Transfer pricing in a challenging market

Whether it is arm’s length for a group company to report a loss depends on what that company does and the risks it bears. Routine distributors and contract manufacturers are typically expected to earn a modest, relatively stable return on their activities. Only in exceptional circumstances that could not have been foreseen (e.g. the COVID‑19 crisis), routine entities may report incidental losses, particularly if those exceptional circumstances led to overall losses for the group.

Caution is required when limited‑risk routine entities are loss‑making, as this is expected to draw scrutiny from tax authorities. Such situations generally require year‑end adjustments that allow the routine entities to earn a limited profit in line with their functional profile and the respective benchmarking studies. Losses are typically expected to be borne by the entrepreneurs (i.e. the entities with decision‑making power that assume and control the economically significant risks) within a group. Only if factual changes have occurred that have altered the functional profile of an entity from routine to entrepreneur, there could be valid reasons for that entity to report losses at arm’s length. Reporting losses where stable returns were reported in the past will, however, still be expected to draw scrutiny from tax authorities.

In this environment, it is key to proactively ensure that transfer pricing policies and documentation remain aligned with the current business reality to limit potential scrutiny from tax authorities. Any corrections may also impact the previously applied VAT positions as well as customs valuation and import duty exposure.

Interest deduction limitations

The interest limitation rule under ATAD1 caps the deduction of net borrowing costs at 30% (or less, under some national implementations) of an adjusted EBITDA. As underlying margins compress under OEM pricing pressure, lower volumes, and the cost of EV programme transitions, the tax-adjusted EBITDA falls. Intra-group financing arrangements sized when earnings were higher may now produce non-deductible interest that would have been fully deductible a year earlier. The availability of any carry-forward of non-deductible interest or deduction capacity varies materially across Member States, and its expected utilisation depends on the outlook for earnings and financing arrangements.

Impairments and deferred tax asset recoverability

The EV programme re-sizing and volume adjustments now working through OEM balance sheets do not stop there. It flows through to the supplier base in the form of contract unwind and cancellation payments, impairments on dedicated tooling and capacity, and portfolio rationalisations that trigger disposal-related charges. Each raises distinct tax questions: characterisation and timing of settlement receipts, whether or not VAT is due on cancellation payments, deductibility of write-downs, and also the recoverability of deferred tax assets under the International Accounting Standard 12 – “Income Taxes”, which feeds directly into Pillar Two GloBE effective tax rate calculations. The first substantive Pillar Two filings are running in parallel with the preparation of 2025 corporate income tax returns, and inconsistencies between the two positions will not go unnoticed.

Carbon Border Adjustment Mechanism (CBAM)

CBAM is a climate policy instrument administered through national competent authorities and national customs authorities. It is not a tax item, but another issue likely to reach various business functions (i.e. tax, procurement, finance, legal) this year. As of 1 January 2026, additional compliance requirements under CBAM apply, and under many long-term OEM-supplier contracts, it remains unresolved whether the Tier-1 or the OEM bears the costs of CBAM certificates.

Each of these issues exists in other sectors. What makes automotive distinctive is that all four are arriving simultaneously, against a backdrop of regulatory change (Industrial Accelerator Act, CBAM, new foreign trade agreements) that will constrain the available structural responses over the next 24 months.

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