Transfer Pricing Handbook 2015 Transfer Pricing Handbook Tax Europe Transfer Pricing Handbook 2015 Transfer Pricing Handbook Baker & McKenzie i Table of Contents Introduction ......................................................................................... 1 Austria ................................................................................................. 3 1. Statutory Rules and Administrative Regulations.................... 4 2. Transfer Pricing Methods....................................................... 7 3. Transfer Pricing Documentation and Filing Requirements.... 8 4. Tax Audit Procedures........................................................... 11 5. Dispute Resolution ............................................................... 14 6. Interest and Penalties............................................................ 16 7. Advance Pricing Agreement Procedures.............................. 17 8. Thin Capitalization............................................................... 18 Azerbaijan ......................................................................................... 21 1. Statutory Rules and Administrative Regulations.................. 22 2. Transfer Pricing Methods..................................................... 25 3. Transfer Pricing Documentation and Filing Requirements.. 25 4. Tax Audit Procedures........................................................... 26 5. Dispute Resolution ............................................................... 34 6. Interest and Penalties............................................................ 36 Belgium ............................................................................................. 39 1. Statutory Rules and Administrative Regulations.................. 40 2. Transfer Pricing Methods..................................................... 43 3. Transfer Pricing Documentation and Filing Requirements.. 45 4. Tax Audit Procedures........................................................... 47 5. Dispute Resolution ............................................................... 51 6. Interest and Penalties............................................................ 52 7. Advance Pricing Agreement Procedures (APAs)................. 52 8. Thin Capitalization............................................................... 55 Czech Republic.................................................................................. 57 1. Statutory Rules and Administrative Regulations.................. 58 2. Transfer Pricing Methods..................................................... 61 ii Baker & McKenzie 3. Transfer Pricing Documentation and Filing Requirements.. 64 4. Tax Audit Procedures........................................................... 67 5. Dispute Resolution ............................................................... 72 6. Advance Pricing Agreement Procedures.............................. 74 Denmark ............................................................................................ 79 1. Statutory Rules and Administrative Regulations.................. 80 2. Transfer Pricing Methods..................................................... 82 3. Transfer Pricing Documentation and Filing Requirements.. 83 4. Tax Audit Procedures........................................................... 87 5. Dispute Resolution ............................................................... 89 6. Interest and Penalties............................................................ 91 7. Advance Pricing Agreement Procedures.............................. 93 8. Other Subjects - Trends - Thin Capitalization...................... 94 Finland............................................................................................... 97 1. Statutory Rules and Administrative Regulations.................. 98 2. Transfer Pricing Methods................................................... 101 3. Transfer Pricing Documentation and Filing Requirements 102 4. Tax Audit Procedures......................................................... 105 5. Dispute Resolution ............................................................. 109 6. Interest and Penalties.......................................................... 111 7. Advance Pricing Agreement Procedures............................ 112 8. Thin Capitalization............................................................. 113 France .............................................................................................. 117 1. Statutory Rules and Administrative Regulations................ 119 2. Transfer Pricing Methods................................................... 124 3. Transfer Pricing Documentation and Filing Requirements 130 4. Tax Audit Procedures......................................................... 139 5. Dispute Resolution ............................................................. 144 6. Interest and Penalties.......................................................... 147 7. Advance Pricing Agreement Procedures............................ 149 8. Thin Capitalization and Interest Deduction........................ 151 Germany .......................................................................................... 155 1. Statutory Rules and Administrative Regulations................ 156 Transfer Pricing Handbook Baker & McKenzie iii 2. Transfer Pricing Methods................................................... 160 3. Transfer Pricing Documentation and Filing Requirements 166 4. Tax Audit Procedures......................................................... 171 5. Dispute Resolution ............................................................. 176 6. Interest and Penalties.......................................................... 178 7. Advance Pricing Agreement Procedures............................ 179 Hungary........................................................................................... 185 1. Statutory Rules and Administrative Regulations................ 186 2. Transfer Pricing Methods................................................... 188 3. Transfer Pricing Documentation and Filing Requirements 189 4. Tax Audit Procedures......................................................... 194 5. Dispute Resolution ............................................................. 198 6. Interest and Penalties.......................................................... 199 7. Advance Pricing Agreement Procedures............................ 200 Ireland.............................................................................................. 203 1. Statutory Rules and Administrative Regulations................ 204 2. Transfer Pricing Methods................................................... 207 3. Transfer Pricing Documentation and Filing Requirements 209 4. Tax Audit Procedures......................................................... 212 5. Dispute Resolution ............................................................. 215 6. Interest and Penalties.......................................................... 216 7. Advance Pricing Agreement Procedures............................ 216 8. Other Topical Subjects....................................................... 216 Italy.................................................................................................. 219 1. Statutory Rules and Administrative Regulations................ 220 2. Transfer Pricing Methods................................................... 223 3. Transfer Pricing Documentation and Filing Requirements 225 4. Tax Audit Procedures......................................................... 233 5. Dispute Resolution ............................................................. 240 6. Interest and Penalties.......................................................... 242 7. Advance Pricing Agreement Procedures............................ 243 8. Other Topical Subjects/Trends........................................... 245 iv Baker & McKenzie Luxembourg .................................................................................... 249 1. Statutory Rules and Administrative Regulations................ 251 2. Transfer Pricing Methods................................................... 252 3. Transfer Pricing Documentation and Filing Requirements 252 4. Tax Audit Procedures......................................................... 253 5. Dispute Resolution ............................................................. 253 6. Interest and Penalties.......................................................... 254 7. Advance Pricing Agreement Procedures............................ 254 The Netherlands............................................................................... 255 1. Statutory Rules and Administrative Regulations................ 256 2. Transfer Pricing Methods................................................... 259 3. Transfer Pricing Documentation and Filing Requirements 264 4. Tax Audit Procedures......................................................... 266 5. Dispute Resolution ............................................................. 271 6. Advance Pricing Agreement Procedures............................ 276 7. Other Topical Subjects/Trends........................................... 280 Norway ............................................................................................ 