How COVID-19 has transformed the hospitality, life sciences and consumer products sectors
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How COVID-19 has transformed the hospitality, life sciences and consumer products sectors

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Deloitte’s Jacqueline Doonan, Aydin Hayri, Oscar Burakoff and Clarke Norton explore the impact that the economic disruption has had on transfer pricing (TP) controversy in the hospitality, life sciences and consumer products industries.

Transfer pricing experts from Deloitte provide separate assessments of the impact of the COVID-19 crisis, and the potential follow-on consequences for TP controversy, in three key industry sectors: hospitality, life sciences and consumer products.

Each of these sectors has experienced unique repercussions from COVID-19 and in some cases, companies in the same sector have seen highly divergent effects on their specific business operations. Based on their analyses of individual sectors, the authors express the consensus that COVID-19 has the potential to generate serious, transformational change to TP compliance and controversy practices in these sectors.

Impact of COVID-19 on the hospitality industry

The hospitality industry has been hit hard by COVID-19. Many hotels closed and locked their doors for the first time in decades. Room, food and beverage, banquet, wedding, and retail shop revenues plummeted. Hotel companies began the difficult task of identifying how to function in the new normal created by the pandemic.

The hospitality industry thrives on customer loyalty and trust, employee commitment, and property excellence. COVID-19 has set significant challenges relating to all of these: how to engender customer and employee trust around the safety of properties (especially those with high volumes of daily traffic), how to keep employees motivated amid economic chaos, and how to maintain property operating standards while maintaining social distancing mandates.

As hospitality executives focused on these gating survival issues, the tax TP challenges faced by these companies took a back seat temporarily. However as the industry moves steadily, albeit slowly, towards recovery, pre-COVID-19 tax challenges – such as the ongoing BEPS issues around control, risk, and substance; the evolving unified and 'tax-back' approaches to taxation; and the ongoing issues around global compliance, reporting, accounting, and recording – and newly emerging challenges stemming from TP changes driven by COVID-19, have put tax planning and controversy readiness back on the priority list.

Hospitality companies are complex businesses with a plethora of inter-company charges between a large group of globally distributed entities. While each company has its own operating model and TP constructs, there are some TP commonalities across the industry. For example, many hospitality multinational corporations (MNCs) have centralised cost allocations. Centralisation, especially of operating costs, brand costs, systems costs, and other similar costs are critical in driving economies of scale, maintaining global brand consistency, and ensuring consistency in customer experience from property to property. Accordingly, costs are often centrally incurred, centrally managed, and allocated to benefiting affiliates based on carefully identified cost driving metrics.

Similarly, globally designed, developed, and owned intangibles (e.g. brand names, loyalty programmes, reservation systems, and training programmes) are commonplace in the industry. The intangibles are often developed under a cost-sharing arrangement or similar arrangement, where regional principals collaborate and contribute market knowledge and resources to develop globally relevant intangibles. Like the centralised support costs described above, intangible development costs are often allocated among regional entrepreneurs based on the benefits reasonably anticipated to be derived by each collaboration partner.

Revenue allocations are also commonplace in the industry. Third-party or related-party hotels are often invoiced for a host of valuable support elements such as management services, brand access rights, loyalty programme operating costs, systems access rights, technical and construction services, financial and accounting support services, design and décor consultation services, and so on. While these charges are often separately negotiated and separately invoiced based on the specific needs of each property, they have collateral aspects that must be considered with the negotiation of multiple contracts with a single property or group.

Prior to COVID-19, these transactions attracted the attention of tax authorities. Tax auditors often scrutinised cost allocations to ensure the activities giving rise to the costs produce a benefit for the transaction counter parties, and to ensure that the allocation metrics used were well supported from an economic and operational perspective. Authorities also scrutinised the profit element on these charges by evaluating the comparable companies used in profit benchmarking analyses. Similarly, authorities scrutinised the revenue streams from properties to evaluate each stream from both an individual and a collateral perspective.

In the midst of the pandemic, tax planning and controversy readiness cannot be overlooked as a critical element in the step plan to recovery. Tax planning may involve suspending pre-COVID-19 inter-company pricing and establishing new pricing to ensure that pricing during the period impacted by COVID-19 can be reconciled with the new and dramatically changed economic reality faced by the industry. New pricing may redistribute limited profits among all entities in the value chain, or more likely, redistribute losses across this group under the equity doctrine. The equity doctrine is often applied by courts when a legal remedy is insufficient or inadequate. In a TP context, the rationale for contravening legally agreed transaction pricing is to ensure that no one contracting party is disproportionally disadvantaged by the unforeseen events, and all transacting parties will, in the long-term, benefit if the impact is borne more 'equitably' among them.

