What is transfer pricing?

Čo v článku nájdete:

• What is transfer pricing?
• Why is transfer pricing important?
• What are the principles governing transfer pricing?
• What methods does transfer pricing use?
• What is transfer documentation?

Transfer pricing is a system of rules and methods that are used to determine prices between related persons – i.e. between undertakings which are intrinsically, economically or staffed. A typical example is transactions between parent and subsidiary. But transfer pricing is not just this example. Let’s look at it in more detail.

This article reads:

• What is transfer pricing?
• Why is transfer pricing important?
• What are the principles governing transfer pricing?
• What methods are used in transfer pricing?
• What is transfer documentation?

What is transfer pricing?

Transfer pricing is a process in which the prices of transactions between dependent persons are determined for tax purposes. In Slovakia, this issue is regulated Act No 595/2003 Coll. on Income Tax, as amended a No MF/019153/2018-724which sets out the content of transfer documentation. This is what we write about in other parts of the article. Transfer pricing works with the notion Dependent persons. What is this all about? Under the Income Tax Act, dependent persons are treated as Close persons, persons or entities economically, personnelly or otherwise linked or persons or entities belonging to the same consolidated entity. A close person is a family relative, such as a sibling, husband or wife, parents, and the like. Economically or personally linked persons are those having a direct or indirect interest in the property, control or management of another person or entity. Participation in an asset shall mean holding at least 25% of the capital or voting rights. It is also important to clarify the concept of transfer pricing controlled transaction. Under the Income Tax Act, a controlled transaction is considered to be a legal or other similar relationship between two or more dependants under points (n) and (r) of the Act, at least one of which is a taxpayer with income under Paragraph 6, or a legal person that obtains taxable income from a business or the disposal of property. On that basis we can Transfer pricing define as a process aimed at setting prices of controlled transactions between dependants which would also be agreed between independent entities under comparable conditions. The purpose is to avoid deliberately lowering the tax base by setting prices for dependent persons below their market price.

Why is transfer pricing important?

In international trade, many companies operate within multinational groups that have their branches, subsidiaries or centres in different countries of the world. However, each country has a different income tax rate. Without regulation, it would be relatively easy to shift profits to lower tax countries and costs would be placed in higher tax countries. Transfer pricing prevents this by requires market (independent) prices between related entitiesi. As a result, tax evasion can be avoided and profits distributed fairly according to actual economic activity. Transfer pricing essential fiscal importance also for the State. If profits were artificially shifted to other countries, it would significantly lose part of their tax revenues. For businesses, transfer pricing is also rightly set up as a question of reputation and credibility. Today, when emphasis is placed on corporate social responsibility ESG a Tax transparency, has a fair transfer pricing increasing weight also in corporate ethics. This process is also prevention of tax disputes and sanctions. Tax authorities pay particular attention to transfer price controls. If they find that transactions between related parties have not been made at market prices, they may adjust the tax base and add a difference with interest and fines. Transfer pricing is also important for international coordination. Thanks to OECD standards, countries follow the same principles. This helps avoid double taxation, a situation where the same profit is taxed simultaneously by several States.

What are the principles governing transfer pricing?

The basis for transfer pricing is the so-called the arm’s length principle (Armûs Lenght Principle). This principle says that prices between dependants should be such as if those persons were independent and acted among themselves on the market. The aim of this principle is to ensure that profits are distributed between countries according to the real economic nature of the activities and that profits are not artificially transferred to countries with lower taxes.

What methods does transfer pricing use?

The Commission notes that the transfer pricing report is based on a cost-benefit analysis. The OECD Transfer Pricing Guidelines for Multinational Enterprises and tax administrations indicate the following methods:

• Comparable Uncontrolled Price

It compares the price between related parties with the price that would be agreed between independent entities under the same conditions.

• Resale Price Method

It shall be based on the price at which the goods are sold to an independent person and a reasonable margin of trade shall be deducted.

• Cost Plus Method

A reasonable profit margin shall be added to the supplier’s own costs.

• Net Margin Method (TNMM)

It compares the profitability of the related entity with the independent companies operating under similar conditions.

• Profit Distribution Method (Profit Split Method)

It is used in cases where transactions are closely linked and cannot be assessed separately. The profit shall be distributed among the undertakings involved according to their benefit.

What is transfer documentation?

Every addict is for controlled transactions required to demonstrate the transfer pricing method used, and maintain appropriate documentation thereof;whose content and scope are determined by the Ministry of Finance of the Slovak Republic. Transfer documentation is a set of information, evidence and arguments that serve as a basis for demonstrating the progress and conditions of controlled transactions. The main purpose is explain and document how the tax entity has determined prices in transactions between dependent persons. The Commission therefore concludes that the arm’s length principle is met. Would you like to know more about transfer pricing within your company? Or do you need advice on how to properly develop transfer documentation? You can turn to our professional teamI’m happy to help you.

Recommended sources for more information:

• The OECD Transfer Pricing Directive for MNEs
• Act No 595/2003 Coll. on Income Tax, as amended
• https://www.valentiam.com/newsandinsights/transfer- pricing-methods
• https://wise.com/us/blog/transfer-pricing-methods
• This Decision is addressed to the Member States.
• https://us.ibfd.org/knowledge-hub/tax-insights/what-transfer-pricing-and-why-does-it-matter
• https://www.easystart.sk/co-is-transference-a-whom-to-toe/