281 1. Statutory Rules and Administrative Regulations................ 283 2. Transfer Pricing Methods................................................... 287 3. Transfer Pricing Documentation and Filing Requirements 290 4. Tax Audit Procedures......................................................... 292 5. Dispute Resolution ............................................................. 294 6. Interest and Penalties.......................................................... 299 Poland.............................................................................................. 301 1. Statutory Rules and Administrative Regulations................ 302 2. Transfer Pricing Methods................................................... 304 3. Transfer Pricing Documentation and Filing Requirements 305 4. Tax Audit Procedures......................................................... 307 5. Dispute Resolution ............................................................. 309 6. Interest and Penalties.......................................................... 310 7. Advance Pricing Agreement Procedures............................ 311 Transfer Pricing Handbook Baker & McKenzie v Portugal ........................................................................................... 315 1. Statutory Rules and Administrative Regulations................ 316 2. Transfer Pricing Methods................................................... 318 3. Transfer Pricing Documentation and Filing Requirements 320 4. Tax Audit Procedures......................................................... 322 5. Dispute Resolution ............................................................. 324 6. Interest and Penalties.......................................................... 327 7. Advance Pricing Agreement Procedures............................ 328 8. Interest Deductibility Rules and Autonomous Taxation .... 331 Russia .............................................................................................. 333 1. Statutory Rules and Administrative Regulations................ 335 2. Transfer Pricing Methods................................................... 340 3. Transfer Pricing Documentation and Filing Requirements 343 4. Tax Audit Procedures......................................................... 346 5. Dispute Resolution ............................................................. 349 6. Interest and Penalties.......................................................... 351 7. Advance Pricing Agreement Procedures............................ 352 8. Interest Deduction and Thin Capitalization........................ 353 Spain................................................................................................ 355 1. Statutory Rules and Administrative Regulations................ 357 2. Transfer Pricing Methods................................................... 361 3. Transfer Pricing Documentation and Filing Requirements 362 4. Tax Audit Procedures......................................................... 366 5. Dispute Resolution ............................................................. 369 6. Interest and Penalties.......................................................... 370 7. Advance Pricing Agreement (APA) Procedures................ 371 8. Thin Capitalization............................................................. 373 Sweden ............................................................................................ 375 1. Statutory Rules and Administrative Regulations................ 377 2. Transfer Pricing Methods................................................... 380 3. Transfer Pricing Documentation and Filing Requirements 382 4. Tax Audit Procedures......................................................... 385 5. Dispute Resolution ............................................................. 392 vi Baker & McKenzie 6. Interest and Penalties.......................................................... 393 7. Advance Pricing Agreement Procedures............................ 394 Switzerland...................................................................................... 397 1. Statutory Rules and Administrative Regulations................ 400 2. Transfer Pricing Methods................................................... 406 3. Transfer Pricing Documentation and Filing....................... 407 4. Tax Audit Procedures......................................................... 407 5. Dispute Resolution ............................................................. 408 6. Interest and Penalties.......................................................... 408 7. Other Topical Subjects/Trends........................................... 409 Turkey ............................................................................................. 411 1. Statutory Rules and Administrative Regulations................ 412 2. Transfer Pricing Methods................................................... 416 3. Transfer Pricing Documentation and Filing Requirements 419 4. Tax Audit Procedures......................................................... 421 5. Dispute Resolution ............................................................. 423 6. Interest and Penalties.......................................................... 424 7. Advance Pricing Agreement Procedures............................ 425 Ukraine ............................................................................................ 431 1. Statutory Rules and Administrative Regulations................ 432 2. Transfer Pricing Methods................................................... 436 3. Transfer Pricing Documentation and Filing Requirements 438 4. Tax Audit Procedures......................................................... 440 5. Dispute Resolution ............................................................. 442 6. Interest and Penalties.......................................................... 445 7. Advance Pricing Agreement (APA) Procedures................ 446 UK ................................................................................................... 449 1. Statutory Rules and Administrative Regulations................ 451 2. Transfer Pricing Methods................................................... 454 3. Transfer Pricing Documentation and Filing Requirements 456 4. Tax Audit Procedures......................................................... 459 5. Dispute Resolution ............................................................. 463 6. Interest and Penalties.......................................................... 466 Transfer Pricing Handbook Baker & McKenzie vii 7. Advance Pricing Agreement Procedures............................ 467 8. Thin Capitalization............................................................. 470 Transfer Pricing Handbook – Introduction Baker & McKenzie 1 Introduction Transfer pricing: changes on the horizon Transfer pricing remains at the top of the agenda for multinational groups, who are facing the prospect of radical change to international tax rules as the OECD’s Base Erosion and Profit Shifting (BEPS) project delivers its proposals for reform. We can expect some significant changes to the OECD’s Transfer Pricing Guidelines as a result, dealing in particular with ownership of intangibles, risk, recharacterization of transactions and hard to value intangibles. The package of September 2014 BEPS deliverables included the much talked-about template for country-by-country (CbC) reporting as part of a new three-tier approach to transfer pricing documentation involving a Master File, Local File and CbC Report. The information required for the CbC report has been revised and while it is less onerous than was originally proposed, it will still present a major compliance burden for multinationals. More details will appear later in the year on all the transfer pricing BEPS Actions, as well as final reports proposing change in other important areas such as the permanent establishment rules, which are likely to have major repercussions for business structuring. The other development that we can expect to influence the BEPS discussions as well as transfer pricing practices is the agenda of the UN member countries. They have already signaled a move away from the OECD approach by deleting from the commentary to the UN Model Tax Convention the recommendation to follow the OECD’s Transfer Pricing Guidelines in applying the arm’s length principle. The OECD published a Discussion Draft on low value-adding intragroup services. This is part of BEPS Action 10, with the aim to “develop rules to prevent BEPS by engaging in transactions which would not, or would only very rarely, occur between third parties. This will involve adopting transfer pricing rules or special measures to provide protection against common types of base eroding payments, 2 Baker & McKenzie such as management fees and head office expenses.” The UN context is especially relevant in this area and it will be a constant theme in developing these proposals. The G20 leaders have committed to finalizing their work on BEPS in 2015, so between now and then we can expect further announcements on sweeping changes to the transfer pricing landscape over the next years. Meanwhile in Europe, the Commission followed up on work begun earlier by adopting a Communication