New rules of transfer pricing adjustments

by Marta Woźnik

12 July 2019 

Transactions with associated enterprises must be made at arm’s length, that is, on terms which independent enterprises would agree. Practice shows, however, that market terms change and the once agreed prices are no longer at arm’s length. Once the financial year is over, it may turn out that the parties failed to foresee significant changes to prices of raw materials or semi-products, interest rate or currency fluctuations.

Then, the profitability achieved by the parties to a controlled transaction may need to be adjusted to bring it in line with the market. Another reason for differences between the anticipated and actual profitability may stem from payments based on budgeted costs while market terms have changed considerably and the taxpayer cannot adjust the budgeted costs to actual costs during the year.

Then, the difference between the budgeted costs and actual costs may require a profitability adjustment.

Inconsistent standpoints of tax authorities

The method and time of recognition of a transfer pricing adjustment in the tax records have been highly controversial. There used to be advance tax rulings claiming that according to Article 12(3j) of the Corporate Income Tax Act (the "CIT Act") effective since 1 January 2016, whenever a revenue adjustment is not caused by an accounting error or another obvious mistake, it should be made by increasing or decreasing revenue earned in the period in which the correcting invoice or another correcting document has been issued. Other advance tax rulings held that the revenue adjustment should be accounted for in the year to which it refers because any other recognition would distort profit (loss) for tax purposes. Some rulings challenged tax-deductibility of adjustments. The Head of the National Tax Information Service held that a correcting invoice that increased profitability was taxable on the date of receipt, whereas a correcting invoice that reduced profitability was not tax-deductible. Provincial Administrative Courts rejected that approach and emphasised that it was absolutely inadmissible that funds exchanged through the same profitability adjustment mechanism were treated as business-related income at one point, and unrelated to business and excluded from tax-deductible costs at another point, depending on which way the money went.

Clear rules for recognition of transfer pricing adjustments

Such an inconsistent approach to recognition of adjustments retrospectively or in the current period and to their tax deductibility has provoked a number of issues. The Ministry of Finance has noticed the problem and added new rules regarding the transfer pricing adjustments to the CIT Act in effect since 1 January 2019.

According to Article 11e of the CIT Act, a taxpayer may adjust a transfer price by amending the amount of its revenues or tax-deductible costs if the following conditions are met jointly:

1. the controlled transactions concluded by the taxable person in a fiscal year were on the terms that would have been agreed between independent entities;
2. significant circumstances influencing the terms agreed upon during the fiscal year changed or the actual costs incurred or revenues earned being the basis for calculating the transfer price become known and the transfer prices must be adjusted to ensure their compliance with market terms;
3. upon adjusting the transfer prices, the taxable person holds a statement from the associated enterprise confirming that the associated enterprise adjusted the transfer prices for the same amount as the taxable person;
4. the associated enterprise referred to in item 3 has its place of residence, registered office or management board in Poland or in a country or a territory with which Poland has concluded a tax treaty and there is a legal basis for the exchange of tax information with that country;
5. the taxable person confirms adjusting the transfer prices in its annual tax return for the fiscal year to which the adjustment refers.

Please note also Article 12(3aa) and Article 15(1ab) of the CIT Act. They say that when you calculate revenues or expenses you should take into account a transfer pricing adjustment which reduces revenues or increases expenses if they meet the conditions laid down in Article 11e(1)–(5) and listed above. However, as regards transfer pricing adjustments which increase revenues or reduce expenses, you just need to meet the conditions referred to in Article 11e(1) and (2). 

The new regulations in practice

Example

Alfa Sp. z o.o. is a contract manufacturer which sells its goods to an associated enterprise, that is, the mother company Beta GmbH of Germany. Alfa Sp. z o.o. manufactures according to the production plan agreed with Beta GmbH every year and sets the sales price on the basis of budgeted costs. Beta GmbH is a distributor with extensive functions and risks. The German mother company seeks sales markets, handles marketing and develops sales plans. The parties have agreed that for its contract manufacturing Alfa sp. z o.o. should achieve profitability of 4%. The profitability’s compliance with arm’s length principles has been confirmed by a benchmarking study. The costs of manufacturing raw materials have dropped significantly in the course of 2019. Consequently, Alfa sp. z o.o. achieves 7% profitability in 2019 which is more than comparable independent enterprises achieve on the market. Therefore, in February 2020 the parties sign an agreement adjusting the profitability of Alfa sp. z o.o. to the market level of 4% by increasing its costs by EUR 0.5 million. Beta GmbH sends a statement to its daughter company about the adjustment that increases its revenues by EUR 0.5 million. Consequently, Alfa Sp. z o.o. may include the adjustment by EUR 0.5 million in its tax deductible costs of 2019.

The practical fulfilment of the transfer pricing adjustment requirements may prove problematic. Doubts arise as soon as you need to tell if the terms of the transaction in the course of the year would have been agreed by independent entities. You may also have problems obtaining the associated enterprise's statement if its tax year is different than yours or if the laws in the country of its establishment prescribe different dates for the adjustments.

The rules of admissibility of transfer pricing adjustments do not prevent tax authorities from checking the grounds for the adjustments.

The new regulations on transfer pricing adjustments apply to adjustments of controlled transactions made after 1 January 2019. If you make in 2019 any adjustments to transactions or other dealings made in 2018 or earlier, you should follow the rules applicable until the end of 2018.