COVID-19 has created a spell of disruptions and changes that have left practically no facet of business untouched. OECD also recently released guidance on how to manage the impact of the pandemic in order to correctly apply the arm's length principle in intra-group transactions. Since the ex-ante arm's analysis is time-sensitive, let’s hear from experts on the proposed solutions on the aforesaid framework and the upcoming challenges for taxpayers.

1. Taxmann Covid TP
Implications
session
April 2021

2. Taxmann Covid TP Implications session 2
Illustrative Framework for TP Analysis for
Covid-19 impact

3. Taxmann Covid TP Implications session 3
Illustrative Framework
Determine variances in operations and the financial impact thereof at the entity/transaction level
Identify group impact of the pandemic on revenue and credit flows
Assess impact on current TP arrangements and benchmarking strategy to assess if any changes are required.
Undertake an analysis of the quarterly data to comprehend contemporaneous financial performance trends, to arrive at an arm’s length range.
Determine exceptional costs that would otherwise not have been incurred but for COVID-19 situations, that could call for adjustment.
Make economic adjustments to the operating results of the tested party or the comparable companies.
Consider undertaking an estimate of the margins of comparable companies by applying statically robust regression models.
Establish the arm’s length range to determine any updates to the transfer prices for FY 2020-21.
Put in place intercompany agreements or addendum to reflect the ex-ante change in transfer prices,if any.
Document the ex-ante analysis in the annual TP report.

4. Taxmann Covid TP Implications session 4
Predictive Modeling Analysis

5. Taxmann Covid TP Implications session 5
• The Coronavirus (COVID-19) outbreak has brought major economic disruption. More than 175 countries and
territories have been directly impacted by COVID-19 infection. The Indian economy has seen unprecedented
contraction, leading to a steep decline in revenues across businesses and sectors. It has emerged as the single
biggest threat to the Indian economy so much so that several economists do not expect Indian economy to reach pre-
covid growth rates for the next 2-3 years
• For many businesses, this pandemic has created unprecedented and unforeseen financial stress and uncertainty,
leading to a negative bearing on the profits as well as cash flow of companies
• The fulcrum of the transfer pricing analysis lies in the benchmarking studies. During an economic downturn, the
margins earned by independent entities are being reduced and can be expected to be on a downward trend, however
the full year data will be available only once the audit cycle is closed toward the later part of 2021.
• However, an overall quantitative impact may still be assessed by observing a predictive relationship between
historical data of macro economic variables and financial data of comparable companies over a reasonable period of
time.
Impact on Indian Economy and its relation to transfer pricing
Background

6. Taxmann Covid TP Implications session 6
The application of transfer pricing methods depend, among other things, on the assumption that the tested party and the
comparable companies operate in stable markets with a viable market driven economy.
In a recession of the current scale and depth, these market dynamics may be disturbed in many industries. Companies may
not be able to sustain profits or may incur losses and benchmarks may have to be revisited to take into account the
business impact caused by COVID-19.
• There may be absence/limited number of comparable companies available to benchmark as:
• Appropriate comparables may be hard to find – because though the comparable may have similar functions and risk
profile as the tested party, it may be in a slightly different segment of the industry, which may not experience the same
economic pressure at the same time as the tested party
• The financial data are typically derived from external databases that provide data which are many months old. Given the
dramatic changes in various markets, financial results of comparable companies with a time lag cannot be compared with
tested party’s present financials due to significant deviations.
• Quarterly data for listed companies may not provide sufficient number of comparable companies
It may be possible to re-assess arm’s length profitability based on macro-economic observations that are inherent to the
market. If a relation with key macro-economic variables and arm’s length results of accepted comparable companies can be
established, it may help estimate current and future profitability of comparable companies in line with predictable macro-
economic environment that drives business and market.
What is the proposition?
Predictive Modeling

7. Taxmann Covid TP Implications session 7
Relationship
between PLI
and GDP
growth rate
• GDP growth was considered as it provides an overall snapshot of the state of the economy
• Scope of study entailed a period ranging from 2007 through 2019
• Objective is to help understand how the PLI of comparable companies reacted to the GDP
growth fluctuations
What is the analysis?
Predictive Modeling
Deloitte has undertaken a study which examines:
• Impact of macroeconomic indicators on PLI of previously accepted comparable datasets
• If an econometric relationship is established, it would indicate how PLIs are expected to be affected in the
future on account of economic growth cycles.

8. Taxmann Covid TP Implications session 8
The arm’s length results will vary as the forecasts for Indian GDP growth rate vary.
Arm’s length range
Revised range of comparable
companies would be computed
based on the predicted
movement of the PLI for each
of the finally accepted
comparable company
• Arm’s length profitability
based on TNMM
benchmarks derived from
independent comparable
company sets
• Existing transfer pricing
theory allow for amendments
to transfer pricing policies in
response to economic
circumstances
• Comparability needs to factor in economic conditions
that result in lower levels of profitability for its entities
• As the financial results of comparable companies for
2020 may not be available until later in 2021, this
analysis supports lower profitability based on ex ante
approach
• Can be included as an ex-ante analysis in the TP
documentation for 2020-21, further supported, if
available by actual results of the comparable
companies ex-post
• Helps to substantiate lower profits/ losses with
financial auditors and tax authorities
• May be used for controversy management including
both litigation and APAs
Insights from the analysis How will the analysis be useful
How will it help
Predictive Modeling

9. Taxmann Covid TP Implications session 9
Quarterly data

10. Taxmann Covid TP Implications session 10
The emerging trends will be updated as quarterly data is released throughout the year
Trends
Highlight and present the extent
of impact basis
contemporaneously available
data for listed (which are also
generally the leading)
companies in the industry
segment
Insights from the analysis How will the analysis be useful
• Analyse impact on any
specific industry segment
and function
• Examine whether the impact
is a continuation of prior
quarterly movements or
whether there is change
because of the pandemic
• Leverage on the analysis to
build justification for the ex-
ante adjustments to client’s
transfer pricing policies in
response to economic
circumstances
• Support for explaining changes made to transfer
pricing policies to statutory auditors and tax
authorities
• Reliable study demonstrating industry impact using
micro level data of corporate financials
• Additional support for transfer pricing documentation
for 2020-21
• May be used for controversy management including
both litigation and APAs
How will it help
Analysing Quarterly Trends

11. Taxmann Covid TP Implications session 11
Adjustments based on Tested Party data

12. Taxmann Covid TP Implications session 12
• Identifying impact of COVID-19 on tested party’s business
• Impact on MNE Group’s business
• Variance analysis over prior years or from budgets
• Segregating COVID-19 specific costs :
– Identify unexpected COVID-19 specific extraordinary costs
– Identify excess/ idle capacity costs resulting from activity stoppage or reduction
Adjustments based on tested party data

13. Taxmann Covid TP Implications session 13
Adjustment based on tested party data - Example
• Tested party, a manufacturer, had almost completely ceased its
operations for three months
• Suffered other re-starting costs to return to normal operations
• Its production volume remained lower than normal after
restarting as well
Background
• Identify for the tested party:
− Fixed costs incurred during the three-month closure
− One time re-starting costs
− Variation in volume/ capacity utilization
Analysis

14. Taxmann Covid TP Implications session 14