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Transfer pricing analysis

Demonstrating that transfer prices are at arm's length calls for a detailed analysis of transactions carried out between related parties and between independent parties.

This analysis involves comparing financial data, including commercial data, in the following form:

  • internal, on the basis of internal data on identical or similar transactions
  • external, on the basis of market data on comparable transactions

Under the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD, Paris, 2010 and OECD, Paris, 2017), a comparability analysis means applying the arm's length principle by comparing the conditions of a transaction between related parties with the conditions of a transaction between independent parties. For such a comparison to be valid, the characteristics of the economic situations taken into account must be comparable. This means that none of the possible differences between the situations compared may materially affect the condition under examination from a methodological point of view, such as the price or the margin, or that reasonably accurate adjustments can be made to eliminate the effect of any differences.

Establishing the degree of comparability

When establishing the degree of comparability, and in particular the adjustments that should be made in order to achieve comparability, it is necessary to understand well how independent companies evaluate potential transactions. When evaluating a transaction, independent parties compare it with other realistically available transactions and will conclude it only if no more attractive option exists. An independent party will not, for example, accept the price offered for its product by other independent parties if it knows there are potential customers willing to pay more. This element matters for comparability, because independent parties normally take into account all economically significant differences between the options realistically available to them, such as differences in the level of risk or other comparability factors.

All methods of examining transfer prices based on the arm's length principle assume that, when independent parties consider the options available and compare them, they take into account those differences between them that may significantly affect their value. It is therefore to be expected that, before buying a product at a given price, independent enterprises will consider whether they can buy the same product at a lower price from another party. In all cases adjustments have to be made to take account of differences between intra-group transactions and external transactions that significantly affect the price applied or the return required by independent parties.

Comparability factors

As already noted, when making comparisons the material differences between the transactions or enterprises compared have to be taken into account. In order to determine the degree of actual comparability and then make the appropriate adjustments to establish arm's length conditions, or a set of them, it is necessary to compare those features of the transactions or enterprises that may affect arm's length conditions. They include:

  • the characteristics of the goods or services transferred
  • the functions performed by the parties, taking into account the assets used and the risks assumed
  • the contractual terms
  • the economic circumstances of the parties, and
  • the business and industrial strategies they pursue.

The weight of each of these factors in establishing comparability depends on the nature of the transaction between the related enterprises and on the pricing method adopted.

Preparing transfer pricing analyses properly can be a considerable challenge for taxpayers. The time involved and the significant effort needed to gather and correctly present comparable data frequently call for specialist knowledge and skills. Obtaining analytical comparable data usually means having to use commercial databases, which may also be a financial burden for the taxpayer. There are firms on the Polish market offering professional advisory services in this area.

The legal position in 2019

Since 1 January 2019 a transfer pricing analysis has been a mandatory part of the local transfer pricing documentation.

Entities are required to prepare a transfer pricing analysis in one of two available forms:

  • a benchmarking study, or
  • a compliance analysis, where preparing a benchmarking study is not appropriate in the light of the transfer pricing method applied or is not possible while exercising due care.

Both the benchmarking study and the compliance analysis have to be updated at least once every three years, unless a change in the economic environment that significantly affects the analysis prepared justifies an update in the year in which that change occurs.

The assessment of whether the conditions set by related parties correspond to the conditions that unrelated parties would have agreed between themselves, that is the comparability review, has to be carried out taking into account in particular the following comparability criteria:

  • the characteristics of the goods, services or other performance,
  • the course of the transaction, including the functions performed by the parties in comparable transactions, the assets they engage and the risks they assume, taking into account the capacity of the parties to perform the given function and to bear the given risk,
  • the conditions of the transaction set out in the contract, agreement or other evidence documenting those conditions,
  • the economic conditions prevailing at the time and place at which the transaction was carried out,
  • the business strategy
  • to the extent that these criteria have or may have a material effect on the conditions agreed or imposed between related parties.

