The economic impacts of the new coronavirus ("COVID 19"), which emerged in Wuhan, China in December 2019 and spread to the world in a short period of time with the contribution of inter-dependency among countries, occur at an unprecedented level comparing to crises experienced before. For many industries, supply chain has been interrupted and customer demand has shrunk at the same time. Moreover, this bilateral pressure differs not only from industry to industry, but also from country to country, and even from region to region within the same country.
To say the least, transfer pricing principles aim to allocate the overall profit in proportion to the value created among the group members. However, as COVID 19 began to show its impacts, the main issue is evolved from how the profit is allocated among group companies to the problem of risk realization and how the loss should be allocated. Although factories are closed and distributors are unable to sell due to the diminishing demand and supply chain disruption, they keep bearing the idle capacity and operating costs which are unavoidable. As it is known, the revenue that the companies in the group should obtain is determined by considering the functions performed, the risks undertaken and the assets owned. However, in the case at hand, there is usually no revenue to be attributed to any addressee. As a matter of course, restructuring and changes in transfer pricing policies will be inevitable for the continuity of businesses and activities since COVID 19 crisis caused an unforeseen global risk realization which could not be predicted at the time when the intra-group contractual relationships were established and the group operation model was designed.
The purpose of this article is to address the impacts and problems that the COVID 19 crisis may trigger in terms of transfer pricing, to present the OECD and EU approach, and to brainstorm on what can be done by multinational enterprises and tax authorities.
I. RISK REALIZATION AND ITS IMPACT ON THE FINANCIALS OF THE GROUP COMPANIES
In the simplest form, the structure of multinational enterprises is comprised of a parent company that holds all intellectual property rights, contract manufacturers or full-fledged manufacturers which carry out the production function in the countries with low labour costs, and the limited or full-fledged distributors that sells the finished goods in various markets and conducts market researches in their countries of operation (depending on the circumstances).
Before deciding on how much share the companies in the business model should receive from profit or loss, the matter of who controls the risks should be reviewed. OECD Guidelines defines the control on the risk as,
If the business model of the multinational enterprises comprise of low risk level distributors or contract manufacturers which do not have impact on decision-making mechanism, the relevant businesses are expected to have a routine return determined by either cost plus or transactional net margin method. Due to their low level of risk, it cannot be expected that those companies get a share from neither high profitability nor unpredictable losses of the group. The expressed idea can be substantiated by an example given under the OECD Guidelines;
Case: “Company B manufactures products for Company A. Capacity utilisation risk and supply chain risk have been identified as economically significant in this transaction. The functional analysis provides evidence that Company B built and equipped its plant to Company A’s specifications, that products are manufactured to technical requirements and designs provided by Company A, that volume levels are determined by Company A, and that Company A runs the supply chain, including the procurement of components and raw materials. Company A also performs regular quality checks of the manufacturing process. Company B builds the plant, employs and trains competent manufacturing personnel, and determines production scheduling based on volume levels determined by Company A. Although Company B has incurred fixed costs, it has no ability to manage the risk associated with the recovery of those costs through determining the production units over which the fixed costs are spread, since Company A determines volumes. Company A also determines significant costs relating to components and raw materials and the security of supply. The evaluation of the evidence concludes that Company B performs manufacturing services. Significant risks associated with generating a return from the manufacturing activities are controlled by Company A. Company B controls the risk that it fails to competently deliver services. Each company has the financial capacity to assume its respective risks.” 
Conclusion: “In the circumstances explained above, the significant risks associated with generating a return from the manufacturing activities are controlled by Company A, and the upside and downside consequences of those risks should therefore be allocated to Company A. Company B controls the risk that it fails to competently deliver services, and its remuneration should take into account that risk, as well as its funding costs for the acquisition of the manufacturing plant. Since the risks in relation to the capacity utilisation of the asset are controlled by Company A, Company A should be allocated the risk of under-utilisation. This means that the financial consequences related to the materialisation of that risk including failure to cover fixed costs, write-downs, or closure costs should be allocated to Company A.”
As mentioned in the example, in a business model where high risks are mainly undertaken by the parent company and affiliates are subject to routine returns, the losses incurred by the affiliates due to COVID 19 can be criticized by the tax administration of their country of residence. It is possible to observe the most typical example of this point in the position of People’s Republic of China in 2008 financial crisis. Tax Administration of China published a guide stating that it would not allow single-function and low-risk organizations to make loss.
