The increasingly effective inspections into transfer pricing force taxpayers to exercise caution when establishing terms in transactions with related entities to meet the arm’s length standard. With respect to future arrangements, security is easily obtained – from the outset, when entering into a deal, taxpayers need to agree terms in line with the arm’s length principle. As to the past, arrangements with related entities can be checked and secured in case of a future inspection through a transfer pricing review.
SUMMARY:
- An internal or external transfer pricing audit will help you identify non-arm’s length transactions with related entities or entities registered in “tax havens”.
- An entity which is not obliged to prepare transfer pricing documentation is not exempt from the duty to comply with the arm’s length principle in transactions with related entities.
- A comprehensive transfer pricing audit comprises several stages, the most important of which is the analysis of compliance with the arm’s length standard of past transactions with related entities/entities from “tax havens”.
As indicated in our earlier publication on “Tax inspection of transfer pricing”, over the past few years tax authorities have been examining transactions with related entities more frequently and more effectively. Taxpayers, as long as their tax liabilities are not statute-barred, should gain clarity as to the terms agreed in their arrangements with related entities by reviewing the principles in place. A transfer pricing review may protect them from the painful upward adjustment of income by tax authorities and having to pay the back tax with interest.
Who should consider a transfer pricing audit?
An audit of related party transactions should be considered by taxpayers obliged to prepare tax documentation as well as those who are exempt from that obligation but nevertheless enter into transactions with related entities. The fact that the entity has not exceeded the statutory threshold placing it under the obligation to maintain tax documentation does not exempt it from the duty to comply with the arm’s length principle in transactions with related entities. As of 2019, there is an additional exemption for “domestic transactions”, i.e. those made between Polish taxpayers who meet certain conditions, e.g. have not reported a tax loss. The exemption does not confer any other privileges, though. The taxpayers are still obliged to apply the arm’s length standard, and there is a simplified tool to monitor compliance in this regard, in the form of the TPR information to be submitted annually.
A transfer pricing audit should also be considered by taxpayers who at any time in the past engaged in transactions with entities registered or resident in the so-called “tax havens” or entered into partnerships/companies, joint ventures or other agreements of a similar nature with such entities.
How to conduct an effective transfer pricing audit?
When reviewing related party transactions, you should first identify capital and personal links with entities belonging to the same group of companies, and how they changed over the years due to various corporate restructuring operations. This will enable you to avoid the situation of missing tax documentation due to the misidentification of related entities. You should then proceed to identify all the transactions made with your related entities, check if they fell under the obligation to maintain documentation, and if so – verify if the documentation meets all the formal criteria provided for in the regulations. Incomplete documentation may lead to a finding of absent documentation by the tax authorities.
The most important stage of the audit comprises the analysis of related party transactions for compliance with the arm’s length standard, including the identification of tax risks and irregularities. At the end of the process, you should consider how to remedy the irregularities, if any.
In conclusion, your preparation for a tax inspection of transfer pricing may include a transfer pricing audit. Verification of past transactions with related entities should preferably be comprehensive – covering all the years back which are not subject to the statute of limitations and addressing each and every aspect affecting your obligations related to transfer pricing – starting from the identification of related parties, through past transactions, to – most importantly – analysis of the agreed terms of those transactions, including transfer pricing terms.
AUTHOR: Aleksandra Trocińska, senior consultant
