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Tax Alert: Transfer pricing adjustments in practice


08.01.2020

Tax Alert: Transfer pricing adjustments in practice

The year end is a busy time for taxpayers making settlements with business partners. For transactions carried out with related parties, new principles of transfer pricing adjustments should be in place for transactions entered into after 1 January 2019.

On 1 January 2019 Chapter 1a (covering articles 11a - art. 11t) concerning transfer pricing and adjustments thereof was added to the CIT Act. Article 11e of the CIT Act regulates transfer pricing adjustment matters. Following this regulation, the taxpayer may adjust transfer prices by way of changing the level of revenues generated or tax costs incurred, provided that the following conditions are fulfilled jointly:

  1. for controlled transactions carried out by the taxpayer during the tax year, such conditions were established as would be established by unrelated parties;
  2. a change occurred of important circumstances affecting the conditions established during the tax year, or actual costs incurred or revenues generated - which constitute a basis for calculating transfer prices - become known and their compliance with conditions that would be established between unrelated parties requires a transfer pricing adjustment to be made;
  3. upon making such an adjustment, the taxpayer holds a related party’s statement to the effect that this party made the same transfer pricing adjustment as the taxpayer did;
  4. a related party referred to in point 3 resides, has its registered office or place of management in the Republic of Poland, or in a country or in the territory with which the Republic of Poland entered into a double taxation agreement and a legal basis exists for the exchange of tax information with that country;
  5. the taxpayer confirms the transfer pricing adjustment in the annual tax return to which the adjustment refers.

Taxpayers’ doubts and uncertainties are caused by whether transfer pricing adjustment covers all adjustments to the price/remuneration in transactions with related parties or whether in practice the regulations in question apply only to a specific type of adjustments, i.e. profitability (set-off) adjustments?

A review of recent tax rulings could be of assistance in clarifying this issue.

Example 1

Operational support services (covering e.g. HR and payroll, IT, accounting services) are provided to related parties by a specialized service centre (in Poland or abroad).

In practice, the remuneration for such centralized services is based on estimated planned costs connected with the provision thereof. However, despite due care being exercised by the service provider, it is difficult to foresee all the expenses connected with its services. Thus, in practice certain deviations between the budget assumed and the actual costs are unavoidable. Hence the need to make  (frequently at the year end) a secondary settlement of costs, this time based on the actual costs of the services provided to related parties.

In accordance with authorities’ rulings (e.g. individual ruling no. 566743/I of 29 Nov. 2019), adjustments arising from such a secondary settlement do not constitute adjustments referred to in article 11e of the CIT Act.

 

Adjustments arising from the secondary settlement belong to contractual adjustments which are not caused by an accounting error or mistake, and the frequency and principles of which have been determined between the transaction parties; their basic goal is to eliminate differences arising from updating the cost base that constitutes a basis for valuing the services, or from deviations caused by the scope or volume of the service actually provided; such adjustments, therefore, should be settled based on general principles, i.e. in accordance with article 12 sections 3j and 3k (for revenues) and article 15 sections 4i and 4j of the CIT Act (for costs).

The only condition to make such adjustments is to issue or receive an adjustment invoice, while in order to make effective use of them for determination of a(n) income/loss - no statement referred to in article 11e point 3 is needed and no additional confirmation of the adjustments is needed in the annual tax return to which such adjustments referred (in accordance with article 11e  point 5 of the CIT Act).

 

Example 2

A related party carrying out operations in Poland (the company A Sp. z o.o.) transacts with its related party acting within the Group as the European Supply Centre and purchases from it goods intended for distribution in Poland. The transfer pricing model applied within the Group envisages a profitability (set-off) adjustment at the year end, the purpose of which is to bring particular financial results of related parties acting within a value chain to the level compliant with the arm’s length principle. The purpose of such adjustments is to correctly distribute the income/profit between the related transaction participants. The adjustment value does not apply to concrete deliveries of goods having been made to A Sp. z o.o. Nor does the adjustment refer to concrete invoices documenting deliveries of specific goods during the year, or to prices or quantities of the goods delivered to A.

Following the authorities’ stance (e.g. individual ruling no. 566743/I of 24 June 2019), this type of adjustments (i.e. set-off adjustments) intended to level off the expected profitability (having been disrupted by the occurrence of hard-to-predict business circumstances) complies with the definition set out in article 11e of the CIT Act.

Consequently, the company A will have to, first of all, prove the correctness of the prices used, i.e. show that the arm’s length principle was applied at the transaction planning stage and that the financial assumptions themselves for the transaction followed the same principle. To this effect, A should hold appropriate transfer pricing documentation supported by a benchmark analysis, showing price calculation principles and a justification for the selection of a transfer pricing method and mark ups or margins.

Secondly, if a difference occurs in the planned and actual transaction results after the year end, the company A should be able to justify that the difference arises from objective circumstances (being beyond the taxpayer's control at the transaction planning stage). For instance, such independent circumstances could refer to changes in the prices of raw materials or salaries, which cannot have been predicted while the transaction was being planned. However, they will not refer to price determination errors.

Thirdly, upon making such an adjustment, the company A holds a related party’s statement to the effect that this party made the same transfer pricing adjustment as the taxpayer A. Fourthly, the taxpayer will indicate in a tax return that it made the said adjustment.

The aforesaid principles will apply only in a situation where the registered office of A's related party is located in a country with which Poland entered into a double taxation agreement and a legal basis exists for the exchange of tax information with that country.

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