Preparation of transfer pricing documentation
KRS Lawyers specializes in the preparation of transfer pricing documentation. Thanks to the experience of our team, we minimize the risk of applying sanction tax rate and a fine towards you in the event of a possible control of the administrative authorities in this regard. We offer solutions tailored to the specific case taking into account, among others, the specificity of the line of business.
The obligation to make documentation
The obligation to prepare tax documentation stems directly from the provisions of Article 9a paragraph 1 of the Law on income tax from legal persons and Article 25a of the Income Tax Act from individuals.
On the basis of those regulations, the taxpayers making transactions, including conclusion of the memorandum and the articles of association of the company that does not constitute a legal person, joint venture agreement or similar agreements with entities related to those taxpayers or transactions in respect of which the payment of claims arising from such transactions is made directly or indirectly to an entity resident, with its registered office or management in the territory or in the country applying harmful tax competition, are obliged to prepare tax documentation of such transactions, if the limits specified below are exceeded:
- EUR 100,000 – if the value of the transaction does not exceed 20% of the share capital, as determined in accordance with Article 16 paragraph 7 (only for legal persons), or
- EUR 30,000 – in the case of services, sales or making intangible assets available, or
- EUR 50,000 – in other cases.
- 20,000 EURO – for transactions in which one of the parties to such an agreement is an entity domiciled, with its registered office or management in the territory or in the country applying harmful tax competition.
Characteristics of relations
With regards to the obligation to prepare tax documentation, a key issue remains to define the notion of a related entity. The definition of related entities is contained in Article 11 paragraph 1, 4 – 6 of the Income Tax Act from legal persons and Article 25 paragraph 1, 4 6 of the Income Tax Act from individuals. Related entity, within the meaning of the aforementioned provisions, can be both a domestic entity or a foreign entity.
In terms of the relationship between a domestic and a foreign entity, the entities are considered related when they meet one of the following criteria:
- domestic entity participates directly or indirectly in the management of the enterprise situated abroad or in its control or has a share in the capital of this enterprise, or
- foreign entity participates directly or indirectly in the management of the domestic entity, or in its control or has a share in the capital of the domestic entity, or
- the same natural or legal persons simultaneously participate directly or indirectly in the management of a domestic entity and a foreign entity or in its control or participate in the capital of those entities.
In terms of the relationship between domestic entities, the entities are considered related when they meet one of the following criteria:
- domestic entity participates directly or indirectly in the management of other domestic entity, or in its control or has a share in the capital of another domestic entity, or
- the same natural or legal persons simultaneously participate directly or indirectly in the management of domestic entities or in their control or have a share in the capital of those entities.
Direct or indirect participation in the management or control of the entity should be considered as exerting real influence on strategic decision-making and control of the company, not only to fulfill formal functions, e.g. in the management or supervisory board of another entity. The provision does not limit the scope of this concept only to the powers of a formal nature.
However, having a share in the capital of another entity means a situation in which the entity has, directly or indirectly, share in the capital of another entity which is no less than 5%. In turn, while defining the size of indirect participation that the entity has in the capital of another entity, the principle which is adopted states that if one entity holds a given share in the capital of the other entity, and the other entity has the same share in still another entity, then the first entity has an indirect share in the capital of another entity in the same amount. If the values are different, the lower value is considered as the amount of indirect participation.
This principle also applies to the relations of the family nature or arising out of employment or assets between domestic entities or persons holding management, control or supervision functions in these entities or in the situation when any person combines the functions of management or control or supervision in those entities. The family relations term is understood as a marriage, kinship or affinity to the second degree.
A special documentation duty is associated with making transactions with an entity resident, with its registered office or management in the territory or in the country applying harmful tax competition. With this type of transaction, documentation obligation exists regardless of the existence of the above mentioned relations. The list of countries and territories in which harmful tax competition is applied can be found in the Regulations of the Minister of Finance dated 23 April 2015 on determining the countries and territories applying harmful tax competition in the field of income tax from legal entities and individuals.
Elements of tax documentation
Tax regulations which impose a documentation obligation, do not determine directly the pattern of tax documentation. However, the rules define certain fixed elements that the documentation should contain. First, the contents of the documentation determine the functions that parties to the transaction are supposed to fulfill, including the information on which party performs more important functions. Under this item, participants should take into account assets used and risks taken, considering its distribution between participants in the transaction.
The second part of the documentation should include a description of all costs associated with the transaction as well as the form and the deadline of payment. The tax law does not define the following term that is used, i.e. all anticipated costs related to the transaction. It should be assumed that they will undoubtedly costs which are directly related to the payment for the transaction object, but also other additional costs incurred in connection with the transaction. Their kind will depend on the characteristics of the transaction. Such costs are usually not included in the price, but they influence determination of the transaction profitability, that is, in consequence, its market character.
A key part of the documentation is an indication of the method used and the profit calculation method as well as determination of the transaction objects price. The methods of calculation are defined in the regulation implementing the Income Tax Acts. The most common one is called the comparable uncontrolled price method. It is based on a comparison of prices for products and services used in comparable transactions between independent entities. Comparability analysis when using the comparable uncontrolled price method should include, in particular, the quality of services or products, the distribution of contractual rights and obligations of the parties as well as the volume of mutual turnover or responsibility for non-performance or improper performance of an obligation.
Documentation concerning, in particular, benefits of an intangible nature should include a description of the expected benefits associated with obtaining the benefits under the transaction by the entity obliged to make the transaction. This section applies to both temporal associated benefits achieved by the entity as well as the benefits that can be revealed in the long term of its operation.
The last part of the documentation constitutes a description of the economic strategy of the taxpayer. In accordance with the aforesaid regulation implementing the Act, this point of the documentation should include information on using promotional prices when entering the market, temporary reduction of profits in exchange for higher long-term returns, bearing higher costs for a certain period of time in order to stay on the market or to acquire a new one and to market innovative products or services. At this point, it is also worth referring to other circumstances having a real impact on the transaction value.
The sanctions which pose a threat to an entity for non-completion of the compulsory tax documentation of transfer pricing should be divided into tax penalties and penal fiscal sanctions.
- Tax penalties – 50% sanction rate
The basic sanction is a 50% tax rate referred to in Article 19 paragraph 4 of the Law on income tax from legal persons and Article 30d of the Income Tax Act from individuals. Under these provisions, the failure to submit obligatory tax documentation results in imposing a penal tax rate of 50% calculated on the taxable amount which is the difference between the income determined by the tax authority and the one declared by the taxpayer. It should be emphasized that the use of the rate of 50% does not relieve persons responsible for financial and economic affairs in companies or self-employed entities or those who are the members of partnerships from the liability under the provisions of the Penal Fiscal Code.
- Penal fiscal sanctions – fine.
In addition to the abovementioned tax sanctions, failure to comply with the obligation to submit documentation of transactions with a related entity results in the fulfillment of the constituent elements of the tax offense defined in Article 80(1) of the Penal Fiscal Code. This provision stipulates that anyone who does not submit required tax information to the competent authority within the proper time, will be punished with a fine of up to 120 daily rates, if an additional tax liability arises in the course of the tax proceedings. Under the Penal Fiscal Code, daily rate cannot be less than one thirtieth of the lowest monthly salary during the ruling in the first instance or exceed its four-hundredfold. Assuming the average salary in August 2016 4t 4,250 Polish zloty, the fine for the abovementioned offense may reach the amount of 1,700,000 PLN.