Tax and Legal News – June 2022

Surprising transfer prices

Transfer prices in the Czech Republic are gradually evolving, and tax administrators are being more careful, more rigorous and more sophisticated. Still, we operate within OECD boundaries, and could boldly argue that developments are foreseeable. A glance at some more advanced jurisdictions gives a sense of where the state administration will be heading and what will be in store for us eventually. Historically, we compared interest to what we get at the bank; now, we calculate credit rating. The cost-plus markup has always been about the markup, but now the taxman is worried about whether the cost should actually include financing and forex. The Berry ratio was an exotic indicator; now it’s a standard tool.

Sometimes, we can be unpleasantly surprised, for example when there can be no loss years in comparable samples. Then again, sometimes we’re pleasantly surprised when the Supreme Administrative Court says that every observation in a given sample is correct, not just the interquartile range. But the surprises are few; the baseline remains unchanged and has been affirmed repeatedly by the courts. The tax administrator must detect a related-party transaction, must prove the entities are indeed related, must find a similar transaction and then establish its price. And once it has all that, it must give the taxpayer a chance to explain the difference.

This was exactly the case until the Supreme Administrative Court issued its decision in Aisan Industry (7 Afs 398/2019 - 49), a nice guide for the tax administrator on how none of the above actually has to apply.

The company purchases from and sells to third parties. But because the price is essentially negotiated by the group, these are related-party transactions (even though they’re not actually related). And so market price rules come into play. The company is loss-making. This is unacceptable for a limited manufacturer, and the tax authority assesses tax on the profit it should have made. The Supreme Administrative Court confirms it’s not actually necessary to find a specific transaction; but rather sufficient to assess profitability. Because the group intervened in the price negotiations, profitability would have to come from it. The Supreme Administrative Court, which at other times is quite precise, here suffices itself with the profit being from “someone” in the group, with no need to prove exactly from whom. The technical explanation for the additional assessment is the taxation of remuneration for a hypothetical service provided by the company to the group (suffered the group’s pricing of transactions with third parties). A logical explanation.

Each case is different, of course. Here, the taxpayer was greatly assisted by submitting a transfer pricing study from a reputable consultant that accurately determined it should achieve profitability. The tax administrator just took and assessed what the taxpayer submitted. A subsequent effort involving a completely different study and the opposite conclusion by the same reputable consultant no longer seemed credible. We can only speculate as to whether the court’s decision was helped by a very extensive lawsuit with a number of objections. The Supreme Administrative Court felt the need to note that in such a large submission there was no need to deal with every single objection (though it may not have helped its mood that it had to read them, anyway).

The lesson? Don't let your guard down. Established principles are important, but every situation is different and may require a different approach. And what you give the taxman once, you can never take back.