Vítězslav Kapoun from the GFD: APA minimizes the risk of sanctions in the area of transfer pricing

What is an Advance Pricing Agreement (APA)?

This is a preliminary price agreement, which allows taxpayers to agree with the tax authority on the methodology of setting transfer pricing in advance and thus minimize the risk of future disputes and additional assessments.

According to published statistics, tax audits of transfer pricing bring the state an average additional income of over CZK 1 billion per year. How are these trends reflected in the strategy of the tax authorities? Do you expect a further increase in tax audits?

These results confirm that transfer pricing has long been one of the risk areas with a significant fiscal impact. From the tax authorities’ point of view, they are therefore reflected primarily in the strategic management of control activities, and there is also an increasing specialization of the tax authorities’ auditors. At the same time, we rely heavily on data– we use analytical tools, international exchange of information and findings from audits conducted in previous years. Therefore, we expect not only an increase in the number of audits in the future, but especially a qualitative shift in them – i.e. an increasingly better targeting of really risky cases and a more comprehensive assessment of intercompany transactions.

In its statement, the government plans to introduce mandatory transfer pricing documentation. What impact will this have on taxpayers and what role will the GFD play in the implementation of this new obligation?

The GFD is a partner of the Ministry of Finance in this area, especially when it comes to setting the practical parameters of the new obligation. Our goal is for the documentation to be set up sensibly – so that its content and substantive value are decisive, not the formal scope or number of pages. It should also be noted that the obligation to keep transfer pricing documentation exists in virtually all EU countries. Therefore, companies that are part of multinational groups usually already have documentation at their disposal today. The purpose of the new regulation should not be to create an additional administrative burden, but rather to emphasize the responsibility of each taxpayer for the correct setting of transfer pricing.

We therefore understand that we do not want to go down the path of purely formalistic fulfilment of documentation requirements, as we have recently seen in a number of other countries. What other expectations does the GFD have towards taxpayers in terms of the content, structure and practical applicability of transfer pricing documentation?

It is important that the documentation reflects the economic reality of a particular taxpayer in the Czech Republic and is not just a mechanical copy of a group document prepared abroad. In addition to the discussion on the legislation itself, it will therefore be necessary to methodically grasp the whole issue – in this regard, we are counting on a revision of the existing guideline D334.

Could you estimate when Czech companies should prepare for the planned obligation and may be expected to submit transfer pricing documentation?

I would recommend everyone to prepare the documentation now – ideally already at the stage of planning new transactions – and to continuously supplement it with specific means of evidence during the tax period. This approach will allow them to set transfer pricing correctly in advance and at the same time be better prepared for a possible tax audit. As for the actual introduction of the legal obligation, I do not have any specific date at the moment.

The APA is often referred to as an instrument of legal certainty. What specific benefits does it bring to companies that decide to take this step?

Both (i) the domestic, i.e. unilateral advance pricing agreements (APA), and (ii) the bilateral APAs allow the taxpayer to describe in advance the nature of the transaction, the division of functions and risks, and the chosen method of valuation, and to have this approach approved by the tax administrator. The main benefit is legal certainty. If the taxpayer subsequently proceeds in accordance with the approved agreement, the tax administrator no longer questions this method of pricing. In the case of bilateral APAs, this certainty is even higher, as an agreement is reached between the competent authorities of the two countries between which the transaction takes place, which significantly eliminates the risk of international double taxation.

I also consider it important that the vast majority of applications – practically close to 100% –are ultimately concluded successfully. Sometimes immediately after the assessment of the initial application, sometimes after an expert discussion with the applicant and modifications to the proposal, but the crucial thing is that the result is a consensus between the taxpayer and the tax administrator.

What does the process of applying for an APA look like in practice, and you will probably be able to share your experience from bilateral and multilateral applications, because in these cases the GFD is the competent authority to negotiate a preliminary price agreement with the foreign competent authority. How long does it take and what are the key steps that the taxpayer must take?

The process begins with the submission of an application in which the taxpayer describes in detail the transaction under consideration, the functional and risk profile of the individual parties and the proposed method of valuation. An economic analysis and relevant comparisons are also included. Taxpayers can base their application on Decree D32, which describes the whole process in quite detail. In more complex cases, preliminary communication before the application is submitted is common. The length of the procedure varies – in the case of unilateral APAs, it is usually in the order of months, in the case of bilateral and multilateral agreements, a timeframe of one to several years should be expected, depending on the complexity of the case and cooperation with foreign competent authorities.

How many APA applications have been submitted in recent years and how many have been approved? Do you see a trend of growing interest from companies?

The number of APA applications has been rather stable in recent years, ranging from about 30 to 40 applications per year, of which only a few are bilateral. I admit that I expected a rather upward trend, especially with regard to the increasing emphasis on transfer pricing. However, as I have already mentioned, the vast majority of applications end with a positive conclusion, which proves that taxpayers prepare their applications well.

What are the most common cases within the APA, i.e. what transactions are usually subject to APA?

Most often, we deal with situations related to a change in the functioning of the company – typically the introduction of new production, significant restructuring, a change in the business model or the transfer of functions and risks within the group. Transactions with intangible assets, financial transactions or intra-group services are also a frequent topic. At the same time, however, it is no exception that APAs are also sought for relatively “standard” models, such as remuneration of contract manufacturers, distributors or routine service providers.

