Balancing risk and control in a COVID-19 world

Tax Alert - August 2021

By Bart de Gouw, William Dawson & Chanelle Stoyanov

The economic impact of COVID-19 has had a catastrophic effect on many global industries. From a transfer pricing perspective, a key question to be addressed is whether (or to what extent) group subsidiaries that did not control the risks that gave rise to losses, should now be required to bear these losses.

The answer is complex and fact dependent but revenue authorities are very likely to question any arrangement that involves large losses being borne in entities where the amount of profit (pre-COVID-19) was limited by the application of a group transfer pricing policy.



Functional characterisation of subsidiary


Economic state of the group


Transfer pricing policy applying to subsidiary



Limited risk – no control over risk


Group highly profitable


Limited profit
(e.g. retaining only a small percent of sales as profit)




Limited risk – no control over risk


Significant and sustained drop in group revenues


Amended transfer pricing may need to be implemented to limit the amount of losses borne due to the COVID economy.


The rationale for these positions by revenue authorities is guided by the work of the OECD. The OECD’s recent transfer pricing work has centred around “aligning transfer pricing outcomes with value creation”, which suggests that an entity that undertakes key decision-making roles (a “Principal”) controls the assumption of risk, and should receive residual profits or bear resulting losses. By contrast, entities that perform routine functions under direction and oversight of a Principal entity are expected to earn low yet stable profits.

As a result of this guidance many groups with centralised management structures adopted transfer pricing policies that targeted a low but stable profit outcome for group subsidiaries that operate without substantial local management, rather than pricing discrete transactions.

Following the impact of COVID-19 on the economy, such transfer pricing policies are coming under pressure in situations where customer revenues drop away to such an extent that local subsidiary costs are not covered. Accordingly, a “top-up” payment may be required by a Principal to achieve the set profit outcome.

In these instances, tax authorities may challenge the deductibility of the top-up payments for a Principal entity on the grounds that it has not been incurred in carrying on its business / deriving income of the Principal, or that it was in fact not in control of the risks that caused the loss. This issue may be more prominent in a post COVID-19 context, particularly as revenue authorities of headquarter jurisdictions are unlikely to consider additional outbound payments to group subsidiaries appropriate while heavy losses are already being sustained at home.

Government assistance

As a result of COVID-19 many governments offered assistance programs (e.g. the New Zealand wage subsidy) to keep businesses afloat and workforces employed throughout lockdowns and periods of economic uncertainty.

The prevailing OECD guidance (endorsed by Inland Revenue) on the treatment of such payments is that third parties (acting at arm’s length) would not gift away the benefit of these subsidies. On this basis payments should be retained in-country and not “transfer priced out”. However, the OECD guidance does not touch on the implications of control over risk in these situations. For example, if a decision to obtain the wage subsidy in lieu of actioning redundances was made outside of New Zealand, should the entity exercising control of that decision be entitled to the benefit? If the Principal entity had known it would not have been entitled to the benefit would this have influenced its decision to retain the staff or not?


As you prepare your tax returns and supporting information for COVID-19 impacted years, you will need to carefully consider these issues, including the deductibility of top-up payments by Principal entities, as well as the loss profile of the group. Please contact your usual Deloitte advisor if you would like any help with considering the impact of COVID-19 on your transfer pricing policy and payments.

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