Proving that transfer pricing is arm’s length concerns a detailed analysis of transactions between related entities and between independent entities.
This analysis includes a comparison of financial data (including commercial data) in the form of:
- internal (based on internal data in the field of identical or similar transactions)
- external (based on market data for comparable transactions)
According to the OECD Guidelines on Transfer Pricing for Multinational Enterprises and Tax Administrations (OECD, Paris, 2010 and OECD, Paris, 2017), comparability analysis means the application of the arm’s length principle where the terms of a related party transaction are compared with the terms of a transaction between entities independent. For such a comparison to be valid, the characteristics of the economic situation taken into account must be comparable. This means that any possible difference between the situations being compared must not significantly affect the condition considered from a methodological point of view (e.g. price or margin) or that reasonable fine adjustments can be made to eliminate the effect of any differences.
Determining the degree of comparability
When determining the degree of comparability, and in particular the adjustments that should be made to achieve the condition of comparability, it is important to have a good understanding of how independent companies evaluate potential transactions. When assessing a transaction, independent entities compare it with other realistically possible transactions and will only conclude it if it is not more attractive. For example, a third party will not accept the price of its product by other third parties if it knows there are potential customers willing to pay more. This element is relevant to the comparability problem as independent parties typically take into account any economically significant differences between options that are realistically available (such as differences in the level of risk or other comparability factors).
All methods of transfer pricing research based on the arm’s length principle assume that independent entities, when considering the available options and comparing them, take into account the differences between them, which may significantly affect their value. Thus, it is to be expected that, before buying a product at a given price, independent companies will consider whether they can buy the same product at a lower price from another entity. In all cases, adjustments should be made for differences between intra-group and external transactions that have a significant effect on the price applied or the return required by independent parties.
Comparability factors
As already noted, when making comparisons, significant differences between the transactions or companies being compared should be taken into account. In order to determine the degree of effective comparability and then to make appropriate adjustments to establish free market conditions (or a set of them), it is necessary to compare the features of transactions or enterprises that may affect the terms of free market transactions. They include:
- the characteristics of the goods or services transferred
- functions performed by the parties (taking into account the assets used and the risks taken)
- contractual conditions
- the economic standing of the parties, and
- their commercial and industrial strategies.
The importance of each of these factors in determining comparability depends on the nature of the related party transaction and the pricing method adopted.
Reliable preparation of transfer pricing analyzes can be quite a challenge for taxpayers. The time-consuming and significant workload necessary to collect and properly present comparative data often requires professional knowledge and skills. Obtaining comparative analytical data is most often associated with the need to use commercial databases, which undoubtedly may also constitute a financial burden for the taxpayer. There are entities on the Polish market that offer professional advisory services in this area.
Legal status 2019
From January 1, 2019, transfer pricing analysis is a mandatory element of the local transfer pricing documentation.
Entities are required to prepare a transfer pricing analysis in one of the two available forms:
- comparative analysis , or
- compliance analysis – if the preparation of a comparative analysis is not appropriate
in the light of a given method of transfer pricing verification or it is not possible with due diligence.
The comparative analysis and the compliance analysis are updated at least every 3 years , unless a change in the economic environment significantly influences the prepared analysis and justifies updating in the year when this change occurs.
The assessment of compliance of the conditions set by related entities with the conditions that would be established by unrelated entities (comparability test) should be carried out taking into account in particular the following comparability criteria:
- characteristics of goods, services or other benefits,
- the course of the transaction, including the functions performed by entities in comparable transactions, the assets they engage and the risks incurred, taking into account the ability of the parties to the transaction to perform a given function and bear a given risk,
- the terms of the transaction specified in the contract, agreement or other evidence documenting these terms,
- economic conditions at the time and place where the transaction was made,
- economic strategy
- to the extent that these criteria have or may have a significant effect on the terms established or imposed between related parties.
The comparability test includes the following stages:
- specification of the period that should be covered by the study,
- analysis of information about the related entity and its economic environment,
- analysis of all circumstances of the audited controlled transaction that may have a significant impact on the level of the transfer price, taking into account the functions performed, the assets involved and the risks incurred, and, if required by the application of the most appropriate method, the selection of the audited entity,
- verifying that there are internal comparative data that can be used for a comparability test,
- identification of available external sources of comparative data,
- selection of the most appropriate method and financial indicator, when the analysis of the financial indicator is necessary for the correct application of the most appropriate method,
- analysis of the available comparative data, in particular in terms of their comparability
with the audited transaction, - making comparability adjustments, if they are necessary to obtain a higher degree of comparability of comparative data to the audited controlled transaction,
- calculation of the results of the comparability test and their interpretation.