The comparability review consists of the following stages:

  • determining the period that the review should cover,
  • analysing information about the related party and its economic environment,
  • analysing all the circumstances of the controlled transaction under review that may materially affect the level of the transfer price, taking into account the functions performed, the assets engaged and the risks assumed and, where the application of the most appropriate method so requires, selecting the tested party,
  • checking whether internal comparable data exist that can be used for the purposes of the comparability review,
  • identifying the available external sources of comparable data,
  • selecting the most appropriate method and financial indicator, where an analysis of a financial indicator is necessary for the most appropriate method to be applied correctly,
  • analysing the available comparable data, in particular as regards their comparability with the transaction under review,
  • making comparability adjustments where these are necessary to achieve a higher degree of comparability between the comparable data and the controlled transaction under review,
  • calculating the results of the comparability review and interpreting them.

The legal position in 2017

Since 1 January 2017 a benchmarking study has been a mandatory part of transfer pricing documentation once the taxpayer exceeds a defined level of revenue or costs.

The obligation to prepare an analysis of comparable data applies to entities:

  • whose revenue or costs within the meaning of the accounting regulations, determined on the basis of the accounting records kept, exceeded the equivalent of EUR 10,000,000.00 in the year preceding the tax year, or
  • holding an interest in a company that is not a legal person whose revenue or costs, within the meaning of the accounting regulations applicable to that company, exceeded the equivalent of EUR 10,000,000.00 in the previous financial year.

An analysis of comparable data (benchmark) is an analysis of data of independent entities (external data) or of data agreed with an independent entity (internal data), regarded as comparable to the conditions established in the transactions or other events, used to calculate the settlements, together with an indication of those sources.

Where there are no data with which to carry out an analysis of comparable data, the taxpayer prepares a description of the conformity of the conditions of the transaction and other events agreed with related parties with the conditions that independent parties would have agreed between themselves. The condition for preparing an analysis of comparable data is that comparable data are held on entities having their registered office or management in the territory of the Republic of Poland.

ELEMENTS OF AN ANALYSIS OF COMPARABLE DATA:

In the Regulation of the Minister of Finance of 12 September 2017 on the information contained in tax documentation for corporate income tax and personal income tax purposes, the legislator set out the information that an analysis of comparable data should contain:

  • the parties to the transaction or other event that are the subject of the analysis of comparable data and, where the manner of applying the method of calculating income (loss) so requires, two or more parties to the transaction or other event, together with an explanation of the reasons for selecting the party analysed,
  • the assumptions underlying the analysis of comparable data that affect the market value of the subject of the transaction or other event, together with a justification of the reasons for finding that the given choice makes it possible, on the basis of the data and information available, to achieve the greatest comparability of transactions or other events, as regards:

the characteristics of the goods, services or other performance that are the subject of the transactions or other events compared,

the course of the transaction or other event, including the functional analysis,

the conditions set out in the transactions or other events compared,

the conditions existing on the markets compared, including the comparability criteria affecting the recognition of a given geographical area, domestic or foreign, as a comparable market,

the business strategy applied,

  • the reasons for using comparable data from a single year or multi-year data, used to analyse the economic situation of the independent entities regarded as comparable,
  • the comparable data, including financial data or financial indicators, relating to business operations with independent parties or concluded between independent parties, which the taxpayer used in applying the method of calculating income (loss) or rejected for lack of comparability, stating the source of those data and how they were obtained, together with the prices or financial indicators relating to those transactions or other events,
  • the adjustments applied, together with a justification of the need to make them, within the scope indicated in point b, eliminating the discrepancies between the comparable data used concerning transactions, other events or entities and the transaction or other event analysed,
  • the point or arm's length range determined, together with a description of any statistical measures used for that purpose, and a justification for finding that the conditions of the transaction or other event do not differ from the conditions that independent parties would have agreed between themselves,
  • the reasons for the absence of any of the information indicated in points b to f, where carrying out the analysis of comparable data does not require it to be held or used.

In addition, the advisory body established at the Ministry of Finance, the Transfer Pricing Forum, issued a document in December 2018: Recommendations on the technical aspects of preparing benchmarking studies, published on the website of the Ministry of Finance.

That document covers the following issues:

  • the criterion of locality and availability of data,
  • the possibility of using internal data,
  • the possibility of using quoted prices,
  • the use of so-called secret comparables,
  • whether it is justified to reject loss-making entities,
  • the minimum sample size,
  • the choice of a point within the range,
  • updating the benchmarking study,

The full text of the document is available on the website of the Ministry of Finance:

https://www.podatki.gov.pl/media/3133/20181221_rekomendacje_fct_dot_analiz_por%C3%B3wnawczych_iv_fct.pdf

ELEMENTS OF A COMPLIANCE DESCRIPTION

In January 2017 the legal system introduced the so-called description of the conformity of the conditions of transactions and other events agreed with related parties with the conditions that independent parties would have agreed between themselves (also referred to below as the compliance description).

