A New Transfer Pricing Guidance and the Czech Translation of the OECD Guidelines
The General Financial Directorate (the “GFD”) issued new Guidance D-34 on the application of international standards to the taxation of related party transactions. This guidance replaces existing Guidance D-332. Together with the new guidance, the Czech translation of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2017 Edition) was published in the Financial Bulletin of the Ministry of Finance no. 5/2019.
The purpose of Guidance D-34 is to ensure that a uniform approach to determining a tax base impacted by related party transactions is applied by both the Tax Administration of the Czech Republic and taxable entities. As opposed to the previous guidance, the update provides more detailed information on, for example, the following topics:
- Actual actions of the parties versus contractual arrangements;
- A functional and risk analysis, including typology of functional profiles, discussion on the key role of industry value drivers, the issue of legal versus economic ownership of intangible assets, or explanation of the difference between a function and an activity;
- Recommendations on how to prepare a benchmarking analysis, including a list of the most frequent quantitative criteria, or recommendations on the approach to updating the analysis; and
- Overview of the methods to identify transfer prices, including comments on their practical application.
What situations may occur or practical considerations
The new guidance also contains some of the GFD’s own considerations which are, in our experience, often applied by tax administrators in conducting tax audits. Such considerations relate to, for example, the possible existence of related party transactions that are not explicitly referred to in contractual arrangements and accounted for but do exist in reality. This may involve a so-called “order of the parent company”, which refers to a control of an independent transaction by a related party, such as when a parent company orders a subsidiary to execute a sale of goods to external customers for a lower than an arm’s length price (and substantiate it by claiming that the transaction will generate a certain benefit for the group as a whole).
If the transaction constitutes a sale of goods to related parties, the tax administrator will try to arrive at a conclusion in the tax audit, by applying Section 23 (7) of the Income Taxes Act, on the difference between the referential price calculated by it and the identified price and subsequently adjust (increase) the entity’s tax base by the identified difference.
However, if the sale of goods involves external entities, the situation will be seemingly more difficult for the tax administrator as it is an independent transaction (it is impossible to directly apply the approach under Section 23 (7) of the Income Taxes Act). Nevertheless, in such a case, the tax administrator can use the institute of the parent’s company order as disclosed above and attribute the difference between the referential price and the identified price to that transaction. The tax administrator will subsequently conclude that the price in that transaction (in the form of a compensation to the subsidiary) shall be determined in an amount corresponding to the identified difference, increasing the entity’s tax base as appropriate.
The above-specified example of the Tax Administrator’s approach as well as the issuance of new Guidance D-34 as such demonstrate that the Czech Tax Administration closely monitors the international developments in the area of transfer pricing and does not hesitate to apply a highly sophisticated approach to its audit activities.
The article is part of dReport – June 2019, Tax news; Grants and investment Incentives.