on the work of the EU Joint Transfer Pricing Forum (JTPF) in the period July 2012 to January 2014. The JTPF’s work included reports on secondary adjustments, transfer pricing risk management and compensating adjustments. Baker & McKenzie EMEA Transfer Pricing Partners Transfer Pricing Handbook – Austria Baker & McKenzie 3 Austria Imke Gerdes, LLM, Partner Imke Gerdes specializes in Austrian tax law as well as in international tax law and has provided tax advice in several international company reorganizations. She has several years of practice in advising purchasers as well as sellers in M&A transactions and their related tax structures. Imke obtained an LLM in International Tax Law at the University of Economics Vienna. She is admitted to the Vienna bar as well as to the Cologne bar. Imke is further admitted to the Chamber of Tax Advisors Vienna as Steuerberater (currently inactive). [email protected] Tel: +1 212 626 4747 Baker & McKenzie LLP 452 Fifth Avenue New York USA 4 Baker & McKenzie 1. Statutory Rules and Administrative Regulations 1.1 Introduction The Austrian transfer pricing legislation follows the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the “OECD Guidelines”), which are supplemented by the domestic guidelines on transfer pricing matters (the “Domestic Guidelines”). The OECD Guidelines are not binding but are used as a means of interpretation. The Domestic Guidelines are only binding on the tax authorities but not on the taxpayer or the courts and are a means of interpretation of the domestic law. Under Austrian domestic law (in particular, Section 6 N°. 6 of the Austrian Income Tax Act [ITA] and Section 8 of the Austrian Corporate Income Tax Act [CITA]), transactions between related parties must follow the arm’s length principle. The domestic and the OECD guidelines are used to further define the “arm’s length principle,” as the law is silent on this. 1.2 Meaning of “related entities” According to Section 6 N° 6 ITA, entities or persons are related in outbound situations, if: • the foreign business is owned by the same Austrian taxpayer who owns the Austrian business; • the Austrian taxpayer is a co-entrepreneur of the foreign business and/or the domestic business; • the Austrian taxpayer holds a share of 25 percent or more in the foreign entity or vice versa; or • the same person (or persons) is directly or indirectly participating in the management or control of each of the affected entities. Transfer Pricing Handbook – Austria Baker & McKenzie 5 1.3 Scope of the rules The Austrian transfer pricing rules set out in Section 6 N° 6 ITA only apply where an Austrian taxpayer enters into transactions with a related foreign entity, whereas Section 8 CITA also applies to transactions where both parties are Austrian residents. The rules apply to a wide range of related party transactions, including goods and services and financing transactions, as well as the licensing and sale of intellectual property. 1.4 Compliance Self-assessment applies to Austrian corporation taxpayers who must decide whether the taxable profits they enter on their self-assessment return reflect an application of the arm’s length principle where relevant. 1.5 Time limits for assessment Most taxes are levied by way of assessments, which, in turn, are normally based on the taxpayer’s tax returns. Only a few taxes are subject to a self-assessment procedure. Assessments can only be made within the statutorily prescribed assessment period, which is subject to the following statute of limitations for assessments: • Three years for consumption taxes and statutorily fixed stamp duties and their refunds • Five years for all other taxes and their refunds • Ten years in the case of tax fraud These periods commence in all cases at the end of the calendar year in which the tax liability arises. The assessment period will, however, not start to run prior to the end of the year in which the tax return was filed. Further, the statute of limitation will be prolonged by one year each time the tax authorities take action in order to assess the tax due (such as commencing a tax audit). As a final statute of limitation, the 6 Baker & McKenzie law provides that, in any event, the right to assess taxes is statutebarred after 10 years from when the tax liability arose. In addition to the rules governing the statute of limitations for the assessment of taxes, the Austrian Fiscal Code (“BAO”) contains provisions that allow for the change of final tax assessments. After the statute of limitation has lapsed, such a final change is only possible in certain circumstances. Examples with particular practical importance include, inter alia, the following cases: • The tax office becomes aware of new facts that have not been brought forward earlier. • The tax assessment has been based on falsified documents. • The assessment will usually be changed in order to implement the results of a mutual agreement procedure (MAP). 1.6 Attribution of profit Austrian law does not have explicit rules on the allocation of profits and therefore generally adheres to the OECD Report on the Attribution of Profit to Permanent Establishments, which describes how profits should be attributed to permanent establishments in accordance with the OECD Model Tax Convention’s tax treaty provisions. However, the separate entity approach as outlined in the OECD Report is only applicable with certain limitations, as Austrian law in general does not recognize transactions between a permanent establishment and its principal, because legally both persons are the same entity. 1.7 Advance pricing agreements (APAs) As of 1 January 2011, the Austrian tax legislation offers APAs to be concluded with the tax authorities. Even though Austrian law does not explicitly provide for bilateral APAs, the Austrian tax authorities are willing to enter into reciprocal negotiations. Transfer Pricing Handbook – Austria Baker & McKenzie 7 2. Transfer Pricing Methods 2.1 Selection of method The OECD Guidelines provide that the transfer pricing method selected be the most appropriate method in the circumstances of the case. However, where a transaction-based method (comparable uncontrolled price or CUP, resale price or cost plus) and a profit method (profit split or transactional net margin method [TNMM]) are both equally valid in the circumstances, the transaction method is preferable. Similarly, where a CUP method and another transfer pricing method are both equally reliable, the CUP method should be used. The Domestic Guidelines follow this approach. Therefore, from an Austrian perspective, a decision on the most appropriate method should therefore always begin with a consideration of whether any CUPs, either internal or external, are available. 2.2 Contemporaneous information Hindsight cannot be used to determine whether a price was at arm’s length; only information available to the parties at the time (including reasonably foreseeable information) can be relied upon. Also, Austrian legislation does not include a commensurate-with-incometype rule. 2.3 Pricing adjustments Year-end and retrospective pricing adjustments may be acceptable, for example, to take into account actual circumstances that have occurred where only budgeted indicators were initially used to set transfer pricing policies. Other factors for which adjustments need to be made may also be relevant. However, those adjustments need to be made prior to filing the corporate income tax return. Further, the parties need to specifically agree on such adjustments. True-ups are likely to be accepted by tax authorities, whereas true-downs may give rise to discussions in an audit. 8 Baker & McKenzie 2.4 Working capital/inventory The Domestic Guidelines do not generally require calculation of comparability adjustments to ascertain levels of working capital or inventory when comparing equivalent business activities. Adjustments may be required if, for example, distributor companies are being used in benchmarking returns as a proxy for commission-based sales functions. 2.5 Business restructurings The recent addition of guidance on business restructurings to the OECD guidelines is also critical in determining the Austrian transfer pricing approach and the impact of changes in functions, risks and assets of Austrian taxpayers. The Austrian approach to business restructurings is very aggressive and sometimes deviates significantly from the OECD approach. 2.6 Safe harbors There are no published safe harbors or rules of thumb, although in general, a debt-to-equity ratio of 3:1 is accepted, and for providing routine services, a cost plus of 5 percent can be appropriate. 