Although subsidiaries that undertake low risk will not suffer a major loss, problem arises on whether these subsidiaries must apply their usual profit margins in case of a force majeure event that affects both supply and demand such as COVID 19. For example, in case the factory of a contracted manufacturer whose routine returns are determined to obtain a net cost plus profit margin of 6% is closed due to the lockdown, the shipment of the necessary raw material for the production cannot be made and therefore the service can be partially performed or not performed at all, shall 6% margin still be added to the costs incurred and invoiced to the parent company? The obvious answer in this regard is that multinational enterprises should act in the same way as independent enterprises would act in a similar situation. Although it is not directly predictable or attainable how independent firms would react in case of force majeure, transfer pricing policies of the firms undertaking limited risk can be revised in the period when the effects of the COVID 19 crisis are in force. In this context, it will be appropriate to draw attention to the following issues;
However, postponing this process and completing the process through issuing additional adjustment invoices may create additional costs in terms of customs duties. As a matter of fact, in the Hamamatsu decision made by the European Court of Justice, it is stated that the changes to be made in the transfer price will not lead to a decrease in the customs value in a way to require a refund.
Making loss in low-risk affiliates may not be preferred in terms of tax risk as well as financial reasons because the related affiliates operating with limited net working capital may ultimately fall into technical bankruptcy position and may have to use intercompany loans if they cannot invoice their fixed costs such as employee salaries and rent payments. Considering the tax burdens on intercompany loans such as resource utilization support fund, reverse charge value added tax, withholding tax on interest payments, and stamp duty, it is more efficient to transfer the necessary cash to the subsidiary with a limited operating margin (in some cases without adding any margin) which is also in compliance with the arm’s length principle.
While this is the case for low-risk affiliates, full-fledged distributors and manufacturers are expected to assume a significant share in the loss, as they have control over the risk. The OECD Guidelines clearly states that, associated enterprises can sustain genuine losses similar to independent enterprises due to heavy start-up costs, unfavorable economic conditions, inefficiencies, or other legitimate business reasons. When markets operate in normal course, the usual practice is to exclude the loss maker companies from the comparability set. However, in the comparable company sets to be established for the periods in which COVID 19’s effects continue, loss maker companies should also be included in order to prove that the loss of full-fledged distributors and manufacturers are in accordance with the arm’s length principle. In the upcoming periods, what is tested will not be the profitability levels, but the level of loss.
II. THE REALIZATION OF THE RISK AND FINANCIAL NEEDS
As noted above, full-fledged distributors and manufacturers are expected to make considerable amount of loss due to the pandemic. Therefore, capital increases, loss compensation funds and loan utilization will be on agenda of multinational companies in the upcoming periods.
Loss compensation fund is a cost element for the parent company making the payment, and an increase in equity for the acquiring company. As it is known, it is stated in various rulings issued by the Turkish Revenue Administration that the loss compensation fund should be added to the taxable corporate income. Whether the loss compensation funds should be subject to tax is not within the scope of this article because it is a highly controversial issue that has recently been taken to another dimension thanks to the Communiqué on the Procedures and Principles Regarding the Implementation of Article 376 of the Turkish Commercial Code dated 15.09.2018. However, the important point to be mentioned here is that the relevant payments can be taken into account as an expense in the country where the payee is a resident, to the extent that the legislative regulations permit and the conditions described below are met. A possible hybrid mismatch can result in favour of the group.
Due to the effects of COVID 19, multinational enterprises might merge companies, transform their full-fledged entities into the ones with limited risks or shut down businesses entirely through restructurings. During this restructuring process, by taking into account the cost-benefit analysis in the middle or long term, the former opinion on the loss compensation fund to be transferred by the investors to the full-fledged distributors and manufacturers might be revised by Turkish Tax Administration in a way parallel with the regulations made under Turkish Commercial Code in order to prevent shut downs or downsizing functions.
