Guidance D - 293
Ministry of Finance
Issue no.: 39/116 682/2005 - 393
Ing. Michal Roháček, tel. 257 044 162
Mgr. Lucie Vojáčková, tel. 257 044 157
Prague, December 23rd, 2005
Guidance D - 293
Communication by the Ministry of Finance in respect of the scope of transfer pricing documentation
In consideration of present development in the field of transfer pricing, Czech Republic’s membership in international organisations as well as responses by taxable public, the Ministry of Finance issues its recommendation concerning the scope of documentation related to transfer pricing between associated enterprises in the frame of this communication.
This communication aims at publishing standards of documenting appropriateness of transfer pricing to make it compliant with s. 23 par. 7 of the Act no. 586/1992 Coll., on income taxes, as amended (hereinafter “AIT”) and Article 9 of most of the Double Taxation Treaties, so compliant with arm’s length principle specified in Chapter 1 of OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereinafter only as “OECD Guidelines”).
Related principles for application of provisions related to transfer pricing in general are arising from AIT (mainly s. 23 par. 7 and other provisions) and are described in details in the Guidance D-258 – Communication by the Ministry of Finance in respect of international standards application in taxation of transactions between associated enterprises – transfer pricing.
Each taxpayer should aim at determining transfer prices for tax purposes in compliance with arm’s length principle based on information reasonably available in the moment of transfer price set-up. In the frame of the transfer prices examination he is obliged to demonstrate how the prices have been set-up, and whether they have been set up in the same way also when effected between two independent enterprises. If the company fails to meet this obligation, a tax authority may apply provisions of s. 23 par. 7 of AIT against the company.
Tax administration could be interested in as wide as possible definition of requirements against taxpayers in order to be able to obtain all documents necessary for the taxation procedure. On the other hand, the taxable public aims at as particular and narrow as possible list of documents to be provided to the tax administration. This recommendation aims at finding some kind of a consensus between the mentioned two tendencies so that the required volume of documentation would be sufficient for the purposes of tax administration and at the same time would not excessively burden the taxpayers.
This communication applies both to purely domestic transactions between enterprises associated within the Czech Republic and cross-border transactions, i.e. enterprises seated in the Czech Republic being parts of multinational groups.
2. The Czech Republic as a member of OECD
The Czech Republic as the member of OECD applies principles and recommendations issued by the mentioned organisation.
As generally accepted manual used as guidance for taxpayers as well as the tax administration in solving the transfer pricing issues, there is a document called Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations processed in the form of OECD Fiscal Issues Committee Report (hereinafter just “OECD Guidelines”). The Guidelines are not legally binding for the Czech Republic, nevertheless the document is considered as very effective one, and its principles are followed not only by the Czech tax administration but also other OECD member states as well as a great number of non-member states.
Chapter V. of the Guidelines deals with the transfer pricing documentation.
3. The Czech Republic as a member of EU
The European Union aims at creation of rules according to which the companies in member states would work out mandatory documentation packages covering their transactions with associated enterprises in accordance with unified procedures.
Not only for this purpose, there had been a working group for the issues of multinational enterprises taxation created - EU JOINT TRANSFER PRICING FORUM (hereinafter just EU JTPF), which in its regular meetings carried out in 2004 and 2005 processed a new concept of EU Transfer Pricing Documentation (hereinafter just EU TP Documentation), based on which there has been a Code of Conduct on Transfer Pricing Documentation for Associated Enterprises in the EU adopted (hereinafter just „Code“). These agreed rules provide the member states with tools for implementation of common and partially centralised principles in respect of transfer pricing.
The fact that existence of different arrangements in respect of documentation obligations in member states would cause creation of new obstacles and constrains in international trade, which the European Union strives to eliminate, was the reason for the definition of the rules. The existence of different arrangements in EU states complicates establishing or execution of business activities with associated enterprises seated in other member state. Processing of a number of documentation packages could represent a burden both from economic and time point of view.