3. Transfer Pricing Documentation and Filing Requirements 3.1 Recordkeeping Austrian law contains specific rules on the obligation of businesses to maintain books and records and to produce financial statements. Generally, if a person or business is obliged to keep books and records pursuant to commercial law, this obligation also exists for tax law purposes. Further, domestic tax law (Sections 124 through 132 of the BAO) requires taxpayers to provide sufficient documentation to enable tax authorities to assess the taxes correctly. In addition, Section 119 BAO in combination with Section 138 BAO states that taxpayers are obliged to provide a higher level of cooperation with tax authorities if foreign parties are involved (erhöhte Mitwirkungs- Transfer Pricing Handbook – Austria Baker & McKenzie 9 pflicht). In this respect, the taxpayer has the obligation to ensure that evidence is available (Beweisvorsorgepflicht) and to provide tax authorities with the requested proofs (Beweismittelbeschaffungspflicht). The documents have to be written in a living language but can be created and stored abroad. However, the taxpayer must be able to bring them into Austria within a reasonable period of time to be set by the tax authorities. Certain basic documentation may be created abroad but has to be stored in Austria. Further, the tax authorities may request a certified translation into German of documents written in a different language, which would trigger additional costs and would definitely prolong the audit procedure. Depending on the scope of the books, records and financial statements, procuring a certified translation might take longer than the period set by the tax authorities. Austrian legislation does not provide for documentation requirements laid down in the law. However, both the OECD Guidelines and case law require intragroup transactions to be documented, and this is also a requirement under the Domestic Guidelines. When it comes to the acknowledgement of intragroup transactions for tax purposes, Austrian tax authorities apply the case law that has been developed in connection with transactions between close relatives (such as transactions among spouses). Therefore, business transactions between related parties may generally only be recognized if the following conditions are met: (i) The agreements are in writing. (ii) The agreements are clear and concise, and easily understandable by any third party. (iii) The conditions are at arm’s length. In very exceptional cases, it may also be sufficient if the taxpayer can prove that an oral agreement has been concluded. However, having a written agreement in place is strongly advisable and no further issues 10 Baker & McKenzie should arise during an audit if a taxpayer complies with the principles in the OECD Guidelines. 3.2 Timing of evidence and analysis Corporate income tax returns filed by paper declaration must be submitted by 30 April of the following year. If the tax return is filed electronically (which is mandatory for all Austrian businesses), this period is extended until 30 June of the following year. In the event that the company is represented by a tax adviser, this period can be extended until 30 September. The maximum extension period is until 31 March of the second following year, which can be requested only by a tax adviser. 3.3 Recordkeeping duration Books, records and financial statements are also required to be kept for tax purposes and generally need to be maintained for seven years. In the event a tax audit is initiated before the end of this period, the documents need to be maintained for as long as they could influence the proceedings initiated. However, because the absolute statute of limitation in Austria amounts to 10 years, it is advisable to store records for this period of time. Further, documents relating to real estate may need to be maintained for 22 years. 3.4 Reviewing and updating documentation Documentation should be reviewed on an annual basis to determine if historical, functional and economic analyses are still relevant, but there is no requirement to update formal documentation. Also, the authorities take the view that transfer pricing documentation has to be established at the time the corporate income tax return is filed. However, this view is highly criticized in literature and is considered to be unreasonable. It is, however, recommended to establish the transfer pricing documentation in a contemporaneous manner. Transfer Pricing Handbook – Austria Baker & McKenzie 11 3.5 Form and depth of documentation The Domestic Guidelines have indicated that documentation in the form of the European “Masterfile” should generally be adequate and sufficient, but emphasize that the depth of documentation and analysis should be commensurate with the complexity and materiality of the transaction. Further, the Domestic Guidelines clarify that tax authorities may request additional information and documents exceeding the content of the Masterfile. 3.6 Returning information There is no special corporation tax return form for reporting connected party transactions, but these must be reflected in the normal annual corporation tax return. 4. Tax Audit Procedures 4.1 Risk assessment Transfer pricing audits are usually part of a regular audit for corporate income tax purposes. Neither Austrian law nor internal administrative guidelines provide for a certain tax audit threshold. 4.2 Indicators of a high-level risk The Austrian tax authorities do not give any indications of what is considered a high-level risk. However, as tax revenues constantly decrease, the Austrian tax authorities have invested quite a large amount of money and effort in the more intensive and specific education of their tax auditors. Specific tax audit techniques and programs have been introduced and mainly applied to so-called “highrisk” companies, meaning companies with a high cash flow such as service enterprises and retail industry but audits are conducted in basically every possible industry. Further, as of January 2003, all tax audits of businesses are being performed electronically with the audit software ACL. The question of whether or not an Austrian taxpayer is audited depends on various factors. First of all, the tax authorities focus on taxpayers that have not been audited for a few years. The 12 Baker & McKenzie data processing system of the tax authorities saves the date of the last tax audit and thereby chooses those taxpayers that have not been audited for the longest time. There is no clear frequency and some taxpayers are audited more frequently than others, as described below. Larger companies are usually audited on a frequent basis and therefore, no fiscal year remains unaudited. Further, it can generally be said that a taxpayer may expect a tax audit every six to eight years, and the period covered by the audit is normally three fiscal years. Any type of business restructuring is also likely to be audited. Moreover, any decrease in profit that goes back to a revised transfer pricing structure indicates a high-level risk. 4.3 Commencement of enquiry The competent tax authority determines the scope of the tax audit and notifies the taxpayer about the initiation of the tax audit, the taxes and periods to be covered, the contemplated date of the first visit, and the name of the tax auditor. Such a notice, which is given in writing, is an administrative act; however, it is not subject to appeal. The tax authorities are obliged to notify the taxpayer by phone one week before the first visit, which begins the tax audit; however, if the object of the tax audit would otherwise be frustrated, the tax audit may also commence immediately. 4.4 Transfer pricing group There are specialists within the Austrian tax revenue who are dedicated to dealing with transfer pricing enquiries and transfer pricing audits. Tax officers are encouraged to liaise with the transfer pricing group specialists at an early stage in the process and usually do so. 4.5 Tax auditor’s current focus Key areas of transfer pricing focus include the following: • Business restructurings Transfer Pricing Handbook – Austria Baker & McKenzie 13 • Loss-generating distribution companies, specifically limited risk distributors • Pharmaceutical companies • Permanent establishment issues 4.6 Information powers Austrian tax auditors may use any source of information they can access, such as witnesses, documents and information from third parties. However, obtaining information from third parties is to be considered a “last resort” method that should be used only if the taxpayer himself refuses or is unable to give the desired information to the tax authorities. Should the auditor use information gained from a witness against the taxpayer, the taxpayer concerned may request disclosure of the name of this person. The Austrian tax authorities do not, however, use “secret comparables” in cases involving transfer pricing issues. The tax authorities are also entitled to request from the taxpayer documentation that is stored abroad. This is frequently done in transfer pricing issues where, for example, the transfer pricing documentation is stored in a foreign-associated enterprise and the request is based on the increased obligation of the taxpayer to cooperate. However, the request of the tax authorities needs to be reasonable and may therefore not contain impossible, unreasonable or unnecessary measures. 4.7 Transfer pricing information The type of information available to the tax auditors might include the company’s transfer pricing documentation, everything that the company has prepared for its corporation tax self-assessment, any further evidence of arm’s length pricing, the company’s transfer pricing manual, budgets for each function, management accounts, and sometimes the financial statements of related entities. 