Transaction repricing does not have to be based on a reallocation of overall company profits and losses: specific pricing arrangements can be modified. For example, cost plus arrangements may be modified to eliminate the 'plus' thus reducing compensation to cost recovery only. Alternatively, certain costs can be eliminated from the cost base, such as those resulting from work-force adjustments.

Similarly, commission, franchise, and license rates may be reduced based on contemporaneous comparable company declining profit trends, or comparable uncontrolled transaction data. These new pricing arrangements may be established for a limited period with a set re-evaluation date or may be established for a fixed period (short-term or longer-term) with a gradual or immediate return to pre-COVID-19 pricing. Revised pricing arrangements may be established with the expectation that lost profits will never be recovered, or with the expectation that lost profits will be recovered through remediation pricing after the economy recovers.

It is too early to gauge how governments will evaluate these revised pricing arrangements under audit. Some governments have begun to provide limited unofficial guidance as to how these and other modifications will be viewed. Given the uncertainty of how authorities will react to COVID-19 induced pricing adjustments, companies that decide to suspend their pre-COVID-19 pricing and introduce revised pricing are well advised to have clear documentation detailing the suspension of the pre-COVID-19 pricing arrangements, outlining specifics of the new pricing arrangements, and rationalising the change. These can be documented in a memorandum of understanding (MOU) or other formal legal document drafted contemporaneously with the pricing change.

As part of the tax component of the recovery programme, companies should also consider new transactions and TP opportunities in light of the changes that will inevitably occur in their business operations as a result of the pandemic. In the hospitality industry there will likely be significant investments in major areas of the business including loyalty plan enhancements, touchless systems, revised greeting, cleaning, and service protocols, and more. Decisions around ownership, control, and pricing related to these business changes need to be evaluated and may give rise to new inter-company transactions. Similarly, as the business changes, pre-COVID-19 transactions may no longer be necessary or relevant.

Changes to TP constructs made as a result of COVID-19 will inevitably lead to additional scrutiny and potential challenges on the part of tax authorities, but if taxpayers and advisors perform adequate up-front analysis, stress-testing, and are diligent with regard to fully documenting changes from a qualitative and quantitative perspective, that should reduce the potential for costly controversy and disputes. It may be a year or two before we begin to see TP audits addressing the pandemic period, but with the significance of the impact of COVID-19 on inter-company pricing, thoughtful contemporaneous documentation will go a long way to managing the risk, burden, and results of global audits.

Impact of COVID-19 on the life sciences industry

The life sciences industry has been front and centre in the COVID-19 pandemic. Many companies in the sector have been leading the fight against COVID-19 and accordingly, have witnessed increased demand for frontline products such as ventilators and diagnostic testing equipment, or certain prescription drugs. More significantly, almost all companies in the industry are involved in accelerated research and development (R&D) efforts for vaccines, therapies, diagnostic tests, and other relevant equipment. However, other parts of the industry have also experienced adverse impacts as clinical trials have been disrupted, demand for elective surgeries has collapsed, and sales of prescription drugs requiring infusions or administration in doctors' offices suffered.

While the life sciences industry was subject to income tax controversy in many jurisdictions pre-COVID-19, the continued uncertainty surrounding the trajectory of the pandemic and its varying impacts across the industry is likely to increase controversy, especially in the areas of accelerated intellectual property (IP) development, supply chain disruptions, and TP changes for routine entities.

Given the critical importance of IP in the life sciences industry, taxpayers must work much faster and under greater uncertainty to ensure the desired IP ownership pattern in an accelerated development timeline. That is, taxpayers must quickly identify the jurisdiction where the IP belongs, arrange the appropriate funding consistent with that ownership, and ensure the consistency of the chain of control of risk.

As an example, companies involved in developing a vaccine could potentially generate IP that becomes extremely valuable in the short-term. This will require immediate attention to determine tax jurisdiction ownership and utilisation, as well as the tax impact of future profits derived from the IP and R&D activities. IP planning that would normally take a year or more will need to be done within months, if not weeks, to ensure new IP developments do not disturb taxpayers' established IP ownership and funding structures. This will likely be fertile ground for future controversy.

On the other hand, companies that were in the process of IP planning may come under pressure to revisit the assumptions underlying their TP valuations. IP valuations in life sciences rely on three factors: (i) projections of cash flows, which are now highly uncertain; (ii) technical probabilities of success derived from scientific experience, which may not be applicable for the accelerated or delayed development processes; and (iii) the market risk premium, which has been highly variable since the start of the pandemic.

