VGD News April 2018
1 Transfer pricing
Transfer price is price applied on transactions between two economically or personally related parties. Transactions between related entities in case of local or even multinational companies affect profits and it may affect the tax liability of the parties involved. According to the requirements of the Czech tax laws should be this price set in common amount, i.e. in the same amount as it would be agreed between independent parties (this is the arm’s length principle).
Compliance with the above specified principle is controlled by a tax administrator in tax controls. In annual report of Czech tax administration was listed that the frequency of controls that focus on compliance with the arm’s length principle or the correct setting of the transfer pricing policy between related parties, from which it follows that the total number of controls the amount of the additional assessed tax increases year on year. When the applied transfer prices differ from those that are negotiated between independent entities and when the taxpayer is unable to provide a satisfactory proof of the difference between the prices, the tax administrator will adjust the basis of the taxpayer‘s tax the difference found and charge the tax.
Approximately 900 inspections took place in 2016 that is an increase of more than 10% compared to the situation a year ago.
|Year||Additionally assessed tax in CZK||Increasing tax base in CZK||Reducing tax losses in CZK|
|2013||71 759 104||336 386 414||131 267 918|
|2014||59 402 410||259 612 320||244 221 586|
|2015||446 263 377||2 431 935 440||390 970 153|
|2016||886 116 252||4 783 203 802||8 502 980 932|
Typical examples of transactions that are negotiated between related parties (within a group of related companies) and among the most common transactions targeted by tax authorities for tax controls include:
- Transactions with tangible property – purchase and sale, renting and hiring
- Transactions with intangible property – sharing costs logo, costs of research and development used by a business group, evaluating licenses and royalties
- Providing services – providing supportive intra-group services (accounting, tax services, public relations, personnel services, etc.), sharing costs of service centers by a business group (full range of services), providing managerial and professional consulting services
- Group funding – providing loans and credits, subordinated debt, bonds, cash pooling and other forms of financing
- Providing guarantees and other forms of reinsurance, etc.
2 Legislative framework for transfer pricing
The transfer prices are covered by Act No. 586/1992 Coll., Income Taxes, where the provisions of Section 23 paragraph 7 states: “If the prices agreed between related parties differ from those that would have been agreed between independent parties in the ordinary course of business under the same or similar conditions, and unless such difference is satisfactorily documented, the basis of the taxpayer‘ s tax will be adjusted by the difference found. If it is not possible to determine the price to be negotiated between independent parties in common business relationships under the same or similar conditions, the price determined under the law governing the valuation of assets shall be used.”
Further, related parties are also defined within this paragraph: “For the purposes of this Act, related parties means:
a) capital-related parties, while
- where one person directly participates in the capital or voting rights of another person, or one person directly participates in the capital or voting rights of more than one person; and this share represents at least 25% of the registered capital or 25% of the voting rights of such persons, all of these persons are directly related to each other by the capital,
- where one person indirectly participates in the capital or voting rights of another person, or one person directly or indirectly participates in the capital or voting rights of more than one person; and this share represents at least 25% of the registered capital or 25% of the voting rights of such persons, all of these persons are related to each other.
b) otherwise related parties, which are persons,
- where one person is involved in the management or control of another person,
- where the same persons or close persons participate in the management or control of other persons, these other persons are otherwise related parties. Other related persons are not persons where on person is a member of the supervisory board of both parties,
- controlling or controlled party and also persons controlled by the same controlling person,
- who have established a legal relationship primarily for the purpose of reducing the tax base or increasing the tax loss.”
OECD Guidelines on transfer pricing for multinational enterprises and tax administrations which was elaborated in 1995 and subsequently completed in 1997, is subject to the issue of transfer pricing. In 2017, OECD Guidelines was updated. The purpose of the OECD Guidelines is to unify tax administration and merger procedures in dealing with transfer pricing issues, minimize conflicts between them and prevent costly litigation, etc. The principles of the OECD Guidelines are not directly embedded in Czech tax laws. However, it is due to the fact that the Czech Republic is a signatory to the multilateral international treaty of the Vienna Treaty.
3 Risks of misconfigured or misidentified transfer pricing within tax control
3.1 Burden of proof
In the case of tax control, the burden of proof lies primarily on the taxpayer‘s side, who is required to provide all the evidence to prove that the prices agreed between the related parties are in line with the arm’s length principle. According to the preliminary information, a provision should be included in the amendment to the Tax Act, which would set the obligation to have processed transfer pricing documentation in advance.