14 Baker & McKenzie 5. Dispute Resolution 5.1 Litigation and settlement strategy During a tax audit, the auditor usually seeks to discuss the issues at stake with the taxpayer and the adviser. Thus, a number of meetings will take place in order to discuss or, if possible, resolve issues of importance that have arisen prior to the final meeting. The final – generally mandatory – meeting is scheduled prior to the close of the tax audit for the purpose of a final discussion of problems, and, of course, for negotiations between auditor and taxpayer. This final meeting generally takes place in the premises of tax authorities. However, it is possible to hold the meeting in the premises of the taxpayer’s business. If possible, the taxpayer should seek to take this option as it facilitates access to all relevant documents. If the parties have already reached an agreement or if the tax audit did not result in an adjustment of the income, the parties may also waive the right to hold the final meeting. 5.2 Domestic appeals process The tax authorities will issue a formal assessment based on the audit report. Unless the taxpayer files an appeal within the appeal period, a tax assessment is deemed to be final after the lapse of one month from receipt of the assessment notice by the taxpayer. “Final” means that, as a matter of principle, the assessment is no longer subject to appeal or change. The appeal has to be filed with the tax authorities who issued the final assessment. The tax authorities of first instance always have to issue a first decision on the appeal. If the tax authorities of first instance render a negative decision, the taxpayer can request the case to be referred to the newly established Federal Tax Court (“BFG”). A decision rendered by the BFG may be appealed before the Federal Administrative Court. 5.3 Mutual agreement procedure To prevent double taxation resulting from changes in income allocation effected either by Austrian or non-Austrian tax authorities, Transfer Pricing Handbook – Austria Baker & McKenzie 15 the Austrian double tax treaties (DTTs) in place provide for competent authority proceedings that the taxpayer is entitled to apply for. The wording of the respective provisions is in most cases similar to Article 25 of the OECD Model Convention. Generally, the taxpayer needs to file its request within three years after it has been notified of the action that leads to a tax result that does not comply with the DTT in place. The request needs to be filed with the Federal Ministry of Finance as the competent authority. Prior to the opening of competent authority proceedings, the Austrian tax authorities will determine if, and to what extent, the taxpayer’s petition can be satisfied domestically, i.e., without involving the other state(s). If this is not possible, the Austrian Ministry of Finance will approach the competent authorities of the other country involved and initiate the competent authority proceedings, which are usually conducted in writing. If the competent authority proceedings fail, the Austrian tax authorities will examine whether double taxation may be avoided unilaterally, which is usually the case if it would otherwise cause hardship. 5.4 Interaction of MAP and domestic transfer pricing enquiry Any request to initiate the MAP should not delay the progress and settlement of a domestic appeals process. The Austrian taxpayer has a great deal of flexibility, as the request to initiate competent authority proceedings may already be filed even if there is only a possibility of double taxation. It is therefore not necessary that the alleged double taxation has already occurred, nor is it necessary that the taxpayer has already filed an appeal in Austria. It may certainly request the initiation of competent authority proceedings prior to filing an appeal, especially as the countries involved are not forced by law to come to an agreement and the proceedings may take several years. For these reasons, it would thus be advisable in most instances to simultaneously file a domestic appeal against the decision. 5.5 The European Arbitration Convention As far as the European Union is concerned, double taxation issues can be addressed on the basis of the Convention on the Elimination of Double Taxation in Connection with the Adjustment of Profits of 16 Baker & McKenzie Associated Enterprises, ratified by Austria on 1 January 1996. In the event that a procedure under the European Arbitration Convention is initiated, the parties to the procedure are obliged to reach an agreement within two years after the case was first submitted. The parties to the procedure are the same competent authorities as in the competent authority proceedings. 5.6 Current areas of potential transfer pricing litigation in Austria Currently, the Austrian tax authorities critically examine business restructurings, especially where functions of an Austrian company are downsized and therefore, the profit margin is decreased. Loss-making distributors are analyzed in details, especially if these distributors are limited risk distributors. The general perception is that limited risk distributors should not generate losses at all or at least not exceeding a certain period of time. 6. Interest and Penalties 6.1 Interest Where additional corporation tax becomes due following a transfer pricing adjustment, any corporation tax paid late will carry interest at a rate of 2 percent above base rate. However, interest will only be calculated for a period of 48 months at the maximum. 6.2 Penalties Penalties may be imposed where a tax return is submitted late or where a criminal fiscal offence was committed. 6.3 Amount of penalty If a tax return is submitted late, penalties of up to 10 percent of the tax assessed may be triggered. The penalty in case of criminal liability varies depending on whether the deed was committed negligently or willfully and ranges between 200 percent of the tax unpaid in case of willful misconduct, 100 percent of the unpaid tax if committed Transfer Pricing Handbook – Austria Baker & McKenzie 17 negligently, and 50 percent of the tax unpaid in minor cases. Further, the court may also sentence the person responsible to prison. 7. Advance Pricing Agreement Procedures 7.1 Who can apply for an APA? An APA can be requested by any Austrian taxpayer involved in transactions to which the Austrian transfer pricing legislation applies. 7.2 Tax authorities’ approach According to the law, the authorities have to charge a fee, which is based on the previous turnover of the taxpayer and ranges from EUR1,500 to EUR20,000. If the application is withdrawn, a fee in the amount of EUR500 is due. 7.3 Typical APA transaction Generally, an APA may only be agreed on if the underlying facts have not yet materialized. Therefore, an APA can only be agreed on for the future but not for the past. In addition, the taxpayer might want to consider applying for an APA where business restructurings are envisaged. 7.4 Procedure The procedure is as follows: • The potential applicant makes an expression of interest to the tax authorities. • The issue is pre-discussed with the tax authorities. • Based on the discussions, a formal application is made. • Tax authorities commence their fact-finding task. • An agreed position is reached. 18 Baker & McKenzie 7.5 Information required Based on the law, the applicant basically has to provide tax authorities with any and all information they need to fully assess the tax situation. Usually, the exact amount of information needed will be discussed with the tax authorities; however, it has to be noted that an APA is only binding to the extent tax authorities were informed completely. If any undisclosed facts emerge later, the APA may be considered null and void. 7.6 Monitoring an APA Any agreement reached with the tax authorities is only binding on the authorities but not on the taxpayer. 7.7 Term of an APA An APA will be operative for a specified period from the date of entry into force as set out in the APA. There are no guidelines as to how long the term should generally be; however the term is usually three years. Under certain circumstances, a five-year term would be granted. 7.8 Renewal of an APA Ideally, the business should request a renewal of an APA not later than six months before the expiry of its current term. The renewal application has to contain all information, including the initial APA, which is necessary to allow the tax authorities to evaluate the underlying facts from a tax law perspective. Further, it should expressly consider any changes or anticipated changes in facts and circumstances since the existing APA was reached, whether any amendments are necessary, and it should demonstrate that the proposed methodology is, or is still, appropriate. 8. Thin Capitalization 8.1 General thin capitalization rules Austrian law does not provide for specific thin cap rules. However, the arm’s length standard is also applicable to services and therefore, Transfer Pricing Handbook – Austria Baker & McKenzie 19 also to loans. The authorities would usually look at the industry standard and the average thin capitalization ratio that can be found there. 8.2 Safe harbor In Austria, there is no published safe harbor for thin capitalization purposes, though a 3:1 ratio is usually acceptable. 