Tax Consultant at RSM Poland
In the previous post, we discussed recommendations of Working Group no. 1 and no. 2 working in the Transfer Pricing Forum. These recommendations focused on benchmarking studies and a description of compliance that must be prepared if benchmarking studies cannot be delivered. In this post, we are going to discuss the recommendations of Working Group no.3, which addressed re-invoicing and the hierarchy of transfer pricing methods. These recommendations have been prepared for transfer pricing regulations that have been in force since 1 January 2019.
TPF recommendations on the hierarchy of transfer pricing methods and the choice of the most appropriate method
OECD guidelines from 2017 distinguish traditional transaction methods and transactional profit methods. The former group includes: the comparable uncontrolled price method, the cost plus method and the resale price method, whereas the latter includes the transactional net margin method and the transactional profit split method. Since 2019, in accordance with the amended provisions of the CIT Act and the PIT Act, the taxpayer may apply another method, known as “the sixth method” to verify transfer pricing. There is no hierarchy of methods in place; however, the entity is obliged to choose the most appropriate method for a given case. The description of the choice of a given method should be an element of the benchmarking study or a description of compliance. The taxpayer may include a thorough description of the process of selecting the most appropriate method for a given transaction; he is not obliged to do so, however. The audit will surely analyse the justification of the choice of a given method and reasons for rejecting other methods in terms of how rational and correct the taxpayer’s decisions are in this respect. Pursuant to Article 11d par. 4 of the CIT Act, the tax authority will apply the method adopted by the related entity when determining the taxpayer’s income, unless another method is more appropriate.
When determining transfer prices, related entities should be guided by an overriding principle that the prices should be agreed the way non-related entities would have done in similar circumstances. The need to apply arm’s length prices in transactions between related entities pertains to transactions that did not exceed thresholds for preparing tax documentations or are exempt from this obligation, as well. Factors that should be considered when selecting the method include: characteristics of a given transaction, availability of data for the taxpayer and limitations of available comparables.
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TPF recommendations on the verification if the re-invoice transaction is at arm’s length
Re-invoicing transactions are often concluded within a group of related entities and can, for example, be connected with group purchases made by a given entity for different companies. As a rule, the cost of the purchase of goods or services from non-related entities in such transactions is recharged for given beneficiaries in the amount of the price paid by the purchasing entity, without any margin/profit mark-up. The lack of any margin or profit mark-up is justified only if the entity purchasing the goods or services performs administrative functions, and does not bear any significant risks involved in the transaction, and if the time between the purchase and resale to a related entity is relatively short.
In order to verify whether reinvoicing processes within the group are in line with the arm’s length principle, the most appropriate method must be applied depending on the transaction characteristics.
Furthermore, Working Group no. 3 put forward postulates concerning reinvoicing transactions, namely:
- to do away with the obligation of transfer pricing documentation as regards reinvoicing made for a single entity,
- recommendations for simplified transfer pricing documentation in the event allocation keys are used for settling the reinvoice,
- to establish a safe harbour for reinvoicing.
Suggested legislative changes in reinvoicing transactions include: simplified tax documentation with descriptions of the objects and type of controlled transaction and an analysis of transfer prices without a description of functional analysis. The introduction of a legal definition of a reinvoice should be considered.
TPF recommendations on reinvoicing shall be welcome. Such transactions are typical for related entities, which make group purchases owing to the fact that they can negotiate better conditions when purchasing large volumes of goods. If relevant documentation obligations are simplified or completely abandoned, as suggested, the bureaucratic burden on taxpayers would be scaled down.
As regards recommendations on the hierarchy of transfer pricing methods and the choice of the most appropriate method, the taxpayer was obliged to indicate and justify the choice of the method for calculating income (loss) already for 2007 tax documentation. The amended regulations in force since 2019 introduce the concept of “another method” the taxpayer may apply if none of the five standard methods in place can be used. However, recommendations on transfer pricing methods are rather concise; if you read source regulations, you arrive at similar conclusions yourself.
The results of TPF works are undoubtedly useful for related entities struggling with transfer pricing and for anyone professionally involved in this field. Opinion sharing and the appropriate interpretation of amended regulations should help meet documentation obligations well. At the same time, as transactions are case-specific and individual, it is difficult to come up with uniform solutions that could be applied to all transactions of the same type, for example. Nevertheless, we are awaiting further positive effects of the dialogue between advisors and business representatives with the Ministry of Finance, producing regulations that are in line with international standards defined in the OECD Guidelines. If the scope of obligatory elements of local and master file is systemised and information included in the CIT Act, PIT Act and regulations is elaborated in more detail, related entities will perform their documentation obligations better.
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