If the controlled entity submits to the tax administrator the transfer pricing documentation, the burden of proof is passed on to the tax administrator who can contradict that documentation by means of the same legal weight, it usually has a similar analysis, documentation or appraisal evidence. However, the tax administrator must first of all accurately state how the prices in question, in his opinion, differ from the common prices or from the prices realized between independent entities.
In addition, for tax control by tax authorities, the taxpayer would have to prove that the consideration was actually provided by the company as consideration for actual performance. If the taxpayer does not have the burden of proof thus designed, the tax administrator is entitled to additionally assess the tax.
3.2 Responsibility of the members of the statutory body
An example of joint-stock company:
In particular, the Board of Directors of the joint-stock company should do the company‘s book-keeping properly, compile and subsequently publish the company‘ s annual report on the company‘s business activities and property status. The breach then entails the risk associated with damages that the members of the board have caused to the company.
If a member of the Board of Directors would breached the duties, a criminal liability may also be imposed for such member of the Board of Directors in accordance with the provisions of Act No. 40/2009 Coll., Criminal Code:
a) Infringement of the obligation to administer foreign property and the care of proper manager can also be punishable by imprisonment. Here it is necessary to draw attention to the fact that the term „proper manager“ falls into the category of so-called vague legal concepts, which lack legal definitions, the meaning of which is supplemented only by the jurisprudence of the courts.
b) In case of inability to prove the costs related to the payment for services, there may be a violation of § 240 of the Act No. 40/2009 Coll., Criminal Code, due to the reduction of the tax, the fee and similar obligatory pay
4 Provided services by vgd as a defense of a company against above mentioned risks
- preparation (or assistance in preparing) the transfer pricing documentation (Local file, Master file) including their periodical updates,
- as an reaction on provisions of Section 23 paragraph 7 states: “If the prices agreed between related parties differ from those that would have been agreed between independent parties in the ordinary course of business under the same or similar conditions, and unless such difference is satisfactorily documented, the basis of the taxpayer‘s tax will be adjusted by the difference found.”,
- preparation (or assistance in the preparation) of benchmarking or preparation of comparative analysis using external paid databases (e.g. TP Catalyst, which also uses the tax administrator in the Czech Republic),
- based on the purchased on-line license to use the „TP Catalyst“ database (Amadeus database extension), https://www.bvdinfo.com/en-gb/our-products/catalyst/tp-catalyst, for sections „Very Large” and „Large and Medium companies europewide“ (consisting of approximately 3.5 million European companies) – contains financial / accounting data on comparable independent companies. The search is possible based on the current state of completion, depending on how companies publish their financial statements or retrospectively – which serves to simulate and defend the state of the real market that existed in the past, respectively for example also for the needs of the so-called „defense file“ (back to maximum until 2008).,
- elaboration (or assisting in the preparation) expert valuations on transfer pricing or assessing the adherence to the arm’s length principle in relation to current or planned transactions between related parties,
- preparation (or assistance in preparing) the assessment of the correctness of internal agreements and tax treaties – preparation / revision of contractual documentation for group transactions,
- assistance during the transfer pricing controls initiated by the financial administration and the elaboration of a „defense file“ in the case of tax control
- an assessment of the basic risks associated with transfer pricing,
- detailed review of transfer pricing, review of existing documentation (Master file and Local file),
- setting or revision of the transfer pricing system,
- advice on intangible property, financing,
- advice on the allocation of profits to permanent establishments,
- training of financial / risk controlling employees on the issue of risk in the setting of transfer pricing.
5 Other services provided by vgd related to usage of paid external database and its outputs:
- sector analysis – e.g. identifying the usual margin in the sector, comparing the selected entity with the peer group, comparing the performance of the entity etc.,
- financial analysis of the entity, including comparison with comparable companies (both dependent and independent),
- comparability study (benchmarking) in different economic indicators within the Czech Republic and Europe,
- elaboration of the future management plan of the selected entity for the purpose of negotiating with the bank or other financial institutions on the basis of development of identified comparable companies,
- economic analysis of the subject including analysis of key indicators and identification of bottlenecks on the basis of development of identified comparable companies,
- processing of business plan of the subject on the basis of development of identified comparable companies,
- processing a founding budget on the basis of development of identified comparable companies,
- revision of calculations, compilation of calculation formulas and consultancy in the area of managerial accounting.
In case you are interested in any of the above mentioned services, even if you have any consultation, do not hesitate to contact our appraisal institution VGD Appraisal, s.r.o., Ing. Dagmar Dušková, firstname.lastname@example.org.