8.3 Recharacterization Interest paid by a thinly capitalized entity will be recharacterized as a disguised dividend and in addition, a deduction will be disallowed in whole or in part. 8.4 Equity-replacing loans In addition to the general thin capitalization rules, Austrian law provides for the Equity Replacement Act, which in essence states that loans granted by a shareholder to an Austrian company which, at the time the loan was granted, are over-indebted, will not be considered debt but equity. Accordingly, any payment made on this loan will not be considered interest but dividend. There are very clear conditions that have to be fulfilled before an Austrian entity is regarded as overindebted. Further, the term “shareholder” is to be interpreted widely and, depending on the circumstances, may cover not only direct shareholders but also persons who would normally be considered unrelated persons. Transfer Pricing Handbook – Azerbaijan Baker & McKenzie 21 Azerbaijan Altay Mustafayev, Partner Altay Mustafayev is a partner in the Baku office of Baker & McKenzie – CIS Limited. He heads the tax practice of the Baku office and advises on a wide range of tax issues in Azerbaijan. Altay finished his LLB and LLM at Baku State University. He also completed another LLM at University of Washington. He is admitted to practice in Azerbaijan and New York. [email protected] Tel: + 994 12 497 1801 Rena Eminova, Associate Rena Eminova is an associate in the Baku office of Baker & McKenzie – CIS Limited. She advises on a wide range of tax matters in Azerbaijan, with special concentration on tax planning. Rena finished her LLB and LLM at Baku State University. [email protected] Tel: + 994 12 497 18 01 Baker & McKenzie - CIS, Limited The Landmark Building 90A Nizami Street Baku AZ1010 Azerbaijan 22 Baker & McKenzie 1. Statutory Rules and Administrative Regulations 1.1 Introduction The tax system, the general principles of taxation, taxes and duties, payment and collection thereof, the rights and obligations of taxpayers, liability for violations of tax obligations, and procedures for lodging complaints are regulated by the Tax Code of the Republic of Azerbaijan, as effective from 2000 (the “Tax Code”). The Tax Code contains very general transfer pricing rules that enable the tax authorities to disregard actual transaction prices and assess taxes based on market prices determined by an independent expert. The market price rule can be invoked not only in relation to transactions between related parties, but also in cases of some other suspicious transactions such as barter transactions, a chain of transactions where prices fluctuate for more than 30 percent within 30 days, and when a company’s assets are insured for a higher price than the residual value of such assets. 1.2 Transfer pricing rules There are certain exemptions in which the tax authorities may exercise control over the contract price and apply market price that differs from the contract price in accordance with the Tax Code. The market price rule can be invoked not only in relation to transactions between related parties, but also in cases of some other following transactions: • Transactions between related parties • Fluctuation (upward or downward) by more than 30 percent of prices for the same or similar goods, works or services within 30 days of the challenged transaction • Assets of an enterprise are insured for a value exceeding their residual value Transfer Pricing Handbook – Azerbaijan Baker & McKenzie 23 • For the purposes of taxation if it is necessary to determine the amount of monthly rent of real estate (other than housing) 1.3 Related parties Parties are considered related for tax purposes if their relationship can influence the conditions and/or results of transactions between themselves and/or affect the economic results of their activities or the activities of the parties that they represent. In particular, parties would be deemed related for tax purposes under the following circumstances: • A party participates in (owns) the assets of another, directly or indirectly, and such participation level or voting power constitutes at least 20 percent. • A party reports to or is under direct or indirect control of another due to the position of the former. • Parties are under direct or indirect control of a third party. • Parties jointly control a third party directly or indirectly. • They are family members. Transactions between related persons can be referred to only if they are at arm’s length. 1.4 Market price determination Market price is determined by reference to the price for identical goods as of the date closest to the date of transaction within 30 days before or after the transaction. If to determine the price as per the immediately preceding paragraph is impossible, the authorities consider typical costs of producing or disposing of goods (work or service), costs of transportation, storage, 24 Baker & McKenzie insurance, and the like, as well as surcharges and discounts standard between non-related parties in a (free) supply and demand situation. As applicable to a good or service, upon determination of a price, the following factors are considered: • Volume of supply • Time period of discharge of obligations and terms of payment • Price fluctuations • Country origin of goods • Terms of delivery • Quality • Marketing conditions (such as introduction of new service) • Territory of supply and other factors that can affect the price If no transactions with similar goods (services) are made on the relevant market or it is impossible to collect information on market price for such goods (services), the following valuation methods can apply: • Secondary sale price • Cost plus profit • Absent determination based on the above methods, by an expert 1.5 Regulated prices If the price is subject to state regulations by establishing a particular price or price formula, such a price is regarded as a market price for transfer pricing purposes. Transfer Pricing Handbook – Azerbaijan Baker & McKenzie 25 2. Transfer Pricing Methods There are no transfer pricing methods in Azerbaijan. 3. Transfer Pricing Documentation and Filing Requirements 3.1 Documentation requirements There are no special requirements for transfer pricing documentation and filing requirements, as the tax authorities carry out the tax audit on the base of all relevant documents not differentiating transfer pricing documents. 3.2 Regulation of documentation In Azerbaijan, the retention of the documents mainly is regulated in accordance with the Model List indicating the retention period of the documents prepared due to activity of executive bodies, enterprises, institutions and organizations (the “Model List”). The Model List was approved by the National Archive Department (Order No 28, dated 24 November 2004) and state-registered by the Ministry of Justice (Registration No 3104, dated 9 December 2004). It is the main normative document for determining archiving periods of documents as well as storing and obliterating documents. Pursuant to the Model List, the following retention periods may apply to tax documents: • Correspondence on tax returns submission dates – 3 years • Correspondence on acknowledgement and specification of tax declarations returns, declarations – 5 years • Customs declarations, invoices, transport documents, etc., confirming the import and export of the goods (works, services) – 5 years • Correspondence on import and export transactions – 5 years 26 Baker & McKenzie • Reports and information on tax payments and tax debts – 5 years • Decisions on violation of tax legislation and its registration book – 5 years 3.3 Electronic Data Processing (EDP) access during audit Under the Tax Code, the tax authorities are entitled to require the electronic files, as well as direct or remote access to such electronic files of a taxpayer for the purposes of the tax audit. The taxpayer shall provide such access within 15 business days upon receipt of such a request. 3.4 Notification requirements Taxpayers shall inform the tax authority within 40 days after any amendments in their information in an application form submitted for registration. 