Transfer pricing considerations for a disrupted global supply chain

This opinion piece articulates key transfer pricing considerations CFOs need to take into account as they formulate their strategies ahead.

The impact of the COVID-19 pandemic has been far-reaching, with significant implications on the supply chains of many multinational companies in Thailand. With travel restrictions and uncertainty across the globe, many players have sought to manage their disrupted supply chains with flex-and-surge capacity management, and by diversifying suppliers and geographies in the search for raw materials, intermediate products, and finished goods.

As businesses review their existing supply chains with a view to restructuring or relocating some of their operations, their business models and supply chain footprints will continue to evolve – and correspondingly, so will their intercompany transactional relationships and transfer pricing approaches. To stay ahead of the game, CFOs and their finance teams will need to take the following transfer pricing considerations into account as they formulate their strategies:

Latest developments in Thailand

For accounting periods commencing on or after 1 January 2019 (FY2019) in Thailand, a set of new transfer pricing regulations will apply. In particular, the Thai Revenue Department (TRD) will require taxpayers with revenues of THB 200 million and above to submit an annual transfer pricing disclosure form and the transfer pricing documentation upon request.

As the authorities may be accustomed to stable profit margins typically reported by the Thai subsidiaries of multinational companies performing routine functions, CFOs will need to be prepared to answer questions relating to the impact of COVID-19 on their profit margins. These could include, for instance, how lower level of profit margins are derived during these times, and if there has been a transfer of profits amongst entities of the multinational group due to realignment of supply chain activities. If the business has been adversely impacted by COVID-19, it is also important that CFOs are able to explain the impacts clearly, and support them with the necessary documents and evidence.

In this context, the transfer pricing documentation could prove to be a useful tool for CFOs and their finance and tax teams to articulate their business profile and any changes in activities, and provide context into their financial results. Before the submission of their year-end filings, Thai entities should also make sure that they have put in place practices to monitor and constantly revisit their business’ transfer pricing policies, and perform benchmarking exercises on a regular basis to ensure that their operating margins are within the arm’s length range established by comparable businesses in similar industries.

Operating losses and low margins

Local Thai subsidaries of multinational corporations are often characterised as “routine” entities due to the limited functions that they perform, for example, as contract manufacturers. With the COVID-19 pandemic resulting in increased business costs for many companies – either from a loss of revenues, or increased spending required to deploy business continuity measures – many of these Thai entities will be facing significantly reduced profits, or even losses.

However, this does not necessarily mean that the local Thai entities should bear the expenses or losses, even when they are incurred by them, due to their limited functionality. CFOs will need to ensure that they carefully identify the appropriate entity or entities within their multinational supply chain and footprint to bear these additional costs, and analyse and document them thoroughly so that they are able to justify them if challenged by tax authorities seeking to limit the impact of losses in tax revenues in their respective jurisdictions.

Transfer pricing adjustments

Generally, tax authorities expect the local subsidiaries of multinational companies performing routine functions to be remunerated with stable returns in line with their “routine” characterisation, while the head office entity assumes the economic risks, as well as all residual profits or losses, in line with their entrepreneurial functions. For example, if a multinational company’s headquarters in Singapore manages its supply and inventory risks centrally, it may not be appropriate for the downside costs from the COVID-19 disruption to be assumed by a local Thai distributor.

Therefore, CFOs will need to consider if and how to bring their transfer adjustments to the targeted level of returns to ensure that these “routine” entities continue to be remunerated with an appropriate level of profit. There also remains the question of whether losses stemming from a decrease in overall market demand and additional costs to cope with the pandemic should rest squarely on the head office entity, or be shared, at least to some degree, by local “routine” entites throughout a multinational company’s supply chain.

New priorities, new opportunities

While supply chain disruptions have resulted in upheavals in business models, intercompany transactions, and the physical flow of goods, they may also present rare opportunities for CFOs and their finance teams to re-evaluate their transfer pricing approaches, and capture the value of adjusted priorities in areas such as procurement and risk management.

No one can predict when the pandemic will end, but one thing is for sure: some of COVID-19’s impacts on supply chains and their corresponding transfer pricing positions, as well as compliance and audit risks, are likely to be drawn out – if not permanent. If these are not well managed now, they could leave multinational companies bearing a set of heavy tax burdens for a long time to come.

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