Legal status 2017
From January 1, 2017, the comparative analysis is a mandatory element of transfer pricing documentation after the taxpayer exceeds a certain level of revenues or costs.
The obligation to prepare an analysis of comparative data applies to entities:
- whose revenues or costs, within the meaning of the accounting regulations, determined on the basis of the books of account, exceeded the equivalent of EUR 10,000,000.00 in the year preceding the tax year, or
- holding shares in a company which is not a legal person, the income or costs of which, within the meaning of the accounting regulations applicable to that company, exceeded in the previous financial year within the meaning of the regulations by the equivalent of EUR 10,000,000.00.
Comparative data analysis (benchmark) – analysis of data from independent entities (external data) or data agreed with an independent entity (internal data) considered comparable to the conditions set in transactions or other events used for the calculation of settlements, together with the indication of these sources.
The condition for the preparation of an analysis of comparative data is the possession of comparable data
on entities with their registered office or management board in the territory of the Republic of Poland.
In the absence of data for the analysis of comparative data, the taxpayer prepares a description of the compliance of the terms of the transaction and other events agreed with related entities with the terms that would be agreed between independent entities.
COMPARATIVE DATA ANALYSIS ELEMENTS:
The legislator, in the regulation of the Minister of Finance of On September 12, 2017 regarding the information contained in the tax documentation in the field of corporate income tax / personal income tax, the following information should be included in the analysis of comparative data:
- parties to the transaction or other event that are subject to comparative data analysis,
and if required by the method of applying the income (loss) calculation method – two or more parties to the transaction or other event, together with an explanation of the reasons for selecting the analyzed party to the transaction or other event, - assumptions underlying the analysis of comparative data that affect the market value of the subject of the transaction or other event, together with the reasons for considering that a given selection allows for the best comparability of transactions or other events to be obtained, based on the available data and information, in terms of:
– characteristics of goods, services or other benefits that are the subject of comparable transactions or other events,
– the course of a transaction or other event, including functional analysis,
– the conditions specified in the transactions or other events being compared,
– conditions existing on the compared markets, including comparability criteria affecting the recognition of a given geographic area, domestic or foreign,
as a comparable market,
– the economic strategy used,
- the reasons for using comparative data from one year or multi-year data used to analyze the economic situation of independent entities considered comparable,
- comparative data, including financial data or financial ratios, relating to business transactions with independent entities or concluded between independent entities, which the taxpayer used to apply the income (loss) calculation method or which was rejected due to lack of comparability, providing information about the source and the method of obtaining this data as well as prices or financial ratios relating to these transactions or other events,
- the applied adjustments, together with the justification for the necessity to make them, to the extent indicated in point (a). b, eliminating the discrepancies between the used comparative data concerning transactions, other events or entities and the analyzed transaction or other event,
- a designated point or market range with a description of the possible use of statistical measures for this purpose, together with the justification for assuming that the terms of the transaction or other event do not differ from the terms that would be established by independent entities,
- the reasons for the lack of any of the information referred to in point (a) b – f – when the analysis of comparative data does not require their possession or use.
In addition, the opinion-making and advisory team established at the Ministry of Finance, ie the Transfer Pricing Forum, issued in December 2018 the document “Recommendations regarding the technical aspects of preparing comparative analyzes were published on the website of the Ministry of Finance”.
This document covers the following:
- the criterion of the locality and availability of data,
- the possibility of using internal data,
- possibility to use offer data,
- the use of the so-called secret comparables,
- legitimacy of rejecting entities at a loss,
- minimum sample size,
- selecting a point from the interval,
- updating the comparative analysis,
The full content of the document is available on the website of the Ministry of Finance:
ELEMENTS OF THE CONFORMITY DESCRIPTION
From January 2017, the so-called description of compliance of the terms of transactions and other events agreed with related entities, with terms that would be agreed between independent entities (hereinafter also: “description of compliance of terms”)
If it is not possible to demonstrate the marketability of the transaction by preparing a comparative analysis, i.e. in the absence of both internal and external comparative data to prepare the analysis, the taxpayer proceeds to prepare a description of compliance of the terms. It is to justify the market level of remuneration adopted by the parties to a given transaction, i.e. such remuneration that would be accepted by independent entities in an analogous situation.. The issue of the form and elements of the description of compliance remains largely the responsibility of the taxpayer. The description of compliance as an element of the tax documentation should include an explanation why independent entities would accept the settlements accepted in a given transaction if there were no links between them. The burden of proving the arm’s-length nature of the remuneration represents a significant burden on the taxpayers.