4. Tax Audit Procedures 4.1 Types of tax audits Pursuant to the Tax Code, a tax audit may be carried out in the following forms: (i) cameral audits (chamber audits); and (ii) on-site audits. (a) Chamber tax audits A chamber audit is carried out using documents related to the calculation and payment of taxes and information from a known source in the tax authorities’ offices without site visitation. A chamber audit is conducted within 30 days upon the submission of the relevant documents by a taxpayer. If the tax authorities discover inconsistencies or mistakes in the course of their review of the relevant documents, they may require explanations and/or additional documents or information. If as a result Transfer Pricing Handbook – Azerbaijan Baker & McKenzie 27 of the analysis of the documents presented by the taxpayer the tax authorities discover wrong calculation of taxes in a tax declaration, they will provide the taxpayer with a decision of the tax authorities on the calculation of taxes, together with reasons for the calculation and the taxpayer’s right to appeal, within five business days. (b) On-site tax audits On-site audits are carried out based on the decisions of the tax authority. There are two types of on-site tax audits: (i) ordinary; and (ii) extraordinary. The tax authorities provide a taxpayer with written notification that reflects the basis for and date of the tax audit, rights and obligations of the tax authorities, within 15 days prior to the start of ordinary on-site tax audit. Ordinary on-site tax audits may not be carried out for more than 30 days. In exceptional cases, this period may be extended to 90 days upon the decision of the tax authorities. The grounds for conducting of extraordinary on-site tax audits are: (i) non-submission of tax report documents related to the calculation and payment of taxes; (ii) discovery of inaccurate and/or misleading information in the act reflecting the results of the tax audit; (iii) allocation of the excess to the paid VAT, interest and financial sanctions for the payment of other taxes, interests and financial sanctions, or allocation as payments for future liabilities; (iv) submission of an application by a taxpayer to return excess to paid amounts of taxes, interests and financial sanctions; (v) discovery of indications of hidden (decreasing) incomes or taxable object by a taxpayer; (vi) a decision of the court or a law enforcement body to conduct a tax inspection in accordance with suspected criminal legislation; (vii) application for liquidation, reorganization of the taxpayer’s legal entity or seizure of business operations of the natural person, operating without formation of legal entity; and (viii) a written request of a taxpayer who does not agree with the results of the tax audit for an on-site tax audit to be conducted. 28 Baker & McKenzie On-site tax audits shall be conducted on business days and during the taxpayer’s business hours. An audit related to the results of an extraordinary on-site tax audit is prepared by a responsible official of the tax authority and signed by the tax officer and taxpayer. The taxpayer may include his or her comments in the report, or refuse to sign the report, both of which shall be noted in the report. An audit shall include all violations of tax legislation and specific articles of the Tax Code, as well as other legislative acts determined during the audit and substantiated by documents or by the absence of any violation. One copy of the act is submitted to the taxpayer no later than five days following the date the audit was conducted. In the event the taxpayer does not agree with the act, he or she may submit the reasons for the refusal to sign the act, or comment on the act or any part of it in writing within 30 days of the receipt of the act. At no later than 15 days upon the expiration of the 30-day period, the tax authority shall review the documents provided by or collected from the taxpayer, the tax audit, issues of noncompliance with tax legislation, and remedial activity on violations determined, as well as the application of relevant sanctions (penalties). 4.2 Follow-up on-site tax audits This is not applicable in the Republic of Azerbaijan. 4.3 Transfer pricing tax audits There is no separate audit related to transfer pricing in Azerbaijan. Transfer pricing audits are covered by the regular tax audits (chamber or on-site). In special cases, an expert may be involved in an on-site tax audit, and he or she may assist the tax authority with transfer pricing issues. 4.4 Expected periodicity The expected periodicity differs subject to type of tax audit. A chamber tax audit may be conducted each time a taxpayer submits a Transfer Pricing Handbook – Azerbaijan Baker & McKenzie 29 tax return. Extra-ordinary on-site tax audit may not be conducted more than once a year. In general, each taxpayer is likely to be audited at least once in three years. 4.5 Tax audit selection criteria There are no special selection criteria for tax audits in Azerbaijan. The periodicity of tax audits described above is conducted for all legal entities on the same terms and intensity. 4.6 Statute of limitation An on-site tax audit shall cover the activity of a tax period performed during the period not exceeding the last three calendar years. Chamber tax audits do not have a statute of limitation, but they logically shall cover the period of the respective tax return. Pursuant to the Tax Code, a person may not be liable for breach of tax legislation in the event three years had passed since the moment of the breach. In other words, the statute of limitation with respect to the application of tax penalties is three years. At the same time, the tax authorities are entitled to charge the amount of already assessed taxes, interests and financial sanctions within five years upon the completion of the respective reporting period. Taxpayers may also demand a calculation and a re-calculation of taxes within three years after the respective reporting report, as well as claim refunding or offset of taxes, interest and financial sanctions within five years after the respective reporting period. 4.7 Anticipation of and preparation for the tax audit It is important that the taxpayer prepare in advance for a tax audit. Such preparation shall start with conducting an internal audit and carrying out the following recommended steps: • Review all documentation that will be submitted during the tax audit. 30 Baker & McKenzie • Appoint external legal and tax advisors who will assist the company during the tax audit. • Review all commercial contracts in the last three years. • Review all sensitive documents and develop relevant audit strategies with respect to weaknesses. • Identify the major tax risks and shortcomings related to the company’s operations and documentation. • Pay additional and unpaid taxes, as well as late payment interests before the start of the audit to prevent any penalties. • Appoint individuals who will communicate with the tax auditors. • Designate a workplace for the tax audit to limit the access of the tax authorities to sensitive information not directly related to the tax audit. 4.8 Areas of tax auditors’ special attention A taxpayer may be held liable for failure to submit certain documents and reports sought by the tax authorities. But the amounts that will be levied with each financial sanction are not significant. In Azerbaijan, the tax authorities are also authorized to check if a taxpayer/employer has proper employment contracts with his or her employees. In case they discover any violation, they can then impose financial sanctions. 4.9 Special tax audits Azerbaijani law does not identify special tax audits. As such, special audits do not exist in Azerbaijan. Transfer Pricing Handbook – Azerbaijan Baker & McKenzie 31 However, the Ministry of Taxes (MoT) created the Special Regime Tax Department, which serves large taxpayers and businesses working in Azerbaijan under various production sharing agreements pertaining to the exploration of oil fields. This department does not apply any special tax audit rules, and tax audits are performed in accordance with the general rules of the Tax Code. The only key difference is that this department is staffed by the best talents of the MoT, which basically brings two implications: (i) there are more professional tax auditors, which leads to less abuses and corruption; and (ii) there is more sophistication, making it more difficult for businesses to conceal their tax issues. 4.10 Multijurisdictional tax audits Azerbaijan has never been involved in any multijurisdictional tax audits. 4.11 Escalation of a regular tax audit into a criminal investigation Regular tax audits may be escalated to criminal investigation if during such audits, tax authorities discover indications of a crime. In such case, the auditors shall inform the Department for Preliminary Investigation of Tax Crimes of the MoT, which will then decide whether or not to initiate a criminal investigation. 4.12 Disclosure of tax law violations without conducting tax audits If the tax authority discovers that taxes were wrongly calculated during the chamber tax audits, it shall send a decision on the calculation of the taxes to the taxpayer within five days. Such a decision shall include the reasons for the calculation and explain the right of the taxpayer to challenge the decision with a higher tax authority or in court within three months. 