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18 September 2020
Singapore IRAS issues guidance for Transfer Pricing on account of COVID-19

The Inland Revenue Authority of Singapore (IRAS) announced a series of support measures to help businesses and individuals. Read ahead for an evaluation of the guidance provided by IRAS to taxpayers for their Transfer Pricing documentation and Advance Pricing Agreements (APA) related concerns.
 
IRAS Guidance for Tax Payers concerning Transfer Pricing1

Transfer Pricing Documentation
 
In Singapore, transactions between related parties are governed by section 34D of the Income Tax Act, and for Assessment Year 2019 onwards, applicable taxpayers are also required to prepare Transfer Pricing Documentation under section 34F of the Income Tax Act. In light of the potential COVID-19 impact, companies are advised to provide additional qualitative information in their transfer pricing documentation to substantiate the arm’s length nature of their transfer pricing outcome. The list of additional qualitative details includes:
  • Effect of COVID-19 on the industry and the impact on the taxpayer;
  • Decision-making authority for the management of risks related to COVID-19;
  • Comparative functional analysis of before and after COVID-19;
  • Highlight whether related-party arrangements have been modified in light of COVID-19;
  • Comparison of budgeted results versus actual results and an explanation of any key variances due to COVID-19 (with supporting evidence);
  • Justification of the negative impact of COVID-19 on the profitability with explanations and evidence;
  • Specify if there has been any COVID-19 specific government assistance received or any impact of government regulations imposed on the operations.

Term Testing
 
Taxpayers were required to consult the IRAS before applying term testing (combining multiple-year financial results as against annual results). In light of the potential impact of COVID-19, taxpayers are advised that they need not consult the IRAS for application of term testing, if the annual testing may result in volatile results due to the impact of COVID-19. This has been suggested with the following key points-
  • The rationale for the usage of term testing is to be substantiated with evidence that would complement the other documentation (as per points mentioned under Transfer Pricing Documentationā€‹); 
  • Explain clearly how the term-testing was applied;
  • Highlight that this is a once-off event for the Year of Assessment 2021;
  • Consider the corresponding impact of this approach on related parties in other jurisdictions. ā€‹
 
Advance Pricing Agreement (APA)
 
New APA Applications: Even during COVID-19, the taxpayer may file for a new APA application. 

APA Applications in Progress: The taxpayer should assess whether there are any transfer pricing implications arising from COVID-19, which may impact the APA application (such as - changes in the functional profile of the covered entities). If so, the taxpayer is encouraged to provide the relevant details to IRAS as soon as possible. 

Existing APA agreement with IRAS in light of COVID-19: The taxpayer should review and assess whether there is any breach of the terms and conditions in the existing APA agreement. In the event there is such a breach in the critical assumptions, they should notify IRAS as soon as possible:-
  • providing an analysis of the impact as a result of COVID-19;
  • explain why the terms and conditions have been breached; 
  • suggest the next course of action. 
Renewal of Existing APA: Where there is an existing APA that covers the COVID-19 period, the taxpayer should evaluate if the business operations and economic performance are not significantly impacted by COVID-19. In case of any significant impact, the taxpayer may choose to consider filing a new APA application rather than a renewal. In the event of doubt, it is suggested to approach the IRAS for an early discussion.
 
Key Takeaways
The ongoing pandemic is unlike any typical supply chain disruption that we may have seen since it has taken a global proportion and compelled companies to respond immediately to address the near-term sustainability of their existing businesses.
 
MNEs need to chart out their path for aligning transfer pricing considerations arising from this exceptional situation. An integrated approach that covers group-level as well as country-specific assessment, will effectively facilitate this process. The transfer pricing impact of such assessment and re-alignment in the transfer pricing structure should be documented, which is reinforced with the IRAS guidance.