Where it is not possible to demonstrate that a transaction is at arm's length by preparing a benchmarking study, that is where neither internal nor external comparable data are available, the taxpayer proceeds to prepare a compliance description. It is to substantiate the arm's length level of the remuneration adopted by the parties to the transaction, that is remuneration that independent parties would have accepted in a comparable situation. The form and the elements of the compliance description are largely left to the taxpayer. As part of the tax documentation, the compliance description should explain why independent parties would have accepted the settlements adopted in the given transaction had no relationship existed between them. The burden of proving the arm's length character of the remuneration is in such a case a considerable one for taxpayers.

Under the published Recommendations of the Fourth Transfer Pricing Forum (the advisory body at the Ministry of Finance) on preparing descriptions of the conformity of the conditions of transactions and other events agreed with related parties with the conditions that independent parties would have agreed between themselves, published on the website of the Ministry of Finance, a taxpayer preparing such a compliance description takes the following elements into account:

  • Anything that may directly or indirectly indicate that a transaction is at arm's length should be admissible within the meaning of Article 9a(2c) of the CIT Act and Article 25a(2c) of the PIT Act as a description of conformity with the conditions that independent parties would have agreed between themselves.
  • A compliance description may be any study or line of reasoning by which the taxpayer makes it plausible that the conditions applied in transactions or other events between related parties are in line with the conditions that independent parties would have agreed between themselves.
  • The description should make it plausible, in a logical manner, that in concluding the transaction the taxpayer was guided by rational economic considerations and that the conditions applied in the transaction are in line with those that independent parties would have agreed between themselves.
  • A compliance description may take any form. It may be, among other things, a study containing a written description, a table, a diagram, a graph, or several of these forms together or in an appropriate combination.
  • When preparing a study containing a compliance description, the taxpayer

https://www.podatki.gov.pl/media/3132/20181221_rekomendacje_fct_dot_opisu_zgodno%C5%9Bci_iv_fct.pdf

The legal position in 2016

Under the legal position in force until 31 December 2016, preparing a benchmarking study was optional for the taxpayer.

It was only on 18 July 2013 that rules on the methodology for preparing a benchmarking study were introduced into Polish tax law. In connection with the amendment to the transfer pricing regulation (Regulation of the Minister of Finance of 10 September 2009 on the manner and procedure for determining the income of natural persons by way of estimation and on the manner and procedure for eliminating double taxation of natural persons in the event of an adjustment of the profits of related parties), a list of stages was introduced that should be taken into account when preparing a benchmarking study:

In order to determine the degree of actual comparability and then make the appropriate adjustments to establish arm's length conditions, or a set of them, it is necessary to compare those features of the transactions or enterprises that may affect arm's length conditions. They include:

STAGES of carrying out a comparability analysis:

1) a general analysis of information concerning the taxpayer and its economic environment;

2) an analysis of the conditions agreed or imposed between related parties, in particular on the basis of the functions they perform, the assets they engage and the risks they assume, as a result of which the economically significant factors in the circumstances under examination are to be identified, taking into account the comparability factors (§ 6(3));

3) checking whether it is possible to compare the conditions agreed or imposed between related parties with the conditions applied by the given party in dealings with independent parties;

4) identifying and verifying comparable conditions established by independent parties;

5) selecting the method most appropriate in the circumstances of the case, taking into account the rules laid down in § 3(2a), and then determining whether a profitability indicator needs to be applied and selecting the type appropriate for the chosen method;

6) identifying comparable data for the chosen method on the basis of the economically significant factors referred to in point 2, and determining whether the adjustments referred to in paragraph 2 need to be made;

7) analysing the comparable data obtained.

Although, as follows directly from the text of the transfer pricing regulation, it is the tax or fiscal audit authorities and not taxpayers who are required to apply the guidance it contains, that guidance may nonetheless serve as a kind of pointer for taxpayers preparing an analysis. Taxpayers may additionally be guided by Chapter III of the OECD Guidelines.

It should at the same time be noted that the provisions of the regulation concerning benchmarking studies are not binding on taxpayers