Transfer pricing? Prepare your documentation first
This week I've asked my colleague, Iwona Georgijew-Ciaston, a tax senior manager and an expert in her field, to share her wisdom about the finer points of transfer pricing regulations. As most of you may already know, the topic has been a hot one this year, with many companies feeling the painful consequences of the tax authorities' changes to transfer pricing policy at the end of 2000. If you are a chief financial officer in a Polish company involved in intercompany transactions, now is the time when you should check whether your company is adequately prepared for a potential tax audit of your the intercompany pricing arrangements.
Most important, you need to review whether your intra-group transactions, both cross border and domestic, are documented in line with Polish transfer pricing requirements.
From Jan. 1, 2001, the corporate income Tax (CIT) act was amended to include a new provision that imposes on the taxpayer the obligation to prepare and keep detailed transfer pricing documentation. The new requirements apply to transactions executed after Dec. 31, 2000. Pursuant to the CIT act, the taxpayer is required to submit documentation that includes the following details: the functions to be fulfilled by the entities participating in the transaction (including the assets employed and the risks assumed); all projected transactional costs and terms of payment (or guess to the best of your knowledge); the method and the manner of calculating profits and the price of the transaction; other factors, including the applied business strategy, if those factors affect the transactional price; the benefits that the taxpayer expects to derive from the purchase of intangible property or services.
The above requirements are tailored on the basis of Organization for Economic Cooperation and Development (OECD) documentation guidelines. However, unlike other OECD countries, in Poland the lack of documentation results in an increase of the standard 28% CIT rate to a 50% penal CIT rate.
In cases where documentation is not presented within seven days of the tax authorities' request, the 50% penal-tax rate is applied to the adjusted income from the intercompany transactions. This differs significantly from other countries, where the penalty for lack of documentation is normally separately calculated as a percentage of the amount of adjusted tax (not the adjusted income). For instance, if the income assessed by the tax authorities is 100, in Poland the tax payable will be 50. Whereas in a country with the same standard tax rate (i.e. 28%) and the same level of penalty (i.e. 50%) the total tax plus the penalty would be 42 (28 plus 50% of 28). In addition, there is some exposure that the whole 50% tax adjustment will be treated as underpaid tax liability and thus subject to penalty interest for delayed tax payments (currently 37% per annum).
An increased number of transfer pricing audits are expected to be launched after December 2001 - when most Polish businesses close their tax year. There are certain thresholds for documenting transactions with related parties that are established for the whole tax year.
It's hard to predict how firm the tax authorities will be in insisting that taxpayers adhere to the revised documentation requirements. It is particularly interesting how the tax (inspection) authorities will assess the completeness of the documentation, i.e. at which point they will declare that the taxpayer has satisfied all the requirements laid down in the CIT act and, consequently, in what circumstances the taxpayer will not be punishable by the 50% tax rate where his income is re-assessed.
Whatever the future practice of the tax authorities, Polish companies involved in intercompany transactions should document their material transactions prior to a potential audit. The documentation should cover all important factors that the parties considered in negotiating the transactional price, and the methodology and mode of pricing. In particular, the documentation should be prepared up front, preferably by the end of 2001, for the so-called risky transactions like purchase of management services or sale of the same goods to related entities at prices nominally lower than those applied to third party transactions.
This approach will not only help taxpayers avoid the penalty tax rate chargeable for lack of documentation but also help them develop transfer pricing defense argumentation before a potential tax audit. By preparing the documentation up-front, the taxpayer has the possibility to develop a comprehensive functional analysis and justification of the transfer pricing method used to establish the intercompany prices. The taxpayer also has the possibility to lay down his arguments and explanations on the factors that had an impact on the calculation of prices. In this way, the taxpayer can treat the documentation as an effective means of communication as the tax inspectors usually take a formal approach during the audit and take initiative in submitting evidence and thus control the audit process.
On the contrary, the lack of documentation prepared up-front and submitted on time within the seven-day limit may attract the tax auditors' scrutiny in their audit of the controlled intercompany transactions.
Iwona Georgijew-Ciaston is a tax senior manager in the transfer pricing services Group of Andersen Warsaw.
