A judgment from the Supreme Administrative Court reveals that the arm’s length principle applies to individuals and to intra-state transactions as well as to corporate entities and cross-border transactions.
Most cases involving transfer pricing for individuals concern rental payments. In one instance, during a tax inspection of individual income tax for 2011 by the tax authority for the Vysočina region, the rent charged by a member of a limited liability company to the company in which he owned a 50% share was reviewed. The tax authority determined an amount of rent based on rent that would be paid for other “comparable” property and on an expert opinion. The taxpayer failed to produce evidence showing the property had been unsuccessfully offered for rent to third parties.
The tax authority assessed additional tax on the part of the taxpayer (the member charging the rent). This adjustment typically would have allowed the other party to the rental transaction (the company) to increase its expenses and as such to reduce its tax liability; however, the time allowed for filing an amended return had lapsed.
The situation in this case is not uncommon in the Czech Republic. While individual and corporate income tax inspections do not primarily focus on transfer pricing issues, the tax authority may still raise this issue during the course of a tax inspection. It is, therefore, prudent for taxpayers with related-party transactions to keep records supporting the arm’s length character of the transactions.
The case further shows that the tax examiners are looking into the character of intra-state transactions.
Taxpayers need to consider actively responding to these issues during the tax audit proceedings, making sure that the principle of “neutrality of additional tax assessment” is observed (i.e., that the other party to the transaction gets the chance to reduce its tax liability).
Read an October 2018 report prepared by the KPMG member firm in the Czech Republic
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