Tuesday, 20 March 2018

Transfer Pricing: Too Expensive to Ignore

Up to now – Hungary was the first in CEE that introduced statutory transfer pricing documentation requirements in 2003 – very complex transfer pricing requirements pertained to affiliated companies. Therefore, group-pricing should be measured in line with the arm’s length principle and be strictly documented. Moreover, unlike in international practice, the Hungarian transfer pricing documentation obligations cover domestic intragroup transactions too. As tax authorities examine transfer prices very closely, it has become vital for groups to have a consistent, reliable TP-system. This is especially so, considering the record high Hungarian penalties for non-compliance that amount to HUF 2 million (appr. EUR 6,500) per transaction per year.

Although the rules have been changed many times in the past, they have become stricter again. Hungary has already adopted the BEPS Action 13 pertaining to Master Files/Local Files in its legislation, which requires a more complex presentation of the TP-related information in the documentations.

Master File
  • a group diagram representing the organization structure, the legal and ownership structure of the group and the geographical location of the organizations;
  • as regards the presentation of the group:
    • the driving force behind business results;
    • the presentation of the supply chain for the five largest products and services of the group and of those exceeding 5% of the turnover of the group by sales revenue – such may also be presented in a table or graph;
    • a list of significant service agreements between the members of the group, excluding research and development services, and a brief description of the arrangements, including a description of the capacity of major sites providing significant services and a transfer pricing policy to allocate service costs and pay within the group for determining service charges;
  • the presentation of the main geographic markets of the group’s products and services;
    • a concise functional analysis that demonstrates the contribution of individual players to value creation, in particular the key functions performed, the significant risks borne and the significant assets used;
    • the presentation of transactions related to major business reorganizations, acquisitions and divestments in the business year;
  • as regards the intangible assets of the group:
  • the presentation of the group’s comprehensive strategy for the development, ownership and utilization of intangible assets, including the geographical location of the main research and development facilities and research and development management;
  • a list of significant intangible assets or their groups and their legal owners;
  • a list of agreements with affiliated undertakings relating to intangible assets, including cost-agreement agreements, key research service and licensing agreements;
  • a general presentation of the group’s transfer pricing policy for research and development and intangible assets;
  • a general description of the assignment of any significant interest in any intangible asset between affiliated undertakings during the business year concerned, including affiliated companies, countries and compensation received or provided for;
  •  concerning the group’s financial activities within the group:
    • a general presentation of the group’s financing, including significant financing arrangements with non-related creditors;
    • identification data of all members of the group providing central funding to the group, including the country whose law governs the operation of the funding organization and the place of effective management of the organization;
  • the presentation of a general transfer pricing policy for the financing agreements between related undertakings;
    • concerning the group’s financial and tax situation: the consolidated financial statements of the group for the financial year, and, in the absence thereof, of other financial reporting, regulatory, internal management reports, taxation or other purposes;
    • listing and short presentation of the group’s current unilateral APAs and other tax arrangements (including, inter alia, conditional tax decisions, rulings) related to the distribution of income between countries; and
    •  the date of preparation of the main document
Local File:
  • a description of the structure of the taxpayer’s management, its organizational chart, the names of the persons to whom the management reports and the names of the countries in which these persons maintain their head office;
  • a detailed presentation of the taxpayer’s business, activity and strategy, including whether the taxpayer participated in or be affected by any relocation of business, reorganization or transfer of intangible assets in the current or immediately preceding fiscal year; and the impact of such to the taxpayer;
  • listing the taxpayer’s most important competitors;
  • data for each controlled or aggregated transactions – to be detailed below;
  • a copy of existing unilateral, bilateral or multilateral APAs in force and other tax arrangements (including, inter alia, conditional tax assessment, ruling decisions) affecting the transactions subject to the transfer pricing and that were issued by the tax authorities of another jurisdiction; and
  • the date of the local document being prepared.
  • The transfer pricing documentation shall also comprise, for each transaction under control, the following:
    • the presentation of a controlled transaction (e.g. obtaining production services, acquiring goods, selling products, providing services, lending, providing financial and performance guarantees, licensing intangible assets) and the presentation of the environment and relevant market in which the transaction is to be established;
    • the name, domicile, domestic or foreign tax number of other affiliated companies involved, if any, of the company's registration number by the court of registry (or other registration number) and the name and registered office of the court (authority) of the company register, and the indication of the basis of the affiliated business relationship;
    • the amount of payments effected or incurred on the basis of the controlled transaction, in the tax year, broken down at least by the parties to the transaction;
    • a copy of all versions that is/was valid in the tax year of the contracts relevant for the determination of the transfer prices; if the contract is not in writing, a detailed description of its content;
    • a detailed comparative and functional analysis of the related undertakings involved in the controlled transaction, including any change compared to the previous years;
    • a description of the most appropriate transfer pricing method, taking into account the nature, type of transaction, available comparative data; and the reasons for choosing the method;
    • where relevant, the designation of the affiliated company chosen for the tested party and the reasons for the choice;
    • a summary of the most important presuppositions taken into account when applying the chosen transfer pricing method;
    • where relevant, an explanation of the multiannual comparative analysis;
    • the listing and presentation of selected internal and external comparative transactions and the presentation of the relevant financial data of the independent companies on which the transfer pricing analysis is relied, including a description of the comparative analysis methodology and the source of that information;
    • the presentation and detailed justification of the comparability adjustments and the indication whether the adjustment is made in the tested party, in the comparable independent transaction or both;
    • a detailed description of how the price was adjusted at the controlled transactions by the chosen transfer price determination method, in accordance with the arm’s length principle;
    • a summary of the financial information used in applying the transfer price determination method;
    • its essential presentation of how the financial data used in the application of the transfer pricing method may be linked to the data contained in the taxpayer’s financial report; and
    • data of any court or other authority proceedings in progress or already closed concerning the transfer pricing of the controlled transaction.

Thus, it is worth preparing these documents in good time, and it should not be put off. However, TP-files must not only fulfil the increasing statutory requirements, but should also be tailored to your business, saving time and money. In present times, the reasonability of the transfer prices is more often required to be substantiated with the applicable databases, like AMADEUS which is widely used by tax authorities too.

Efficient transfer pricing documentation greatly reduces the risk of double taxation, compliance costs, as well as time-consuming discussions with the tax authorities involved. In the increasing level of international exchange of information, you should also consider the defense of your transfer pricing systems, for which assistance during audits and mutual agreement procedures may also be highly important. Thus, it is essential to place your transfer pricing issues in the hands of experienced specialists who provide comprehensive, competent support. Even a transfer pricing quick check can identify the risks and offer tailored solutions to reduce them.

Transfer pricing may be simplified and higher confidence could be achieved by using the official Advance Pricing Agreement (APA) system. This gives a guarantee on the acceptance of the tax authority over the transfer prices applied by your company and fixes it for 3-5 (+3) years, during which period no TP-documentation updates are needed and the price-determination related uncertainties can also be eliminated.

LeitnerLeitner is one of the most influential tax consulting, accounting and auditing companies in Central Europe; in Hungary we work in the Hungarian, German and English languages. You may rely on our specialized full-scope transfer pricing service-package: quick checks, documentations, advisory, benchmark studies, AMADEUS database searches, and representation in transfer pricing disputes, MAP and APA processes. And you can take advantage of our renowned international Tax advisory service and network covering more than 40 locations.