As the hospitality industry struggles, taxes are knocking on the door

One of the long-term effects of the pandemic - besides the business effects that vary between different activities in the hospitality industry - are the tax consequences that result from the dramatic changes due to COVID-19.

The hospitality industry in general, was performing at a great level until December 2019, while the pandemic was in gestation. Hotels, restaurants, adventure activities, airlines and all related services attached to that “normal” situation were in a booming stage; then suddenly every single activity related to hospitality reduced almost to nil.

Countries in full lockdown stopped hospitality and the freedom mobility value chain. Almost every flight was cancelled and a zero-tourism season - never seen before - became a reality. The nightmare started…

Despite all this well-known reality, governments have spent their scarce resources trying to address at least three priorities:

1. To solve the health effects of the pandemic,
2. To mitigate huge unemployment rates, another consequence of the lockdowns, and
3. To compromise on both current and extraordinary expenditure; whilst income derived from taxes is also plunging, stressing the conditions of deficit severely.

The OECD has stressed the fact that governments must focus on getting the economy back to work, while acknowledging that fiscal equilibrium might not be the goal for 2020 -2022. Yet all jurisdictions are seeking innovative ways to obtain fresh fiscal income that will start the road towards the fiscal recovery.

Knowing this, the hospitality industry must prioritise transfer pricing and its impact in their taxable bases, when dealing mainly with cross border transactions. These cross border business relationships with related parties will become subject to scrutiny.

Thresholds vary from jurisdiction to jurisdiction and relevant documentation as well, yet most of the countries imposed the burden of proof on the taxpayer to document that those transactions with related parties are in accordance with the arm´s length principle.

On December 18^th, 2020, the OECD issued a paper titled “Guidance on the Transfer Pricing Implications of the COVID-19 Pandemic.” This document stresses the severe impact of the pandemic and the consequences of it, using several business models to illustrate the impact on the normal circumstances of transfer pricing adjustments, to be considered by both the tax administrations and taxpayers as well.

“Accordingly, this guidance focuses on how the arm’s length principle and the OECD TPG apply to issues that may arise or be exacerbated in the context of the COVID-19 pandemic, rather than on developing specialised guidance beyond what is currently addressed in the OECD TPG. This guidance focuses on four priority issues: (i) comparability analysis; (ii) losses and the allocation of COVID-19 specific costs; (iii) government assistance programs; and (iv) advance pricing agreements (“APAs”); where it is recognised that the additional practical challenges posed by COVID-19 are most significant.”[1]

[1] OECD. Guidance on the transfer pricing implications of the COVID-19 pandemic. Dec 2020. Pg. 2.

Be aware that matters that are obvious today, might not be clear some years from now; when businesses in general may get back to their regular operations. You should have highly well documented the elements of current circumstances, mainly those issues about comparability analysis of your support documentation of related parties’ transactions, awaiting the audits by tax authorities.

Undoubtfully, economic activity for hospitality businesses would not be comparable to the pre-existing conditions prior to COVID-19. It is going to take many years to recover and get back on track, if ever, to those pre-2019 levels.

The OCDE’s recommendation is to create the appropriate documentation that shows the effects of the extraordinary expenses needed to be incurred as result of the pandemic, in an isolated manner. It would also be wise to create a separate profit and loss statement that illustrates the evidence of these effects. The need to isolate this is critical for the comparability analysis, mainly for the first quarter of 2020 and any periods of permanent or temporary reopening, so that the database analysis can be adjusted when doing the extraordinary adjustments that will be triggered by the COVID-19 effect.

It is also important to have clearly segregated information in the P&L, such as the received government support programs when applicable. Do not mix such income with regular income that will distort comparable numbers.

It is highly recommended to contact your team of transfer pricing experts to solve multiple issues regarding COVID – 19. Consider that there would be a high level of uncertainty surrounding tax inspections in the future. Our best advice is to fully document everything, to prepare for huge and potentially massive audits induced by the lack of fiscal resources.

At HLB we understand the hospitality industry and have vast experience in cross border transactions that could become a new nightmare soon. We will move from the pandemic to the endemical effects in taxation and in transfer pricing matters.