Further complicating IP valuations is the new 'hard to value intangibles' (HTVI) concept introduced in the latest edition of the OECD Transfer Pricing Guidelines. Judging by the examples provided, the HTVI concept appears to have particular relevance to the life sciences industry. Taxpayers may be able to prevent application of HTVI by carefully documenting what is known at the time of the valuation, but this area will likely generate controversy.

COVID-19 has also caused severe disruption to life sciences companies' supply chains. Although the demand for COVID-19-related products has increased, companies have had difficulty getting these products to market because of backlogs in the supply chain. Border closings and social distancing measures have forced production sites to partially or completely close, causing shortages and delays in procurement. These disruptions are generating national security concerns, as companies are re-thinking their supply chains from the perspective of resiliency, as well as cost effectiveness.

Manufacturing footprint and intermediate and finished product flows are critical elements in a multinational's tax position. Taxpayers may use various arrangements, such as toll or contract manufacturing, or 'substantial contribution' or 'control of risk' arrangements, which can have the effect of attributing the economic risks and benefits of manufacturing and supply activities within the multinational group, but recent supply chain disruptions could generate uncertainty around these arrangements.

Finally, in view of the business disruptions from COVID-19, some taxpayers in the life sciences industry may want to re-evaluate the target profitability levels for their routine entities. In general, the regulatory frameworks in most tax jurisdictions provide that routine entities should report profits within an arm's length range, supported by the results of comparable companies that engaged in a similar range of business activities.

With the unprecedented COVID-19 crisis, the most prominent comparability criterion for benchmarking routine entities would be the degree of company's resilience to demand and supply disruptions. This criterion is likely to outweigh more traditional considerations for building an arm's length range for 2020. Such a range may potentially support lower levels of target profitability, or even indicate losses for routine entities. Although consistent with the arm's length standard, a benchmark range with losses may be subject to close scrutiny by tax authorities.

As they try to help governments address critical healthcare priorities, some life sciences companies are receiving direct or indirect government assistance. While TP would normally follow the financial statement treatment of such assistance, governments have started to provide specific guidance concerning how such assistance should be treated for TP purposes. Considering the fungibility of funds within a corporation, any attempt to isolate the government assistance from TP may generate controversy.

As companies consider making changes to their TP policies in this time of economic and social pressures, they should not delay planning decisions or preparation of associated documentation. In lieu of the potentially labourious process of revising existing inter-company agreements, some taxpayers may prefer to adopt a group-wide MOU as an overlay to their existing agreements, or as an interim step toward a substantive revision of those existing agreements. To the extent that taxpayers prepare such an MOU or other contemporaneous documentation to support any TP changes, this may help reduce future controversy.

As it sits at the forefront of the pandemic, the life sciences industry may draw scrutiny from tax authorities. It is therefore critical for taxpayers to act quickly to address open questions on IP ownership and valuation, supply chain reorganisations, and TP changes.

Impact of COVID-19 on the consumer products industry

As countries stare at what will likely be a sharp recession this year due to the impact of COVID-19, a key casualty will be consumer spending as households hunker down and businesses shut shop to prevent further spread of the virus.

Analysis of data on real personal consumption expenditure reveals that consumer spending often declines at times of economic contraction. Rising unemployment, slowing incomes, and uncertainty over economic prospects during a recession often force consumers to cut back spending and save more. These trends have been even more pronounced in the global crisis caused by COVID-19. For example, between March 21 2020 and June 30 2020, almost 50 million people in the US filed claims for unemployment insurance.

The global marketplace, already in the midst of a massive transformation, has experienced an acceleration of many of the industry changes. Now more than ever as national economies start to re-open in the wake of the COVID-19 crisis, retail and consumer product (RCP) companies must look in the mirror to evaluate their readiness for the evolution of the industry.

However, questions remain. When will consumers feel safe enough to return to their 'normal' lives and what will the 'new normal' look like? RCP companies that struggled to adapt to changing consumer preferences pre-pandemic are finding it challenging to navigate the new landscape.

In the midst of the pandemic, tax planning and controversy readiness cannot be overlooked as a critical element in the step plan to recovery. Tax planning may involve suspending pre-COVID-19 inter-company pricing and establishing new pricing to ensure that transfer prices during the period impacted by COVID-19 can be reconciled with the new and dramatically changed economic reality faced by the RCP industry.

As part of the tax component of the recovery programme, companies should also consider new transactions and TP opportunities in light of the changes that will inevitably occur in their business operations as a result of the pandemic. In the RCP industry there will likely be significant investments in major areas of the business, including and especially in technology relating to digital supply chains and omnichannel solutions, as well as in-store safety procedures such as cleaning, and service protocols, and more.

