Question 1: My company has been severely affected by COVID-19. What information do I have to provide in the transfer pricing documentation to substantiate the arm’s length nature of my transfer pricing outcome?
Please include the following information in your transfer pricing documentation, where applicable:
- A broad analysis of how your industry has been affected by COVID-19 and the direct impact of COVID-19 on your company. This could include the following:
- Macroeconomic information like country specific GDP data or industry indicators from central banks, government agencies, industry or trade associations to the extent useful in understanding the context of the related party transaction
- Statistical methods such as regression analysis or variance analysis that are used to predict the extent to which a certain variable will vary with reference to other variables under certain specific conditions (e.g. the response of corporate profits in certain industries to GDP movements)
- Documentation of who and which entity within the group made decisions relating to management of risks relating to COVID-19. This information will help to indicate which entities are in control of the decisions and thus should bear the related risks
- The functional analysis of your company and the related parties before and after COVID-19 (i.e. any re-allocation of functions, assets and risks, as well as any recharacterisation)
- The contractual arrangements between the company and its related parties, and highlight whether any obligations or material terms and conditions have been varied, amended or terminated in light of COVID-19 and supporting evidence to show that independent parties in comparable circumstances would have revised or modified their existing contractual arrangements
- A comparison of the budgeted (pre-COVID-19) and actual results of the profit and loss analysis of the company, providing explanation and evidence to support the variances
- Reasons and supporting evidence to justify how your company’s profitability has been negatively impacted by COVID-19. This could include the following as applicable:
- An analysis of how sales volumes have changed during COVID-19, including whether the change is due to the use of other sales channels, and specifically compared to sales generated in pre-COVID-19 years
- An analysis of the change in the company’s capacity utilisation, taking into account its related party transactions and/or transactions with independent parties
- Specific information related to incremental or exceptional costs borne by parties to the related party transaction (either with related or unrelated parties) or by the group as a whole
- Details relating to COVID-19 specific government assistance that the company has received or government regulations imposed on the company which has an impact on its operations and the accounting treatment of the government assistance. The receipt of any COVID-19 specific government assistance should be included in the comparability analysis
- Details of government intervention measures (for example, the temporary cessation of business due to COVID-19 measures) that affect the pricing of transactions with related parties
Question 2: Can I apply term-testing for my company’s related party transaction (i.e. testing of the related party transaction over a multiple-year period) so that the impact of COVID-19 can be spread out over a longer period of years?
Under usual circumstances, you are required to consult IRAS before applying term testing1.
If you are of the view that annual testing may result in volatile results due to the impact of COVID-19, you may apply term-testing (generally over three years) for the Years of Assessment (“YAs”) 2021 and 2022.
This view would need to be substantiated with evidence, which would complement the information listed in Question 1 above. In your transfer pricing documentation, you should explain clearly how the term-testing was applied. You do not need to consult IRAS prior to the application. This is a short term measure to address the impact of COVID-19. IRAS will review this measure in due course.
When considering to perform term-testing, you should also take into account the corresponding impact of this approach on your related parties in other jurisdictions. If term testing is not allowed in the other jurisdictions, this may result in potential disputes.
The application of term testing is illustrated in the example2 below:
Company A is a distributor for the Group’s products. It buys the products from its parent company for onward distribution to third party customers in Singapore. As the data for year 2018 is the latest available set of comparable data at the point of preparing the contemporaneous TP documentation for financial year 2020, Company A uses the comparable data for 2016, 2017 and 2018 to establish the arm’s length range of the remuneration for its distribution function.
Based on the transfer pricing analyses and TP documentation, Company A is to be rewarded with an operating margin (i.e. operating profit over sales) between 3% and 5% for its distribution function.
Company A’s actual results for financial years 2018, 2019 and 2020 are as follows:
Financial year 2018
Financial year 2019
Financial year 2020
Financial year 2018 to 2020
Sales to third party customers
Less: Purchases from parent company
Less: Operating expenses
Actual operating profit
Actual operating margin (B/A)
As Company A’s actual operating margin for financial year 2018 to 2020 is lower than the nearest edge of the arm’s length range of 3%, Company A makes year-end adjustments as follows:
Arm's length result
Financial year 2018 to 2020
Sales to third party customers
Less: Purchases from parent company
Less: Operating expenses
Arm's length operating profit
Arm's length operating margin (Y/X)
Company A will make year-end adjustments to the actual results of financial year 2020 by reducing the purchases from parent company by S$600,000 (i.e. S$49,000,000 – S$48,400,000). There will be a corresponding reduction in the parent company’s accounts for the sales to Company A.