4. Concept of EU TP Documentation
The fact that the multinational enterprise group prepares transfer pricing documentation in two parts is the basic principle of EU TP Documentation.
- The Masterfile, i.e. precisely determined documentation package containing information of the whole multinational enterprise group applicable for all the EU member states. Information contained should reflect all economic reality of the business and should provide a general overview of the multinational group. The group’s transfer pricing policy should be documented in the frame of this package, and all internal transactions should be explained there.
The Masterfile should contain namely the following information:
a general description of the business and business strategy, including changes in the business strategy compared to the previous tax year;
a general description of the MNE group’s organizational, legal and operational structure (including an organization chart, a list of group members and a description of the participation of the parent company in the subsidiaries);
the general identification of the associated enterprises engaged in controlled transactions involving enterprises in the EU;
a general description of the controlled transactions involving associated enterprises in the EU, i.e. a general description of:
flows of transactions (tangible and intangible assets, services, financial);
amounts of transaction flows;
a general description of functions performed, risks assumed and a description of changes in functions and risks compared to the previous tax year, e.g. change from a fully fledged distributor to a commissionaire;
the ownership of intangibles (patents, trademarks, brand names, know-how, etc.) and royalties paid or received;
the MNE group's inter-company transfer pricing policy or a description of the group's transfer pricing system that explains the arm's length nature of the company's transfer prices;
a list of cost contribution agreements, APAs and rulings covering transfer pricing aspects as far as group members in the EU are affected;
an undertaking by each domestic taxpayer to provide supplementary information upon request and within a reasonable time frame in accordance with national rules.
a detailed description of the business and business strategy, including changes in the business strategy compared to the previous tax year;
information, i.e. description and explanation, on country-specific controlled transactions, including:
flows of transactions (tangible and intangible assets, services, financial);
amounts of transaction flows;
a comparability analysis, i.e.:
characteristics of property and services;
functional analysis (functions performed, assets used, risks assumed);
specific business strategies;
an explanation about the selection and application of the transfer pricing method[s], i.e. why a specific transfer pricing method was selected and how it was applied;
relevant information on internal and/or external comparables if available;
a description of the implementation and application of the group's inter-company transfer pricing policy.
Expressed in graphic way, the concept of EU TP Documentation can be demonstrated as follows:
Documentation package for state A would contain Masterfile complemented by the country-specific documentation required by the state A. In the same way, to meet the documentation requirements of the state B, the company would complement the Masterfile with the country-specific documentation required by the state B.
It is assumed that the MNE’s Masterfile will be processed by specialists knowing transfer pricing issues more deeply so it is expected that it should have higher informative value and should contain higher quality data than in cases when each company prepares its documentation in a separate way. The tax authority should gain an overview of all the transactions within the group and should be able to understand its transfer pricing policy.
The utilisation of information obtained from various registers and paid databases is also an important issue. Information about comparable independent transactions both internal and external ones is the part of the specific documentation. It has been stated that not all the companies have databases available to find comparable independent transactions from external resources. So there should be information about internal comparable independent transactions presented as a matter of priority when requiring specific documentation, and only then the external independent transactions one.
The application of EU TP Documentation is not mandatory for the multinational enterprises yet. That means the company may decide itself whether to process Masterfile for the whole group. It must be considered whether benefits arising from keeping the concept are worth the costs related to the processing of the documentation.
The member states shall apply the same transfer pricing documentation requirements in respect of the permanent establishment profit definition.
5. Principles of the transfer pricing documentation applied in the Czech Republic
All EU member states including the Czech Republic have decided to implement the European Code of EU TP Documentation and its rules in their laws or to apply them using other binding instruments and tools.
The Ministry of Finance has decided to issue a guidance concerning the scope of transfer pricing documentation, and processing the mentioned guidance followed the above stated concept while reflecting all national specifics and circumstances, i.e. all the principles shall be applied in accordance with the valid Czech Republic regulations.
