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Transfer Pricing adjustments in multinational enterprises: yet another challenge for taxpayers

Transfer Pricing: yet another challenge for taxpayers

In recent years, unfavourable decisions issued by tax authorities and lack of uniform approach in the judgments of administrative courts increased uncertainty around the tax implications of transfer pricing adjustments. New regulations that have been effective as of 2019, envisioned and designed as a solution to this growing uncertainty, might now be a source of new challenges for taxpayers.

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Scope of transfer pricing adjustments

Transfer pricing adjustments (profitability adjustments) are applied by multinationals and groups of companies to adjust the transfer prices in transactions between related entities so that they are at arm's length level. Such adjustments are usually based on analyses of comparative data (benchmarking analysis) performed.

Typically, taxpayers undertake adjustments to transfer prices after the end of their tax year, when they have knowledge of any circumstances that might have affected the profitability of their intra-group transactions during the given year. Such circumstances may include exchange rate fluctuations or the actual cost of the transaction (if, for example, the cost was only estimated or assumed (cost budgeting) during the year.

Although the adjustment mechanism is commonly used by groups of companies, and the possibility of making such adjustments is indicated in the OECD Guidelines (i.e. compensating adjustment), the rules governing the recognition of such adjustments for CIT purposes and determining the moment of recognition had not became part of the Corporate Income Tax Act until the beginning of 2019.

The uncertainty of the tax implications resulting from application of this mechanism in previous years will affect taxpayers for quite some time, even after implementation of the new rules.

Approaches adopted by Polish tax authorities and administrative courts

Depending on the economic effect (“direction”) of the TP adjustment (i.e. either ‘plus’ or ‘minus’), the final amount of corporate income tax liability may be either increased or reduced as a result of increasing or reducing the taxable revenue or costs. As transfer pricing adjustments are made typically after the end of the tax year, taxpayers may document such adjustments in a variety of ways and different approaches to recognize them in their accounting books. A transfer pricing adjustment can be recognized in the books of the financial year, which it relates to - both through posting a reserve (accrual) as well as posting the document itself, which may still be issued in the year, to which it refers, or after year-end. All such circumstances regarding the methods of recognizing transfer pricing adjustments in accounting books and their documentation had to be considered by taxpayers when determining the moment of recognition of these adjustments for income tax purposes. Before the new regulation was introduced, the tax implications of transfer pricing adjustments were determined by general rules contained in the Corporate Income Tax Act as regards both the right to recognize adjustments for CIT purposes as such and the moment of their recognition (under provisions on corrections of costs or revenue, or under the general rules of the Corporate Income Tax Act).

Under the general rules of the Corporate Income Tax Act, tax authorities have, in recent years, developed an approach unfavourable for taxpayers in this respect especially in the case of transfer pricing adjustments documented with a single document, where adjustments are made with respect to a particular period, and not to specified with particular transactions.

In relation to such documented transfer pricing adjustments, where they led to an increase in the tax base, the comments of the tax authorities were limited to the issue of the correct moment of their recognition for CIT purposes. In this regard, the tax authorities departed from the provisions on the moment of recognition of corrective documents and indicated that such TP adjustment should be recognized at the time the taxpayer receives payment.

Where a transfer price adjustment resulted in reduction of the tax base, tax authorities stated that since it was impossible to link the adjustment to a particular transaction, there was no causal link between the adjustment and the taxpayer’s revenue and, as such, the adjustment must not be recognised as a cost for CIT purposes.

According to tax authorities, an exception to the above may be applied in situations where a TP adjustment is reflected in an APA (advance pricing agreement).

The controversy over whenever transfer pricing adjustments may be recognised for tax purposes is also affecting taxpayers operating in special economic zones. For such taxpayers, the tax authorities' approach was that the revenues from transfer pricing adjustments should not be recognized as tax exempt revenues since such adjustments are not expressly specified in the permit to operate in a special economic zone.

The approach adopted by tax authorities in individual tax rulings has, to some extent, been corrected by administrative courts finding that it is not acceptable that invoices documenting transfer price adjustments should be regarded, depending on the tax implications, as linked with the taxpayer's business activities (the ‘plus’ adjustments) or without such a causal link (the ‘minus’ adjustments).

This approach, however, is not presented consistently in Polish administrative courts' judgements, as some recent judgments have shared the view of tax authorities. For example, the District Administrative Court in Poznań (‘Wojewódzki Sąd Administracyjny w Poznaniu’) expressed in its judgment at the end of 2018 that ‘the purpose of incurring a cost to adjust operating margin down a level previously adopted is not to maintain or secure a source of revenue, but only to adjust the margin to a previously agreed level. Such a cost cannot be linked with any potential revenue.’

It is worth stressing that the view adopted by tax authorities has failed to consider the general purpose of making transfer pricing adjustments, i.e. the statutory tax-law requirement that transactions with related parties must be transactions of arm's length nature and following the arm's length profitability requirement. In fact, tax authorities have only interpreted the general rules of the Corporate Income Tax Act regarding the tax-deductibility of costs.

The new regulation

At the beginning of 2019, the Corporate Income Tax Act has been amended to include provisions regarding transfer pricing adjustments. These provisions allow such adjustments to be recognised in the year to which they relate, even if they are ‘minus’ adjustments, but only if all the requirements set out in the Corporate Income Tax Act are met.

These include, in particular, the obligation to specify the circumstances justifying such adjustments for corporate tax purposes, e.g. changes of material circumstances affecting the terms agreed during the year and having to rely on historical data for transfer price calculations because actual data becomes available at the end of the tax year.

The new provisions also require taxpayers to comply with new administrative obligations, including, in particular, the obligation to obtain, from the other party in a transaction, a statement confirming that the other party has made a mirroring transfer price adjustment.

With the new regulation imposing many new obligations on taxpayers and with the controversy over the recognition of transfer pricing adjustments in previous years, taxpayers are set to face new transfer pricing adjustment challenges which, in some cases, may be resolved only on the basis of international mutual agreement procedure between the tax authorities in different countries.

Maciej Preiss, Consultant in the International Tax Team at KPMG in Poland

Katarzyna Szymańska, Manager in the International Tax Team at KPMG in Poland

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