA signed by both parties that violates the terms of the agreement will be canceled, Butani said. Still, he advised his client “that over a period of time laws will evolve and will be amended. So even though there is no statute that you can go back and revise, you need to sit and renegotiate again with the tax authorities,” he said.

Those seeking new APAs will be “dramatically affected by the lockdown situation” as the formal process for applying for an agreement begins with an in-person pre-consultation, Butani said.

India’s Income Tax Department didn’t immediately respond to requests for comment.

Temporary Holds

Italy has placed a temporary hold on issuing tax rulings and responding to new agreements until May 31.

If other countries adopt this approach, it could pose a problem for companies needing to renew expiring agreements, Sutter said. The terms of an APA typically last about five years, but can be shorter or longer.

“This could be an issue if, like in Switzerland, tax rulings do not have an indefinite effect. So if you have a ruling that is only valid for six months you will need to renegotiate a new ruling,” Sutter said.

Companies should check on the status of their ruling with the responsible tax administration—and make sure the authorities are actually working. Some local tax authorities for Swiss Cantons that are heavily hit by the outbreak, such as Vaud, have closed their offices or are temporarily running on smaller teams, for example. Companies may not be able to communicate in a normal way, Sutter said.

The ATO, for instance, is replacing face-to-face interviews with telephone conferences as a result of social distancing and travel restrictions. It is also carrying out negotiations with treaty partners over the phone, an agency spokesperson said.