Considering the extra costs of intra-group loans, another way to finance full-fledged distributors and manufacturers for the parent company is to be a guarantor for the third-party bank loans. Customarily, the guarantor company collects an arm’s length remuneration in return for the risks undertaken and benefit provided to the related party. In order to guide the implementation in this matter, we believe it is necessary to refer to the interesting and unexpected Hornbach decision of the European Court of Justice. In the referred case, the German resident parent company named Hornbach DE, in order to enable its Dutch subsidiary (with negative equity) to use bank loans, had acted as guarantor without charging any remuneration for this explicit benefit. German Tax Administration criticized this practice, and increased the taxable earnings of Hornbach DE at the amount of arm’s length guarantee service fee. Hornbach DE took the matter to the European Court of Justice. Accordingly the Court has held that “In a situation where the expansion of the business operations of a subsidiary requires additional capital due to the fact that it lacks sufficient equity capital, there may be commercial reasons for a parent company to agree to provide resource on non-arm’s-length terms” and then concluded that there is no need for remuneration if there is a commercial and economic justification for the non-arm’s length behaviour. It is inevitable that the COVID 19 crisis will create similar and even more solid economic grounds. Although the Hornbach decision can be binding only for members of European Union, the flexibility to interpret Turkish Tax Laws which are based on substance over form principle and the compatibility with economic, commercial and technical requirements, in the same manner should be allowed in times of crisis.
III. TRANSFER PRICING ADJUSTMENTS
In a related party transaction, setting the price at the time of the transaction and testing the arm’s length nature of the prices at the date of reporting are different concepts. Whereas, in order to set the prices at the moment of transaction the market prices or (in the situations where transactional profit methods are used) the latest publicly available financial data of the comparable companies are considered, testing the price at the time of reporting is usually made by taking into account the financial data of the relevant year and two years preceding that year. However, as a result of the interruption in supply chain and shrinking demand caused by the COVID 19 crisis, regular market conditions do not occur, and it becomes impossible to find internal or external comparable prices and to apply the comparable uncontrolled price method. The latest published data of the comparable companies are at best the data of the previous financial periods which is not a viable way to assess transactions taking place in these strange times.
In extraordinary situations such as COVID 19 crisis, it is an undeniable fact that the prices should not be determined according to the data of the previous financial year. Therefore, it is almost certain that the prices to be determined at the time of the transaction will be subject to adjustments later. For this reason, multinational enterprises may need to issue price difference invoices in order to ensure that the COVID 19 impact is reflected to the financials of external comparable companies that meet the comparability criteria. In practice, adjustment amount can only be calculated when the financial data of the comparable companies is published in publicly available databases, in other words, in the middle of 2021.
Different discussions will come to the agenda regarding clarification of price difference amounts. The accrual basis is used in calculating the commercial income, and in order for an expense to be deducted from commercial earnings, it must become definite in terms of nature and amount. The availability of public data towards mid-2021 would create controversies regarding when the amount is actually accrued and becomes definite. If it is claimed that this expanse is related to 2020 as required by the periodicity concept, the precautionary actions facilitating the refund processes of taxpayers who reduce their tax bases should be taken or an opinion should be given by the Revenue Administration ruling that this expense has become definite in 2021 and a deduction can be made in the calculation of the tax base of 2021. On the other hand, the opinion mentioning that the finalization took place in 2021 would be appropriate in order not to add the burden of default interest to the economic burden already faced by taxpayers who increase their tax bases of 2020 as a result of the adjustment amount calculated due to the abovementioned emergency situation. In fact, the mentioned adjustments may lead the 10% limit in advance tax application to be unintentionally exceeded due to factual impossibility. Within this framework, it is recommended to take precautions in advance to reduce the compliance costs on taxpayers.
Transfer pricing adjustments would also lead to some disputes in terms of customs. While the above mentioned Hamamatsu decision has ruled that there is no need for a customs correction in case of downward transfer pricing adjustments, it is known that EU customs legislation allows upward price corrections. Uniformity should be ensured in terms of corrections occurring after the importation date and that are directly related with imported goods and return mechanisms for downward price adjustments related to imported goods should be developed.
IV. THE EFFECT OF FORCE MAJEURE CONCEPT ON INTERCOMPANY AGREEMENTS
Companies that fail to fulfil their contractual obligations due to the unexpected results of the COVID 19 crisis may request the application of force majeure clauses or the alteration of contract terms. The concept of force majeure refers to unexpected events which develop beyond the will of the parties and cannot be prevented by them such as war, terrorist act, earthquake and epidemic illness and thus restrains borrower from fulfilling its obligations. In cases of force majeure, obligations can be suspended, postponed or entirely eliminated.