Importance of Appropriate Industry Analysis
 
In Singapore, the early outbreak of the COVID-19 virus, followed by a surge in cases among the migrant worker population had prompted companies to suspend non-essential services and close several offices to stem the spread of infections. As per the Ministry of Trade and Industry (Singapore)2, the COVID-19 pandemic has caused a disruption in the Singapore economy due to interrupted economic activity on account of change in demand as well as supply. A brief overview of the impact on key industries reveals that: 
  • Severely affected: Safe distancing and border controls have resulted in a significant reduction in tourist arrivals, while the domestic outbreak has caused a decline in domestic consumption for the following key industries - Accommodation, Air Transport, Arts, Entertainment and Recreation (AER);
  • Significantly affected: In addition to the above, other key industries that have also experienced a fall in demand on account of reduced footfall - Food Service, Retail Trade, Land Transport;
  • Moderately affected (Outward oriented): A fall in external demand and supply chain disruptions have affected various industries – Manufacturing, Wholesale Trade, Other Transportation and Storage, Information and Communications, Professional Services, Finance, and Insurance;
  • Moderately affected (Domestically oriented): Negative spillovers from a slowdown in domestic activity have also been impacted – Construction, Real Estate, Other Business Services, Other Services ex AER.
Even as most sectors are expected to be adversely affected by the COVID-19 outbreak, some new opportunities have emerged due to the growing demand for online sales and services. Accordingly, in the context of transfer pricing documentation, taxpayers should detail out a critical evaluation of the impact of COVID-19 on the industry in which they operate. Such documentation should be supplemented with the relevant impact that such factors may have had in their operations during the affected period. 

 
Importance of Appropriate Contractual, Functional, and Risk Analysis 
 
The taxpayers are required to conduct analysis on functions performed, assets used, and risks assumed (FAR) concerning the related party transaction. The IRAS has recommended a comparison of the FAR before COVID-19 and the FAR considering the impact of COVID-19. This is aimed at assessing if there is a presence of any re-allocation of key functions, assets, or risks that could affect the transfer pricing outcome or result in a re-characterization. 
 
As the level of return derived by a taxpayer needs to be correlated to the FAR, this comparison is particularly important to either showcase -
  1. Impact of COVID-19 on the transfer pricing policy; 
  2. Justification of any change in transfer pricing policy on account of the impact of COVID-19. 
Further, in a transfer pricing analysis, the functional control of risks is an important element that helps assess the returns associated with such risks. The entity in a group that controls the risks is also expected to be the party that should be remunerated for controlling such risks. Accordingly, identification, analysis, and documentation of various key operational and financial risks involved in a related party transaction, along with ascertaining the related party actually making the decisions to take on, lay off, and mitigate each of such risks, are essential. In these novel times, specific details of the entity that is responsible for making relevant group decisions in relation to risks associated with COVID-19 that affect the Singapore Taxpayer is recommended. This would assist to re-affirm the transfer pricing outcomes. 
 
In light of potential re-allocations, the corresponding effect in the contractual terms/agreements are also essential. That could include:-
  • Changes in pricing terms;
  • Changes in payment terms;
  • Changes in responsibilities/nature and extent of services/quality and quantity of goods;
  • Change in termination or force majeure.
In the event there is any change in the contractual arrangement, it would also be recommended to provide the relevant economic explanation for the basis of such change that is in line with the transfer pricing and functional analysis.

 
Impact on Financial Analysis and Benchmarking
ā€‹
In light of COVID-19, the IRAS has recognized the importance of economic/financial adjustments and provided guidance to collate data points that can facilitate better comparability analysis-
  • Variances in financial results of the taxpayer on account of the impact of COVID-19 (from a budgeted to actual comparison supplemented with evidence) that can help explain the business scenario;
  • Justification of the negative impact of COVID-19 on the profitability; 
  • Government assistance received or any government regulation imposed that may impact the operations of the taxpayer;
  • Term Testing: The IRAS has provided specific guidance to use term testing in exceptional circumstances for comparison over a multiple-year period due to the volatile results of annual testing. Formerly taxpayers were to consult IRAS before the adoption of term testing. However, to facilitate better comparability, even term testing could be adopted with appropriate disclosure as prescribed. However, the usage of term testing would be dependant on the acceptability of the corresponding effect in the jurisdiction of the related party. 

1. https://www.iras.gov.sg/irashome/COVID-19-Support-Measures-and-Tax-Guidance/Tax-Guidance/Transfer-Pricing/
2. Ministry of Trade and Industry (Singapore) | Click Here | Impact of the COVID-19 Pandemic on the Singapore Economy
Our Comments

The Singapore IRAS has provided relevant guidance regarding transfer pricing documentation in the COVID-19 scenario. We can expect other jurisdictions to follow suit in due course. It is in the interest of MNEs to be proactive and start collating relevant quantitative as well as qualitative points that can assist in justifying any changes in transfer prices/re-alignment in FAR, etc. in their transfer pricing documentation.
 
While this guidance may not be a blanket application for all cases, this documented analysis will certainly help to justify the view that any adverse results are on account of commercial/business reasons rather than transfer pricing. We would be glad to discuss any queries you may have specific to your facts and situation pertaining to Singapore and other jurisdictions.

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