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Taxpayers transacting with related entities have probably encountered the problem of transfer pricing adjustments more than once. This issue raises many doubts. When should taxpayers make such an adjustment, what conditions must be met, and is it a taxpayer's obligation or a right? We will try to answer these and other questions in this article.
What is a transfer pricing adjustment?
Article 11e of the CIT Act / Article 23q of the PIT Act provides that a taxpayer may adjust transfer prices by changing the amount of revenue earned or tax-deductible costs incurred.
In other words, a transfer pricing adjustment involves adjusting the taxpayer's revenue or tax costs for the tax year to bring the transfer prices set in a transaction with a related entity into line with market conditions.
It is worth noting here that the Minister of Finance issued tax clarifications on transfer pricing adjustments dated 31 March 2021. They state that a transfer pricing adjustment means correcting (aligning) transfer prices. A transfer price is a price, remuneration, financial result, financial indicator or another financial outcome of conditions agreed or imposed between related entities as a result of their relationship.
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Conditions for a transfer pricing adjustment
The provisions state that a transfer pricing adjustment may be applied if all the following conditions are met:
the terms of the controlled transactions carried out by the taxpayer during the tax year were those that unrelated entities would have agreed;
material circumstances affecting the terms agreed during the tax year have changed, or the actual costs incurred or revenue earned forming the basis for calculating the transfer price are known, and an adjustment is necessary to bring them into line with terms that unrelated entities would have agreed;
when making the adjustment, the taxpayer has a statement from the related entity or an accounting document confirming that the entity has made a transfer pricing adjustment in the same amount as the taxpayer;
there is a legal basis for exchanging tax information with the country where the related entity (mentioned in point 3 above) is resident, registered or managed.
In this context, it is very important that a TP adjustment can be used only if related entities set the terms of the controlled transaction in accordance with the arm's-length principle, that is, on terms comparable to those independent entities would have agreed with each other.
In practice, entities operating in corporate groups prepare a special document called a transfer pricing policy. It sets in advance, as it were, the transfer prices to be used between related entities for the group's transaction or transactions. A comparability analysis is prepared before the policy and shows the prices and terms used for similar market transactions between independent entities.
During the year, taxpayers should set and apply transfer prices in line with the arm's-length principle. After the year ends, a taxpayer makes a TP adjustment only if, despite acting reasonably and diligently when entering the transaction to comply with the arm's-length principle, the transfer price ultimately turns out not to be at market level.
Retrospective or current adjustment?
A transfer pricing adjustment is always retrospective: it relates to settlements between related entities made in the past.
The general rules for adjusting revenue and tax-deductible costs in the current settlement period or retrospectively, depending on the reason for the adjustment (an accounting error, obvious mistake or another cause), do not apply here.
What is not a transfer pricing adjustment?
Importantly, not every circumstance involving a price correction constitutes a transfer pricing adjustment.
In the tax clarifications, the Minister of Finance identified cases where a transfer pricing adjustment is not possible and revenue or tax-deductible costs must instead be adjusted under general rules. Apart from taxpayers applying transfer prices during the year that did not comply with the arm's-length principle, the following also do not qualify:
An accounting error or another obvious mistake – if an adjustment to revenue (costs) results from an accounting error or another obvious mistake, the taxpayer should correct it retrospectively, in the period to which the error (obvious mistake) relates.
A transfer pricing adjustment cannot be used in cases such as granting or receiving a discount or rebate, or changing the scope of a service.
Nor is it a transfer pricing adjustment when the price during the year is based on plans or cost estimates and then, usually after the year ends, the taxpayer receives a final settlement once the related entity's actual costs are known. This adjustment should follow general rules. The Minister of Finance thus confirmed in the clarifications the position taken by tax authorities in individual rulings.
When to make a TP adjustment
In principle, a transfer pricing adjustment is made for a given tax year after it ends. However, a TP adjustment during the tax year is also possible after a settlement period, such as a month or quarter.
Furthermore, the transfer pricing adjustment should be made before filing the annual return for that year and should cover no more than a tax year. It is also possible to make an adjustment after filing the annual return.
In summary, transfer pricing adjustments are a difficult issue. The key is to establish whether, in the particular situation, the taxpayer should make a transfer pricing adjustment or an adjustment under general rules. It is worth requesting an individual ruling or consulting one's accountant and tax adviser.
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