By Stuart Simons,
Special to The Nation
Many countries are under lockdown and have issued travel advisories or border restrictions to control the spread of the virus.
This has also been the case in Thailand, where the government has issued advisories and restrictions in response to how the situation unfolded over the past few months.
Such measures have set off a global economic crisis of unprecedented magnitude, with many businesses facing major disruptions.
Particularly multinational companies (MNCs) with a global supply chain have been affected by many of the policies being put in place and will now have to review their existing supply chain with a view to restructuring or relocating to cope with the impact.
Transfer pricing considerations
Transfer pricing (TP) laws require an arm’s length pricing of goods, services, intangibles and financial transactions between related entities.
Tax authorities use TP laws to prevent MNCs from artificially reducing their tax bill by transferring profits from high to low tax jurisdictions using the transfer prices of transactions with related parties.
In Thailand, specific TP laws have been effective from 2019.
MNCs have typically organised their supply chains by looking at certain qualities of a country and associated benefits it will bring to the whole business. For instance, a Singapore-headquartered MNC may centralise its manufacturing facilities in Thailand due to lower cost of production and establish its back-end support functions in the Philippines due to language proficiency.
Correspondingly, each of the related entities should be remunerated on their respective contributions based on the functions they perform, assets they employ and risks they assume relative to the overall supply chain.
TP laws make it important for MNCs to consider TP seriously when they review and re-evaluate their global supply chains. A disrupted global supply chain caused by this pandemic could pose several unprecedented challenges with regard to the MNCs’ TP positions.
Operating losses and low margins
This pandemic has resulted in increased business costs, either from loss of revenue or from additional spending to deploy business continuity measures.
Thai subsidiaries of MNCs characterised as “routine” entities due to the limited functions they perform, such as contract manufacturers, may have losses or significantly reduced profits as a result.
However, this does not necessarily mean that these entities should bear the expenses or losses due to their limited function, even when they are incurring them.
The entities within the MNC’s supply chain that have to bear the losses should be carefully identified, analysed, and documented, as this could be an area challenged by tax authorities to limit the impact of lost tax revenues in their respective jurisdictions.
Tax authorities generally expect local subsidiaries of MNCs performing routine functions to be remunerated with stable returns in line with their characterisation, while the head office takes residual profits or losses in line with their entrepreneurial functions and economic risks.
For example, if supply and inventory risks are managed centrally by an MNC’s Singapore headquarters, it may not be appropriate for the downside costs from the disruption to be assumed locally by a Thai routine distributor.
As routine entities are typically remunerated with a stable level of profit, TP adjustments might need to be considered to bring them to their targeted returns. However, there is a question of whether the losses from decreased market demand should rest with the head office or be shared, to some degree, with the local routine entities in the supply chain.
Contemporaneous TP documentation
TP documentation is required under Thailand’s TP laws to show that a Thai company’s transactions with its related cross-border or domestic parties are priced on an “arm’s length” basis.
It will be necessary to examine the Thai company’s previous year’s TP documentation to assess the functional and risk profiles of related entities, and verify whether the documentation has to be updated in the context of any business changes in response to the pandemic.
One key step typically performed to determine the arm’s length price is the preparation of a benchmarking study to find comparable companies that have the same or similar functions to the Thai company.
Based on this study, an arm’s length range of profitability is determined, which is then compared with the Thai company’s profitability. When performing this study for 2020, comparable companies that had been used to previously benchmark inter-company transactions may need to be revisited as they may no longer be appropriate, particularly as they were under different economic circumstances.
Proactive mitigation strategies
TP has been at the forefront of many countries’ tax authorities’ agenda since the inception of the project led by the Organisation for Economic Co-operation and Development to tackle Base Erosion and Profit Shifting activities of MNCs. Thailand’s new TP laws largely adopt the outcomes from this project.
As no one can predict when this pandemic will end, MNCs also need to analyse longer-term effects to their operations. They need to consider the potential impact early on, review their supply chains and the corresponding TP positions, and consider steps to mitigate compliance and audit risks. If these effects are not managed and addressed appropriately, the Covid-19 pandemic could potentially leave MNCs with heavy tax burdens to bear.