1 Section 5.115 of the IRAS Transfer Pricing Guidelines (TPG) (5th edition).
2 This example is adapted from page 99 of IRAS TPG (5th edition).
Question 3: My company received government assistance [e.g. Jobs Support Scheme (“JSS”)]. How should my company treat the benefits from the government assistance for transfer pricing purposes?
Benefits from government assistance potentially have transfer pricing implications, whether the assistance is provided to a member of a group directly or made available to independent parties within the market where a group operates.
Where the benefits from government assistance are economically relevant (in that the benefits are taken into account by independent parties when evaluating the terms of a comparable transaction under comparable circumstances), such benefits would have to be examined as part of transfer pricing analysis.
As a general rule, government interventions should be treated as conditions of the market in the particular country. The receipt of government assistance may be part of the economic circumstances of the parties and a feature of the market in which they operate. Thus, the potential effect of the receipt of government assistance on the pricing of a related party transaction will depend on the economically relevant characteristics of the transaction, following an accurate delineation of the related party transaction and the performance of a comparability analysis. It would be contrary to the arm’s length principle to assume that the mere receipt of government assistance would affect the price of the accurately delineated related party transaction, without performing a careful comparability analysis (including an analysis of how the receipt of government assistance would affect the price of independent party transactions, if at all) and considering the perspective of both parties to the transaction.
In addition, the provision of government assistance to a related party should not change the allocation of risk in a related party transaction for transfer pricing purposes. However, it may reduce the quantitative negative impact of a risk.
The application of the guidance above is illustrated using a situation where a limited risk distributor within a group receives JSS3 from the Singapore Government:
- The related party transaction is the sale of goods by the limited risk distributor to other related parties in the group.
- Whether or not JSS is economically relevant and has a direct impact on the related party transaction would depend on how independent parties would have treated it in comparable transactions.
- Comparable transactions between independent parties would have to be examined to determine if the effect of JSS was passed on to the customers in terms of a lower price. This would be dependent on economic circumstances, level of competition, elasticity of demand and the availability of similar government assistance to competitors within the relevant markets, etc.
- A comparison would need to be done on the accounting treatment for JSS adopted by the tested party (i.e. the limited risk distributor in this illustration) and the comparables selected for benchmarking purposes. Comparability adjustment may be required to eliminate any differences in the accounting treatments adopted.
IRAS is aware of the practical challenges that businesses may face in performing the analysis due to the lack of detailed and reliable information, as well as the delay in data availability in the public domain.
Generally, IRAS is of the view that an independent party acting in a commercially rational manner would retain the benefits from government assistance, unless it is specifically stated in the government assistance that the benefit has to be passed on or shared with another party. In this regard, your company is not expected to pass on the benefits from government assistance to your related parties through transfer pricing. An exception may apply if there is reliable evidence showing that third parties would have done so under comparable circumstances. An illustration is provided in the example below:
Singco, incorporated in Singapore, is a contract manufacturer of a food product for its overseas related company. In the financial year 2020, Singco incurs gross wages of S$10,000 and other operating expenses of $9,000. Singco receives JSS payouts of S$5,000 to subsidise its local employees’ wages.
An unrelated Singapore manufacturing company (in the food industry that manufactures a similar food product) has been identified as a potential comparable company. The company receives JSS payouts in the financial year 2020. It charges an average mark up of 25% for providing similar contract manufacturing services to several other independent companies.
In the absence of detailed information on whether the unrelated Singapore manufacturing company would have passed on the benefits of the JSS payouts to its customers, Singco can take the view that the unrelated manufacturing company would retain the benefits from government assistance.
The transfer price for SingCo’s related party transaction is computed as follows:
Add: Other operating expenses
Total cost base*
Arm's length mark-up (25% x S$19,000)
Transfer Price (S$19,000 + S$4,750)
*The cost base is not reduced by the JSS payouts for purposes of computing the transfer price. Singco retains the benefits from the JSS payouts unless there is reliable evidence showing that third parties would have behaved differently under comparable circumstances.