In addition, RCP companies may make changes to their supply chain and vendor bases to prepare for future business disruptions, or make other changes to the functions, assets, and risks of the relevant parties in their supply chain. Decisions around ownership, control, and pricing related to these business changes need to be evaluated and may give rise to new inter-company transactions. Similarly, as the business changes, pre-COVID-19 transactions may no longer be necessary or relevant.

Any changes to TP constructs made as a result of COVID-19 will inevitably lead to additional scrutiny and potential challenges on the part of tax authorities. Still, some governments are signaling that they are willing to take the economic circumstances of the pandemic into account when analysing a company's TP. Regardless of these signals, companies that change their inter-company transaction pricing in response to COVID-19 should develop clear documentation rationalising the change. The preparation of robust documentation now can significantly mitigate the risk of costly controversy disputes in the future.

It may be a year or two before we begin to see TP audits addressing the pandemic period, but given the significant impact of COVID-19 on inter-company pricing and supply chains, thoughtful contemporaneous documentation will go a long way toward managing the risk, burden, and results of global audits.

Click here to read the entire 2020 Deloitte/ITR Transfer Pricing Controversy guide

Jacqueline Doonan


Deloitte US

T: +1 415 783 5651


Jacqueline Doonan is a national partner in Deloitte's US TP practice and the global leader of the transportation, hospitality, and service industry sectors. She has been a partner for over 20 years and has pioneered many strategic initiatives within the TP practice. She began her career with Deloitte in London and now serves global clients from Deloitte's San Francisco office.

Jacqueline has financial consulting experience in several areas including TP planning, compliance, US and UK financial audits, and industry trend analysis.

Jacqueline has authored numerous articles on TP, international tax, and business-related topics and is a frequent speaker on TP topics. Euromoney's 'Guide to the World's Leading Transfer Pricing Advisers' has recognised her as one of the world's leading TP advisors every year since 2004. ITR has repeatedly recognised her as one of the world's leading practitioners in TP.

Aydin Hayri


Deloitte US

T: +1 202 257 0821


Aydin Hayri leads Deloitte's mid-Atlantic TP practice of more than 40 professionals working on regional and national clients. He is also the global life sciences industry leader for TP. He also serves as TP representative on the Tax Steering Committee for US inbound clients.

Since 1998, Aydin assisted clients with tax planning for IP, IP development, cost-sharing, and licensing strategies; and planning and implementation of supply chain and business model restructurings. He developed a profit-split methodology addressing the issue of 'non-outsourceable' activities that has been the basis for a number of advance pricing agreements (APAs) for inbound companies and Internal Revenue Service (IRS) audit settlements.

Aydin recently published a highly accessible book, 'Transfer Pricing in Action' sharing his experiences in a business-novel, case study format, focusing on an emerging multinational company.

Before joining Deloitte in 1998, Aydin was an assistant professor of economics at Charles University, Prague; the University of Warwick, England; and a research fellow at Princeton University.

Oscar Burakoff


Deloitte US

T: +1 619 237 6822


Oscar Burakoff is a principal in Deloitte's TP practice, based in San Diego. He is a member of Deloitte's TP global strategies group. He is also Deloitte's global TP industry lead for the consumer products and retail, wholesale, and distribution sector.

Oscar focuses his practice on TP and valuation and has experience managing global TP projects covering all types of transactions, including cost-sharing, transfers of tangible and intangible property, inter-company services, and financing. Some of his specific areas of focus include intangible property valuation and planning, cost sharing, supply chain optimisation and restructuring, and services allocation analyses.

Oscar is a frequent speaker at a number of internal and external professional seminars and trainings. He has also been recognised on multiple occasions as a Rising Star by Euromoeny's Expert Guides.

Prior to joining Deloitte, Oscar was a principal economist at DLA Piper.

Clarke Norton


Deloitte US

T: +1 415 646 6633


Clarke Norton is a principal in the TP group of Deloitte. Clarke is the US tax leader for the retail, wholesale and distribution industry group, as well as the consumer product industry leader for TP globally.

As a leading authority in the consumer industry, Clarke helps companies drive growth in the rapidly-evolving, customer-centric, consumer products industry. She is a recognised specialist on global sourcing/procurement structures, and has extensive experience assisting multinational corporations with the operational, tax, and TP aspects of their supply chain organisations. She also specialises in intellectual property and consumer goods brand valuations, helping companies and governments understand the unique characteristics of intellectual property for the consumer product industry.

With a history that spans more than 29 years in tax, Clarke first served as the chief economist at the IRS' APA programme. Her knowledge gained while at the IRS, as well as in other consulting roles, has provided her with a specialised experience that has been very beneficial to clients, particularly in the planning and defense of their tax and TP positions. Her deep consumer industry knowledge has led to her serve as an expert witness for two US Attorney's Office investigations as well as in numerous other global tax disputes.

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