Impact of the crisis on transfer prices

Postponement of the annual filing of the transfer pricing policy

Companies exceeding given turnover thresholds, or belonging to the same multinational enterprise (“MNE”), must electronically apply a special file that consists of a simplified and recapitulative version of the standard transfer pricing (“TP”) documentation (Master file (“MF”) and Local file (“LF”)).

In principle, this tax return filing must be sent to the French tax authorities within 6 months after the filing of the corporate income tax (“CIT”) return.

However, to take into account the postponement of the deadline for filing the tax return for companies facing difficulties due to the health crisis, the French tax authorities have specified that this filing may exceptionally be filed at the latest 31 December 2020 (for the financial year ending 31 December 2019).

COVID-19: amendments to 2020 Master and Local Files

The economic impact of the health crisis involves fairly significant changes in the implementation of the transfer pricing policies of MNEs. The documentation must be adapted accordingly to justify these changes in the event of a tax audit.

Consolidated profits could decrease in 2020 and in the coming years for some industries, and such a decrease could also be observed in the independent companies’ results that are used as a comparable to test the arm’s length nature of intra-group transactions.

So as to determine the remuneration to be allocated to intra-group entities, and in application of the transactional net margin method, groups carry out research of independent comparable companies (benchmark studies) in order to determine the arm’s length margin ranges. However, this research is necessarily based on the use of historical financial data since there is a time lag between the time the accounts are approved and the availability of this information. As a matter of fact, the tested party will measure the controlled transactions made in the financial years (“FYs”) affected by COVID-19, comparing with results of selected comparables, but scored in the pre-COVID-19 periods. Such objective discrepancy gives rise to the question as to whether or not the traditional comparability practices are still applicable for 2020.

It is a matter of fact that MNEs will need treasury to re-load their activities. In the framework of Base Erosion and Profit Shifting (“BEPS”) Action 4, France introduced limits to the deductions of interest. Interest accrued by a French corporation in relation with borrowings from its direct shareholders may be deducted only if the interest rate does not exceed the average interest rate on loans with an initial duration of more than two years granted by banks to French companies or a higher rate if it can be demonstrated that this rate would be at arm’s length. The figure as at 20 May 2020 is 1.31%.

Effective 1 January 2019, in line with the implementation of the ATAD 1 rules, interest deduction is further limited.

With effect from 1 January 2019, interest deduction is generally limited to EUR 3 million or 30% of adjusted taxable profits. Where a company is thin-capitalised (i.e. the company has a debt-to-equity ratio exceeding 1.5/1), these limits are reduced to EUR 1 million or 10% of adjusted taxable profits (article 212 bis of the CGI).

Also, interest deduction limitation rules have been deemed to be unsustainable in macro crisis periods. COVID-19 is going to hit MNE also below the earnings before interest and tax (“EBIT”) line, indeed:

• Enterprises scoring operating losses or small operating profits can bear lower interest expenses. Such limitation is in contradiction with the companies’ need for additional liquidity to reload their operations.
• Increasing debts and equities eroded by losses will affect the debt equity ratios generating additional not-deductible interest in those countries with D/E deduction rules.
• Downsizing of turnover, margin and profits as well as an increase of D/E ratios could determine a worsening of the credit rating, and an additional interest burden as well as the application of the default conditions in main financing agreements.

Action must be taken now!