Transfer prices under investigation no matter the pandemic

by Dominika Tyczka

4 September 2020

Despite the worldwide pandemic tax authorities are not standing still and continue their inspections and launch new ones. However, not all their findings withstand the challenge before administrative courts. Taxpayers do not always agree with the inspectors.

In this article we are describing our experiences with transfer pricing inspections, but be mindful that our conclusions are by no means universal. This study shows the trends that our tax advisers have identified.

Which businesses are inspected?

Our practice shows that transfer prices are most often checked among companies which have disclosed tax losses over several consecutive years. It is now an established practice of tax authorities to call upon taxpayers to explain the main reasons behind their losses. Such a call may lay the groundwork for a tax inspection. However, inspections without any advance enquiries about the reasons behind the losses happen just as often.

Trading businesses are inspected as often as loss-making ones. It seems that the authorities draw on the data disclosed in CIT/TP (or PIT/TP) forms and tend to favour inspections among distribution companies.

Still, the taxman comes for an inspection also to companies which do not fall into any of the above categories.

The procedure

All tax inspections are different. We have noticed that the authorities focus on business operations after 2017, that is after the new TP documentation laws came into force, and especially on benchmark studies. We have also noticed that the authorities limit their efforts to checking the company’s profitability and comparing it to the median calculated for a group of comparables identified by that company. Very often they check thoroughly the group of comparable entities used by the taxpayer. The authorities either check the adopted comparability criteria and modify them to identify their own sample or accept the comparability criteria but check the group thoroughly, e.g. by checking carefully if the products offered by the comparables are indeed comparable to the taxpayer’s products on offer.

We have been glad to welcome the practice of checking the taxpayer’s profitability over a period exceeding one year. We know cases where the authorities have accepted lower profitability in one year if growth followed in subsequent years. The data proved to be crucial there and the rulings were positive in specific cases. Fluctuating profitability of entities serving routine functions may spark a dispute with the taxman.

We have also witnessed traditional inspections of income tax where the transfer prices are somewhat in the background while inspectors focus on evidence of the performance of intangible services by associated enterprises. Of course, withholding tax and limited deductibility of expenses for intangible services of associated enterprises remain in the limelight.

How to get ready?

Transfer prices are still at the centre of tax authorities’ interest. We are witnessing a growing number of income tax inspections focusing on transfer pricing and possibly the additional related hot topics. We believe that you can get ready for such an inspection. What to remember?

1.  First and foremost, you must have the paperwork ready. Please remember that the TP documentation laws have changed in the last few years a number of times, so it is good to check if your documentation is correct, complete and up to date. Remember to have the source documents underlying your TP documentation and your transfer pricing policy ready.
2. Review your benchmark studies. Companies which have achieved profit(loss) which is not at arm’s length should consider revising their tax accounts or collect evidence that entitles them to apply such prices. The key in the benchmark study is the selection of comparables. This part must be done in partnership with a transfer pricing expert. Please remember to keep evidence of the study and its findings, especially the criteria for acceptance to or rejection from the comparable group. You need to keep those data until they become statute-barred. 
3. Even if your transfer price falls within the interquartile range identified through the benchmark study, you are not immune to a dispute with tax authorities. For instance, they may argue that the median is the optimum value. A well-done benchmark study includes a substantiation of the taxpayer's profitability compared to the arm’s length range.
4. Given the varied interpretation of withholding tax rules and tax-deductibility of expenses for intangible services of associated enterprises, you may consider securing your position by means of an advance tax ruling or an Advance Pricing Agreement. The documentation of intangible services remains crucial.