Reviewing intercompany agreements due to force majeure will have implications for transfer pricing. In the OECD Guidelines, it is stated that companies in declining economies may need commercial restructurings. As a matter of fact, it is stated in paragraph 6.184 of the OECD Guidelines that the occurrence of major events or developments unforeseen by the parties at the time of the transaction or the occurrence of foreseen events or developments considered to have a low probability of occurrence which change the fundamental assumptions upon which the pricing was determined may lead to renegotiation of the pricing arrangements by agreement of the parties where it is to their mutual benefit;
“6.184 For example, a renegotiation might occur at arm’s length if a royalty rate based on sales for a patented drug turned out to be vastly excessive due to an unexpected development of an alternative low-cost treatment. The excessive royalty might remove the incentive of the licensee to manufacture or sell the drug at all, in which case the licensee will have an interest in renegotiating the agreement. It may be the case that the licensor has an interest in keeping the drug on the market and in retaining the same licensee to manufacture or sell the drug because of the skills and expertise of the licensee or the existence of a long-standing co-operative relationship between them. Under these circumstances, the parties might prospectively renegotiate to their mutual benefit all or part of the agreement and set a lower royalty rate. In any event, whether renegotiation would take place, would depend upon all the facts and circumstances of each case.”
For example, it may be advisable to review in-group licensing contracts as a remedy to financial difficulties likely to be experienced by full-fledged distributors and manufacturers, mentioned earlier in the article. The related enterprises pay a certain percentage of their sales to the group company, which owns intellectual property rights as a result of the use of brand and technical information. These payments are called royalty fees. Due to the unexpected situation created by COVID 19, the force majeure articles of the trademark and know-how usage contracts should be reviewed and whether royalty payments would be suspended in such cases should be re-considered.
In addition, OECD clearly states that there should be no presumption that all contract terminations or substantial renegotiations should give a right to indemnification at arm’s length, as this will depend on the facts and circumstances of each case. The analysis of whether an indemnification would be warranted at arm’s length should be made on the basis of the accurate delineation of the arrangements before and after the restructuring and the options realistically available to the parties.
However, terminations that cannot be explained with the conduct of independent businesses, commercial practices and valid economic reasons will require compensation for the damaged party. According to OECD, restructuring might be a better option for an entity than going out of business altogether except the situations in which total shutdown is required.  Accordingly, the COVID 19 period creates a favourable ground for evaluating intra-group restructurings.
A number of problems such as interruptions in the supply chain, the diminishing demand and the termination of the activities caused by COVID 19 health crisis would lead multinational enterprises to review, change and partially or completely terminate some of their transfer pricing policies and business models. The OECD is expected to publish a guidelines, as it did in the impact of the COVID 19 crisis on tax treaties, on how loss caused by global risk realization should be shared among the companies within a group, the effects of possible restructurings and impact of financing instruments on the arm’s length nature of the intercompany transactions. Ministry of Treasury and Finance should take steps in order to prevent Turkish economy from possible damages resulting from potential restructurings and should introduce regulations and guidelines for this purpose when necessary.
Although the existence of conditions that require the need for policy changes is often considered as negative, it can also be turned into an opportunity by the multinational enterprises.
In the stable periods of the economy, structural changes that are put on the table attract more attention and are scrutinized in detail by the tax authorities. However, rare periods where fluctuations and predictability are minimal such as COVID 19 period, are suitable for producing a solid rationale for paradigm shifts. In addition, it would be reasonable now to sell out tangible and intangible assets which have been planned to be transferred between related companies as market values would be lower, if exists, than it is in the stable periods.
 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, Paragraph 1.65. 2017.
 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, Paragraph 1.84. 2017.
 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, Paragraph 1.102. 2017.
 Bloomberg Tax. “OECD Transfer Pricing Guidelines—A Practical Guide for Applying the Arm’s-Length Principle During an Economic Crisis” (https://news.bloombergtax.com/transfer-pricing/insight-oecd-transfer-pricing-guidelines-a-practical-guide-for-applying-the-arms-length-principle-during-an-economic-crisis) Date Accessed: 25.04.2020
 European Court of Justice. “Case C-529/16”, Date Accessed: 26.04.2020 https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:62016CJ0529&from=EN
 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, Paragraph 1.129. 2017.
 European Court of Justice. “Case C‑382/16”, Date Accessed: 26.04.2020
 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, Paragraph 6.184. 2017.
 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, Paragraph 9.78. 2017.
 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, Paragraph 9.71. 2017.