In what cases do you recommend companies to consider APA?

To put it simply – whenever they want to be sure. From my point of view, it is better to have transactions assessed in advance in the form of a binding assessment than to wait for a tax audit that comes retrospectively and with insufficient documentation it may not be easy to explain and defend the pricing and processes. The process of approving an APA, on the other hand, gives a chance to consult the planned or existing model and possibly simply modify it.

We have to confirm that this is exactly how we perceive it from the side of advisors to Czech companies. The opportunity to discuss the transfer pricing model with the tax administrator in advance and in a constructive manner is invaluable, because a tax audit, in which a taxpayer tries to prove its transfer prices retrospectively, is not only time-consuming, but also very financially burdensome.

We would also like to ask about unilateral APAs, where neither the foreign related party of the Czech taxpayer nor the foreign tax administrator is involved. Such applications are decided by the locally competent tax authority of the Czech taxpayer, so they will not reach you at the GFD, but in what cases do you think such a unilateral APA would be sufficient?

A unilateral APA is particularly sufficient if there is no foreign related party on the other side of the transaction at all, or if the transaction is perceived as marginal abroad, while in the Czech Republic it has a major tax impact. In such cases, a unilateral assessment may provide a sufficient degree of legal certainty. And I will just add that these types of applications can also be assessed by the GFD. Specifically, in a situation where the application concerns several Czech taxpayers and each of them falls under a different tax administrator.

Historically, we have sometimes perceived concerns on the part of companies that filing an application for an APA may lead to the disclosure of information that the tax administrator would not otherwise have accessed, and thus to an increase in the risk of a tax audit. Is it now possible to say that a significant part of this information is available to the tax administrator by default through existing submissions (e.g. CbCR, TP annex to the tax return, annual report) and that this significantly reduces these concerns?

Yes, at present, thanks to the tools you mention, the tax administrator has a significantly wider and more structured database at its disposal than in the past.

What are the most common obstacles that companies encounter when applying for an APA? Is it the complexity of the process, the cost, or the lack of information?

I don’t think that the main obstacle is cost. At least not the costs directly related to the application – the administrative fee in the Czech Republic is only CZK 10,000. Of course, there is some cost associated with preparing the documentation, but here I expect that the documentation has already been processed by a responsible taxpayer, regardless of whether the taxpayer is requesting a binding assessment or not. The quality and scope of documentation do not differ between an APA application and a request by the tax administrator during a tax audit. I don’t find the process itself to be overly complicated either. I consider the lack of information or the misconception that APA is a tool intended only for the largest multinational corporations to be the biggest barrier.

On the other hand, what are the most common shortcomings of submitted applications or mistakes that companies make in practice when applying for an APA?

A common shortcoming is the incompleteness of the documentation and the need for the tax administrator to better understand the transaction. But this situation can be easily overcome by asking questions, ideally even in a personal meeting, and it does not pose such a significant problem.

How does cooperation with other countries work in bilateral and multilateral negotiations on APA? Are the processes smooth, or do you encounter different legal frameworks, approaches, perhaps even cultural customs?

Experiences vary widely and depend largely on the country. Even within the EU, there are countries where negotiations are time-consuming and procedurally complex. On the contrary, cooperation with some non-European countries is very effective and pragmatic. Differences can be due not only to legal frameworks, but also to the approach of tax administration or organizational culture.

To what extent does APA really eliminate the risk of tax audits? Can the APA be seen as an “insurance policy” against future disputes?

APA cannot be understood as absolute immunity from tax audits, but in the area of transfer pricing, it really does serve as a very strong “safeguard”. If the taxpayer complies with the terms of the approved agreement and the facts correspond to the situation described, the tax administrator has no reason to reopen this model. The audit may then focus on verifying whether the conditions of the APA are being complied with, or on the evaluation of individual items that are included in the price, rather than on the pricing principle itself.

How should the company proceed in the event that the circumstances of the transaction under consideration change after the APA has been negotiated? In what situations can changes be addressed, for example, by adjusting a specific calculation? And is there even a risk that the decision granted in the matter of the APA may be considered invalid?

If for some reason the terms of the evaluated transaction change, then the APA cannot be used of course, or not in its entirety. The practical procedure always depends on the nature of the change and the significance of the impact on pricing. The most practical application is to submit a modified application, where the taxpayer explains the nature of the change and its impacts, and the tax administrator reassesses the application knowing that the previous one has already been approved once.

How would you assess the development of the APA practice over its 20 years of existence and what can we expect in the future?

In the twenty years of its existence, the practice of APA has undergone significant development. From what was originally a rather exceptional instrument, it has become a standard tool that is well known to both tax administrators and the professional public. The quality of applications and the level of professional discussion are increasing. Looking ahead, I expect APAs to grow in importance as transfer pricing pressures increase, tax administrations become increasingly digitalized and international cooperation intensifies. APA will increasingly be seen as a natural part of tax risk management.

Conclusion

The interview with Vítězslav Kapoun showed that APA is one of the most effective tools offered by the Czech tax system to ensure legal certainty in the area of transfer pricing. If a company presents its model to its tax administrator in advance and the tax administrator approves it, it minimizes the risk of inspection and additional assessments. At a time when transfer pricing is increasingly under the scrutiny of the state, an APA offers a clear path to transparency, stability and predictability.