3 The JSS provides wage support to employers to help them retain their local employees (Singapore citizens and permanent residents) during this period of economic uncertainty.
Question 4: My company is a “limited-risk” distributor for the group’s products. The group suffered substantial losses in FY 2020 due to the impact of COVID-19. Is my company allowed to share the losses of the group in FY 2020?
The specific facts and circumstances will have to be considered to determine if your “limited-risk” company could incur losses at arm’s length.
The analysis on the allocation of risks among the entities in the group is particularly important. It affects how profits and losses resulting from the transactions are allocated.
For example, there is a significant decline in demand due to COVID-19 resulting in losses for the group. If the analysis on the allocation of risks following the guidance in the IRAS Transfer Pricing Guidelines reveals that your company assumes some market risk but not risk of inventory obsolescence, at arm’s length, your company may incur a loss associated with the playing out of the market risk. This is subject to reliable evidence showing that independent distributors undertaking a comparable transaction would have similarly incurred losses under comparable circumstances. However, your company should not bear a portion of the loss associated with the playing out of the inventory risk.
If the analysis shows that your company does not assume any market risk, inventory risk or another specific risk, your company should not bear a portion of the losses associated with the playing out of any of those risks.
Question 5: My company has been severely affected by COVID-19. Can I include loss-making comparables in my benchmarking study in the course of determining the arm’s length remuneration of my company’s related party transaction?
IRAS’ preferred approach is that you use multiple year data as opposed to single year data in your comparability analysis. This would help to enhance the reliability of the comparability analysis. At present, given that the impact of the pandemic can only be seen in the years 2020 and beyond, IRAS is of the view that excluding the following comparables would eliminate persistently loss-making independent parties i.e. entities which sustained losses over a period of time for reasons other than the COVID-19 pandemic4:
- Comparables with weighted average loss for the tested period; or
- Comparables which incurred loss for more than half of the tested period.
Hence, a comparable that satisfies the comparability criteria, suffers losses in the year(s) affected by the COVID-19 pandemic but does not suffer sustained losses over a period of time as mentioned above can be included in your benchmarking study.
As more financial data for the years affected by COVID-19 becomes available, IRAS will monitor and review the guidance above where appropriate.
4 Section 5 of the IRAS TPG
Advance Pricing Arrangement (“APA”) application
Question 1: Can I file a new APA application or request for renewal of an existing APA during this COVID-19 period?
You may file a new APA application or request for renewal of an existing APA if the company’s business operations and economic performance are not significantly impacted by COVID-19. Otherwise, the company should consider filing a new APA application or request for renewal of an existing APA only when there is greater level of certainty on the factors which may affect the determination of arm’s length transfer prices between related parties. In the event of doubt, please approach IRAS early for a discussion.
Question 2: What should I do if I have an APA application which is under review?
You should assess whether there are any transfer pricing implications arising from COVID-19 which may impact the APA application (e.g. changes in functional profile of the covered entities). If so, please provide the relevant details to IRAS as soon as possible. We can then review the case and discuss with you on next steps. Where there are significant uncertainties involved or anticipated, it may be difficult for us to progress the case review further. If so, we would engage you in a discussion on alternatives such as putting the case on hold or terminating the APA process.
In the case of an ongoing bilateral/multilateral APA, we will also need to discuss the case with the other Competent Authority(ies) and come to a mutually acceptable conclusion.
Question 3: What should I do if I have an existing APA agreement with IRAS?
The terms and conditions of an APA agreement would include critical assumptions that provide for no material changes throughout the covered period to the economic environment in which the covered entities operate, the functions performed, assets employed and risk assumed by each covered entity with respect to the covered transaction.
The company should review and assess whether there is any breach of the terms and conditions in the existing APA agreement as a result of COVID-19. If so, the company should notify IRAS as soon as possible, provide an analysis of the impact as a result of COVID-19, explain why the terms and conditions have been breached and suggest the next course of action. With the information, IRAS will evaluate what is the best possible outcome and discuss with you. These include continuing to apply the terms APA if the effect of the breach is not material, revising the terms of the APA, cancelling the APA (i.e. treating the APA as being effective and in force up to the cancellation date and not for the entire covered period) or revoking the APA (i.e. treating the APA as if it had never been entered into).
In the case of a bilateral/multilateral APA, we will also need to discuss the case with the other Competent Authority(ies) and come to a mutually acceptable conclusion.