On 12 September 2023, the European Commission published a proposal for a transfer pricing directive (the “EU Directive”) as part of the so-called “BEFIT” package. In addition to introducing a common EU-wide income tax base, the package also aims to harmonise transfer pricing approaches for EU companies, i.e. those that are based in the EU or whose transactions are subject to taxation in the EU.
Current practice shows that the approach to the basic principles of transfer pricing often differs to a greater or lesser extent from one EU country to another. The EU Directive should harmonise the approach to transfer pricing across the EU, thereby reducing potential disputes. In addition, the EU Directive should unify the approach of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (currently a generally accepted but not formally legally binding document) and implement some binding rules in the legislation of both OECD and non-OECD Member States (currently Malta, Cyprus, Romania, and Bulgaria).
The stated ultimate aim of the EU Directive is to reduce the compliance costs for multinational group companies based in the EU (or subject to EU taxation), increase certainty in corporate taxation, and, at the same time, prevent aggressive transfer pricing tax planning. The rules set should also help prevent double taxation and excessive tax burdens on EU companies.
Flagship Topics introduced in the proposed EU Directive
Definition of Associated Enterprises
The EU Directive proposes to introduce a uniform definition of associated enterprises and a uniform interpretation of the arm’s length principle compliant with the current version of the OECD Guidelines. According to the draft EU Directive, person who is related to another person in any of the following ways will be considered associated enterprises:
I. a person participates in the management of another person by being in a position to exercise significant influence over the other person;
II. a person participates in the control of another person through a holding that exceeds 25% of the voting rights;
III. a person participates in the capital of another person through ownership that, directly or indirectly, exceeds 25% of the capital; or
IV. a person is entitled to 25% or more of the profits of another person.
Using this definition, the EU Directive clearly proposes a threshold of 25% share of the voting rights/capital/profits for assessing persons as directly associated enterprises. As some EU countries currently apply a 50% independence threshold, the EU Directive proposal may represent a significant change in some cases. The rules applicable in the Czech Republic will not be significantly changed by this definition.
Transfer Pricing Methods
In the area of the use of transfer pricing methods, the draft EU Directive does not introduce anything fundamentally new but simply refers to the recommendations in the OECD Guidelines, both in terms of the overview of transfer pricing methods and the way they are applied. This gives taxpayers certain freedom in the selection of transfer pricing method, however the most appropriate method for the given transaction must be selected.
Transfer Pricing Adjustments to the Tax Base
The EU Directive also addresses the topic of transfer pricing adjustments, which can be classified into two categories: (i) adjustments made by the tax administrator after the tax return has been filed (i.e. primary adjustment and corresponding adjustment) and (ii) adjustments made voluntary by the taxpayer before the tax return has been filed (i.e. compensating adjustment).
In the first case, this is a situation where, following a tax audit, the tax base is increased in relation to a specific cross-border transaction against a taxable entity in one jurisdiction (primary adjustment) based on the claim of the relevant tax administration in that jurisdiction, that the transaction was not compliant with the arm’s length principle. A subsequent adjustment should then be made in the other country in amount corresponding to the primary adjustment so the double taxation is avoided.
In some cases, the EU Directive proposes so-called “fast track” solution, based on which EU Member States should have implemented mechanisms to prevent double taxation. In the absence of doubt as to the justification of the primary adjustment, it should be possible to reach an agreement within 180 days. The EU Directive essentially proposes a simpler and quicker form of elimination of the double taxation.
In the second case, the transfer price is adjusted before the taxpayer files its tax return with aim to be in compliance with the arm’s length principle, although the price actually charged was different. Some jurisdictions do not accept such adjustment, such situation leads again to undesirable double taxation. Even in these cases, the draft EU Directive enhances tax certainty by proposing the possibility of making adjustments on both sides of a cross-border transaction.
Establishing the arm’s length range
The EU Directive also proposes that where the application of the most appropriate transfer pricing method results in a range of values, as the arms´ length range to be considered the interquartile range (i.e. the range between the 25th and 75th percentile of values). In order to minimise disputes, the EU Directive proposes a common approach, which is that the taxpayer’s tax base should not be adjusted where the results fall within the interquartile range (provided that either the tax authority or the taxpayer does not demonstrate that another value within the range is defensible). Conversely, if the results fall outside the arms´ length range, the tax administrator should make an adjustment to the median of all values (unless either the tax authority or the taxpayer demonstrates that another value within the range represents a more reliable arm’s length price). Both proposed procedures differ from current practice in the Czech Republic, where administrative courts often accept adjustments to the minimum of the identified full range in favour of the taxpayer. We will closely monitor whether and what impact the (expected) introduction of such specific rules will have on the decision-making practice of tax authorities and courts.
What is next?
This initiative by the EU signals that efforts to unify the approach to transfer pricing at the EU level are on track. However, given the tax sovereignty of EU Member States and the need for unanimous consent of the proposed EU Directive, it is premature to expect that it will be approved in its current proposed form. Further negotiations may depend on political and economic aspects in the Member States ‒ such as upcoming EU elections or the need for Member States to fill their national budgets, as well as the need to amend individual rules with aim to meet the requirements of individual EU Member States, which have veto right in this respect and can block the adoption of the Directive.
If adopted, then under the currently proposed form, the EU Directive must be adopted and published by the Member States by 31 December 2025 at the latest, with harmonised rules expected to come into force on 1 January 2026.