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Preparing transfer pricing documentation — the significance of selecting the right service provider

20 May 2014

Apart from corporate tax returns, May is also the month of preparing transfer pricing documentation in the case of companies that carried out transactions with their affiliated undertakings in the previous year. These documents, which must be prepared on a compulsory basis, have an increasing significance, as in recent years, greater emphasis has been placed on the issue of the burden of proof during tax inspections. In our experience, today, there is no comprehensive tax inspection or even corporate tax inspection without checking the returns submitted by affiliated undertakings or without requesting the transfer pricing documentation. Our clients have reported that the Tax Authority requests such documentation already at the beginning of the inspection, and they have taxpayers sign a letter of representation, according to which all documents relating to transfer pricing have been submitted. The significance of such practice is that upon submission, the burden of proof is transferred to the Tax Authority, and if it finds that the documentation is deficient, it is given a free hand to determine the ordinary market price again. Last year a court judgement was delivered concerning this practice.

 

Consequently, if an enterprise decides to commission an expert to prepare the transfer pricing documentation, it needs to consider very carefully whom it enters into a contract with. Considering that companies have an increasing need for such support, as a special field of taxation is at issue that internal financial specialists do not necessarily have the time or the experience to deal with, participants have appeared on the market claiming that they are experts in transfer pricing, but in fact, they do not have the actual knowledge the Tax Authority requires in 2014. We find that it is a field expertise in which can be acquired on the basis of many years’ experience and a relationship of trust is also required between the company and the advisor, which is generally ensured by long-term continuous cooperation. Why is that so? When talking about transfer pricing and about transactions between affiliated undertaking in general, we actually undertake to study and analyse in detail the internal structure and pricing of the given company group. The company allows the advisor to get to know the secret to its success, or shares the reason behind the losses sustained in the past years with the advisor. As determining the ordinary market price means the auditing of the pricing of individual transactions, gross-level data (cost price calculations, etc.) are made available by the company. This requires a confidential relationship, so it is essential to consider carefully who are the specialists and companies who have proven their reliability.

Considering that the Tax Authority is allocating increasing resources to inspect the prices themselves, one must not be satisfied with a general register that can be adapted to every purpose, as it does not reveal the conditions the pricing of a given company's audited transaction is based on. There are many participants on the market who try to assert themselves by cost-efficiently classifying the transactions of companies into templates, which is a practice obviously used in pricing, but is a risky area, as it does not reflect the specific features of companies and transactions, so it can be easily challenged. We can say that there are no identical transactions, so it is not possible to have identical registers either. Obviously, this requires very careful and thorough work from the advisor, but at the same time, it offers assurance to the taxpayer that the work he or she is provided with suits current auditing practices.

 

Having regard to the fact that transfer pricing documentations are typically audited years after they are prepared, it is important to commission a party to prepare them, who will be definitely available even years later to help us, and who will support us when these documents are actually inspected. Such party must be someone who can answer questions and provide explanations for the document section he or she was responsible to prepare. Typically, it is the comparative analysis, when the pricing of transactions concluded between independent parties under similar conditions are taken as a basis. The preparation of such analysis requires real expertise as one must understand economic connections at both micro- and macro-level, the Tax Authority's expectations must be taken into consideration very sensitively and, if needed, the company must be consulted if, according to the result of the analysis, the price applied does not meet the arm’s length principle. The advisor who enters into a contract resolved that whatever happens, the applied price must be supported somehow, leaves the company with a risk. Obviously, the taxpayer shall decide on his or her own how to react to the information received, but his or her attention must always be drawn to uncertainties. An experienced advisor is aware of what the Tax Authority aims at, and thus, what fields need to be handled with special care. While earlier management services received closer attention, today, the focus is on financial transactions within the company group. A good advisor makes an effort to anticipate possible points of attack and flexibly adapts his or her strategy to justify the price of the targeted type of transactions, using databases and models that substantiate the applied price without doubt.

 

We would finally wish to point out again that the issue of establishing and applying prices within the company group is an increasingly important field of tax inspections, where findings involving very high amounts can be made, even due to that fact that there is no pure calculation methodology, so if the burden of proof is transferred, the Tax Authority has great latitude. For this reason, when selecting the right service provider, the taxpayer should preferably take into consideration that it should choose a reliable, discreet advisor with several years of — possibly — international expertise, who does not offer template-like solutions and whom it can trust to be there when there is trouble.