In accordance with the published Recommendations of the 4th Transfer Pricing Forum (consultative and advisory team at the Ministry of Finance) regarding the preparation of descriptions of compliance of transaction conditions and other events agreed with related entities with terms that would be agreed between independent entities published on the website of the Ministry of Finance, the taxpayer proceeding to prepare the description of compliance of the terms of transactions or other events agreed with related entities with terms that would be agreed between independent entities takes into account the following elements:
- Anything that may directly or indirectly indicate that the transaction is market-oriented should be allowed within the meaning of Art. 9a (2c) of the CIT Act and Art. 25a (2c) of the PIT Act as a description of compliance with the conditions that would be established by independent entities.
- A description of compliance may be any study or argument under which the taxpayer can reasonably believe that the terms used in transactions or other events between related parties are consistent with terms that would be agreed between independent entities.
- The description should logically prove that the taxpayer, when concluding the transaction, was guided by rational economic conditions and the conditions used in the transaction comply with the conditions that would be established by independent entities.
- The description of compliance may take any form. The description of compliance may be, inter alia, a study containing a verbal description, tabular summary, diagram, graph or several of these forms together or in an appropriate configuration.
- When preparing a study containing a description of compliance, the taxpayer
The full content of the document is available on the website of the Ministry of Finance:
https://www.podatki.gov.pl/media/3132/20181221_rekomendacje_fct_dot_opisu_zgodno%C5%9Bci_iv_fct.pdf
Legal status 2016
In the legal status valid until December 31, 2016, the preparation of a comparative analysis by the taxpayer was optional.
Only from 18.07. In 2013, regulations regarding the methodology of preparing a comparative analysis were introduced to Polish tax regulations. In connection with the amendment to the content of the transfer pricing ordinance (Regulation of the Minister of Finance of 10/09/2009 on the method and procedure for determining the income of natural persons by way of estimation and the method and procedure for eliminating double taxation of natural persons in the case of adjusting profits of related entities) a list of steps that should be considered when compiling a comparative analysis:
In order to determine the degree of effective comparability and then to make appropriate adjustments to establish free market conditions (or a set of them), it is necessary to compare the features of transactions or enterprises that may affect the terms of free market transactions. They include:
- the characteristics of the goods or services transferred
- functions performed by the parties (taking into account the assets used and the risks taken)
- contractual conditions
- the economic standing of the parties, and
- their commercial and industrial strategies.
STAGES of the comparability analysis :
1) general analysis of information on the taxpayer and its economic environment;
2) analysis of the conditions established or imposed between related parties, in particular on the basis of the functions performed by them, the assets involved and the risks incurred, as a result of which factors economically significant in the circumstances of the case under examination should be identified, taking into account comparability factors (§ 6 (3)) ;
3) checking whether it is possible to compare the conditions established or imposed between related entities with the conditions applied by a given entity with independent entities;
4) identification and verification of comparable conditions set by independent entities;
5) selection of the most appropriate method in the given circumstances of the case, taking into account the principles set out in § 3 sec. 2A, and then determining the need to use the profitability ratio and selecting its type appropriate for the selected method;
6) identification of comparative data for the selected method on the basis of the economically significant factors referred to in point 2, and determination of the need to make the corrections referred to in para. 2;
7) analysis of the obtained comparative data.
Although, as it is clear from the content of the transfer pricing regulation, the tax authorities or fiscal control authorities, and not taxpayers, are obliged to apply the guidelines contained therein, they may constitute a kind of guidance for taxpayers when preparing the analysis. In addition, taxpayers may also be guided by the content of Chapter III of the OECD Guidelines.
At the same time, it should be pointed out that the provisions of the regulation concerning comparative analysis are not binding on taxpayers