The principles stated in this communication shall apply both to domestic transactions with associated enterprises as well as international transactions with associated enterprises.
The taxpayer may be asked to present the transfer pricing documentation to the tax authority in the following cases:
when evidencing his tax liability,
when applying for the binding consideration under s. 38nc of AIT – Binding consideration in respect of the transfer pricing between associated enterprises,
when initiating mutual agreement procedure under Article 25 of bilateral Double Taxation Treaties which may lead to the presentation of a case to the Arbitrary Commission under the provisions of the Arbitration Convention.
The terms for presentation of transfer pricing documentation shall meet the provisions of Act no. 337/1992 Coll., on administration of taxes, as amended (hereafter “AAT”).
As already stated, the application of the Masterfile shall be voluntary one for associated enterprises. It means that the companies may decide themselves whether to process Masterfile for the whole group together. If the group of associated enterprises selects this option, the Czech tax administration shall apply provisions of the Code of Conduct on transfer pricing documentation for associated enterprises in the EU in accordance with respective Czech law.
Irrespective to the fact whether the company applies the concept of EU TP Documentation and decides to process the Masterfile for the whole group in a unified way or whether the company decides to document its transfer pricing independently, the documentation presented should contain the following information:
- information concerning the group (possibly Masterfile) – description of business activities, complete ownership and organisational structure of the whole group, information on associated enterprises engaged in transactions including an overview of financial results of particular associated enterprises, allocation of functions within the group, allocation of risks, overview of intangible property ownership (licences, patents, know-how etc.) and licensing fees flow, overview of the transfer pricing policy implemented, list of cost contribution arrangements concluded, overview of advance pricing agreements entered into by the associated enterprises (binding consideration issued), commitment of the company to submit other evidences in reasonable time if the presented information about the group is insufficient etc. If it is expected that some of the above mentioned facts would be changed in close future, the changes should be also stated together with their reasoning.
- information concerning the company – precise description of business activities, complete ownership and organisational structure, financial results of previous years and corresponding financial indicators, strategies adopted etc.
- information concerning the transaction – precise description of subject of the transaction (i.e. precise description of goods and services traded), financial and trading terms, all relevant agreements and contracts entered into by the enterprises concerned, volume of the transaction, functions and risks associated to the transaction concerned etc. In case of intangible performance (management and marketing services, consultancy etc.), it is necessary to describe characteristics of the services provided in a sufficient way, to identify purpose of the services and expected benefits arising from them in more detailed way.
- information concerning other circumstances effecting the transaction – company’s marketing strategy, specific economic conditions of the market, legislation specifics etc.
- information concerning transfer pricing methods used – an explanation about the selection and application of the transfer pricing method, explanations why the particular way of pricing has been selected, information concerning comparable transactions (internal ones within the group and/or external ones between two comparable independent enterprises), comparability analysis under par. 1.15 – 1.35 of OECD Guidelines.
The above stated content should be sufficient for the tax authority to determine whether the company acts in accordance with the arm’s length principle and whether its transfer prices correspond to prices of comparable uncontrolled transactions. At the time these requirements are compatible to EU TP Documentation.
If in exceptional cases there is a need to evidence other facts through other documents, the tax authority may apply valid provisions of s. 31 of AAT (Evidencing). However the situation when the tax authority requires documents exceeding the scope of recommended transfer pricing documentation should happen only in exceptional cases. During the tax audit, the tax authority shall fully respect the principle of tax administration pursuant to which when requiring the fulfilment of taxpayers´ liabilities it shall chose only the means representing as low as possible burden for the taxpayer while providing for appropriate collection of taxes.
The company should archive its documents during the period for which the tax may be assessed (s. 47 of AAT) at least, and simultaneously for the period determined in Act 563/1991 Coll., on accounting, as amended (10 or 5 years).