Transfer Pricing: A Developing Area in Slovak Tax Law
Transfer pricing can be identified as an area of tax law that continues to attract the attention of both tax authorities and businesses worldwide. The growing importance of transfer pricing can be observed in the Slovak Republic as well, as it has become one of the dominant tax issues addressed during tax audits. Failure to comply with the arm’s length principle may result in additional tax assessment by the Tax Authority and a penalty may be imposed if taxpayers fail to submit transfer pricing documentation. Recently, transfer pricing has been addressed from different perspectives by the legislator and the Tax Authority. Most significantly, we would like to stress a recent legislative proposal to broaden the personal scope of transfer pricing legislation, new rules on transfer pricing documentation and new guidance regarding advance pricing arrangements.
In general it can be concluded that transfer pricing legislation requires that mutual transactions between foreign related parties be compliant with the arm’s length principle. According to this principle, the conditions in transactions between foreign related parties should not differ from the conditions that would exist between independent parties. Otherwise, such difference is included in the tax base and taxed accordingly. In order to determine transfer prices in controlled transactions, taxpayers should apply the methods set out in tax legislation or a combination thereof. Alternatively, other methods may be applied that comply with the arm’s length principle.
Definition of related parties
The definition of “relation” between parties is therefore a primary prerequisite for application of transfer pricing legislation. According to the current rules, parties are considered related if they are close parties or economically, personally or otherwise connected. The current legislation is focused exclusively on foreign related parties that include a cross border element. However, the proposed amendment to the Income Tax Act intends to broaden the personal scope to cover also mutual transactions between domestic parties. Such change to domestic legislation would significantly strengthen the current tax treatment and would also impose new obligations on taxpayers. In addition to foreign related parties, also domestic taxpayers with no cross border element would be obliged to prepare transfer pricing documentation and to comply with the arm’s length principle.
Transfer Pricing Documentation
Transfer pricing documentation can be seen as the heart of transfer pricing legislation and a formal tool to demonstrate compliance with the arm’s length principle. In August 2014, the Slovak Ministry of Finance published a new set of rules on the content of transfer pricing documentation that impose increased obligations on certain categories of taxpayers. The primary purpose of the documentation is to describe the selection of the transfer pricing method and its application in line with the arm’s length principle.
The new rules distinguish three categories of taxpayers who are obliged to keep different transfer pricing documentation depending on the size of the taxpayer, IFRS reporting or other criteria. As a result, related parties need to keep either reduced (simplified) documentation, basic documentation, or full scope documentation. Reduced documentation should contain general information on the group members and general information on the controlled transactions with related parties. As such, it is intended for small taxpayers that qualify as micro accounting units.
Basic documentation and full scope documentation should include more specific information on a group of related parties (Masterfile documentation) and information regarding a particular domestic taxpayer (country specific documentation). Country specific documentation should contain, for example, function and risk analysis and a description of the transfer pricing policy of the taxpayer. This is the common feature of basic and full scope documentation. In addition, full scope documentation, which is intended, among others, also for IFRS reporters, should include, for example, a comparability analysis of controlled and uncontrolled transactions. The process of documenting transfer prices is usually very complex and requires significant effort on the part of taxpayers. Should the taxpayer fail to submit documentation, a penalty of up to 3,000 EUR may be imposed, repeatedly. As new legislation requires (from 1 January 2014) the submission of transfer pricing documentation in only 15 days, upon the request of the Tax Authority, it is best practice for taxpayers to prepare documentation on a contemporary basis.
Advance Pricing Arrangements
Another important aspect of Slovak transfer pricing legislation is the opportunity for taxpayers to have the transfer pricing method approved by the Tax Authority before the controlled transaction is realized. This can be effectuated via the Advance Pricing Arrangement (APA) initiative, which has recently received attention in the form of methodic guidelines issued by the Financial Directorate of the Slovak Republic. Based on the parties involved, the APA can be issued as unilateral, bilateral or multilateral. A unilateral APA involves communication only between a domestic taxpayer and the Slovak Tax Authority. A bilateral APA includes taxpayers and tax authorities in two different countries. Under circumstances involving more than two states it is also possible to initiate a multilateral APA.
Under amended legislation, the APA procedure is subject to a special fee ranging from 4,000 EUR to 30,000 EUR. In addition, taxpayers applying for the APA are required to submit full scope transfer pricing documentation. The APA may be issued for up to 5 tax periods, and may be extended to another 5 tax periods upon request. It should be kept in mind, however, that the APA has to be initiated no later than 60 days before the commencement of the tax period. Therefore, communication with the Tax Authority should be scheduled in such a way that the above deadline is met. At the end of the day, this tax law initiative may be regarded as a feasible way to avoid future transfer pricing disputes and achieve an increased level of legal certainty.
Based on the above, it can be concluded that transfer pricing involves considerable legal aspects and requires comprehensive understanding of the functions performed by the taxpayer and the risks borne. When advising our clients on transfer pricing aspects we stress the importance of contemporaneous transfer pricing documentation and sufficient argumentation for the selection of a particular transfer pricing method. As the OECD is finalizing the first working papers of the BEPS (Base Erosion and Profit Shifting) initiative, it may be expected that the Slovak Republic will continue developing domestic transfer pricing legislation. In such legal environment, we consider it very important to continue following the ongoing debate on transfer pricing issues and to reflect on the outcomes of such developments in the day to day practice of our clients.