32 Baker & McKenzie 4.13 Administration level (a) During audit The tax authorities issue an act indicating discovered and documented tax violations (if any) and relevant provisions of the Tax Code or other laws stipulating liability for those violations. The act must be signed by the officials of the tax authority and the head of the enterprise. The taxpayer may include his or her notes or refuse to sign the act, and these circumstances shall be reflected in the act. The counterpart of the tax audit act shall be presented or sent to the taxpayer (or its authorized representative) within five days after the issuance of that act. If the taxpayer disagrees with the act or certain parts thereof, it may file a written explanation why the act was not signed, or note his or her objection substantiating his or her disagreement with the act or certain parts thereof, within 30 days of the receipt of the act. Within 15 days of the expiration of this 30-day period, the head (or deputy head) of the tax authority considers the results of the tax audit, as well as any objections or explanations made by the taxpayer. If the taxpayer provided its explanations or objections in connection with the tax audit act, the audit materials shall be reviewed with the participation of the taxpayer or its authorized representative. The taxpayer must be informed about the place and time of the hearing in advance. If a taxpayer who was duly notified about the place and time of the consideration does not appear, without any excusable reasons, the tax authority may proceed with the consideration of the materials. Moreover, the MoT established the Tax Appellate Council (TAC). The TAC aims to consider repeated complaints of the taxpayers about the decisions of the functional departments of the MoT (except complaints regarding corruption offences), substantiated complaints of the regional tax authorities from the written instructions of the functional departments of the MoT, and any other matter directed to it by the Minister of the Taxes. The important point the taxpayer shall take into account is that, if the decision of the tax authority is already disputed in the courts, it cannot simultaneously challenge the same decision with the TAC. The TAC will refuse to consider such a Transfer Pricing Handbook – Azerbaijan Baker & McKenzie 33 complaint. The complaints to the TAC must be written and signed by the head or the authorized representative of the taxpayer (in the event the taxpayer is a legal entity, the seal of that legal entity must also be on the complaint document). The conclusions of the TAC are documents in the form of decisions. (b) After the release of the decision concerning the results of the tax audit A decision concerning the results of the tax audit may be challenged with a higher-level tax authority (administrative manner)/ the TAC, or in administrative-economic courts (judicial manner). An appeal in an administrative manner does not preclude the taxpayer from raising the same appeal before the court simultaneously or afterward. An administrative appeal must be submitted within three months of the date when the taxpayer become aware or should have become aware of the alleged violations. (c) Administrative appeals An appeal by a taxpayer must be considered and responded to in writing within 30 days of receipt. An appeal does not suspend the payment of the taxes. However, the taxpayer is entitled not to pay the sanction while its appeal is under review. Except under this circumstance, the appeal does not suspend the execution of the decision of the tax authority. If the decision is contrary to the laws of Azerbaijan, the tax authority reviewing the appeal can suspend the execution of the decision or part thereof. However, in practice, the higher-level tax authorities rarely suspend the execution of such decisions. If, as a result of the appeal, the decision is cancelled wholly or partly, the taxpayer has following rights: (a) to get compensation for wrongly withdrawn amounts; and (b) to get interest payments on those amounts. 34 Baker & McKenzie 5. Dispute Resolution 5.1 Tax litigation (a) First-instance trials Azerbaijan has a three-tiered court system. The tax disputes between the taxpayers and tax authorities are considered by the administrativeeconomic courts and administrative-economic panels of the higher courts (namely, of the appellate courts and the Supreme Court of Azerbaijan). Such tax disputes are regulated by the Code of Administrative Procedure, effective as of 1 January 2011. In general, the jurisdiction of the administrative-economic courts spread to economic disputes and disputes with the state authorities. If a taxpayer wants to challenge the decision of the tax authority, it must file a claim with the administrative-economic court where the tax authority is located. Such a claim is called a claim for challenging. The claim for challenging the decision must be filed within 30 days of the date when the decision was declared, or when appealed in an administrative manner, within 30 days of the date when the administrative act on the appeal was presented. Unlike the civil procedure legislation, the administrative procedural legislation allows the application for preliminary relief, not only during the proceedings, but also before the submission of the claim. However, if the taxpayer has filed an administrative complaint with the tax authorities, it must first apply to the same authority for the desired preliminary relief. If, within 15 days, the tax authority does not grant preliminary relief, the taxpayer may apply to the court seeking the same remedy. Further, the burden of proof of factual circumstances necessitating the issuance of the challenged decision lies with the tax authorities. Transfer Pricing Handbook – Azerbaijan Baker & McKenzie 35 (b) Appellate trials If the administrative-economic court did not sustain the taxpayer’s claims, it may file an appeal through the same administrativeeconomic court to the relevant appellate court. The appeal must be filed within 30 days of the date when the written decision of the below court was officially received. (c) Supreme Court The taxpayer may file a cassation appeal with the Supreme Court of Azerbaijan within 30 days of the official receipt of the written decision, if that decision does not sustain the taxpayer’s claims. (d) Constitutional Court The taxpayer may appeal the decision of the Supreme Court to the Constitutional Court of Azerbaijan. The constitutional proceedings are regulated by the law of Azerbaijan on Constitutional Court of the Republic of Azerbaijan, dated 23 December 2003. The taxpayer may appeal to the Constitutional Court only in limited cases, particularly if by the decision of the Supreme Court: (a) the normative legal act, which should have been applied, was not applied; (b) the normative legal act, which should not have been applied, was applied; or (c) the normative legal act was incorrectly interpreted. The Constitutional Court cannot review the factual circumstances of the case. The taxpayer may file an appeal with the Constitutional Court: (a) within six months of the effective date of the decision of the Supreme Court; or (b) within three months of the date when its right of access to court has been breached. The consideration of the appeal shall start, as a rule, within 60 days of the date when it was admitted for the consideration. The decision of the Constitutional Court is binding in the whole territory of Azerbaijan and for every natural or legal person or state authority or municipality. 36 Baker & McKenzie (e) European Court of Human Rights Azerbaijan has ratified the Convention for the Protection of Human Rights and Fundamental Freedoms (the “European Convention”). In this context, the case law of the European Court of Human Rights (ECHR) must be taken into account by the courts of all instances, along with the requirements of the European Convention. Decision No. 5 of the Supreme Court of Azerbaijan, dated 30 March 2006, is dedicated to the application of the European Convention and the precedents of the ECHR. The taxpayer, upon exhaustion of the domestic remedies (usually once the decision of the Supreme Court is rendered) may apply to the ECHR. 5.2 Competent authority/arbitration convention The respective treaties on avoidance of double taxation to which Azerbaijan is a party usually names the Ministry of Finance and the Ministry of Taxes as competent authorities. However, neither these treaties nor the laws and regulations of the Republic of Azerbaijan contain any procedural rules on the functioning of these competent authorities. Azerbaijan is not a party to any tax arbitration convention. 6. Interest and Penalties 6.1 Adjustment of income and assessment of additional tax In most cases, based on the previous enforcement practice, the tax authorities would adjust income and assess additional taxes in the following cases: (i) When a taxpayer artificially increased the amount of deductible expenses (ii) Transfer pricing Transfer Pricing Handbook – Azerbaijan Baker & McKenzie 37 (iii) When a taxpayer failed to assess withholding tax or reverse VAT charge (iv) When a taxpayer did properly indicate the value of its fixed assets for property tax purposes 6.2 Tax penalties These are the main tax penalties applied by the Azerbaijani tax authorities: (i) Decrease in the amount of payable tax or failure to calculate and pay tax when it is required – financial sanction in the amount of 50 percent of the decreased or not paid taxes (ii) Making any payments despite the restrictive order of the tax authority – financial sanction in the amount of 50 percent of any prohibited payment (iii) Failure to register as a VAT payer when it is required – financial sanction in the amount of 50 percent of the VAT-able turnover of a taxpayer (iv) Late payment of VAT – financial sanction in the amount of 50 percent of payable VAT (v) Failure to account for raw materials, products, cash, and other assets in a taxpayer’s accounting books if the value of such hidden assets exceed AZN1,000 (approximately EUR1,030) – financial sanction in the amount of 5 percent of the value of the hidden assets, or 10 percent of the value of the hidden assets when this violation is repeated 6.3 Interest for late payment of tax A taxpayer shall pay a penalty in the amount of 0.1 percent for each day of delinquency. This penalty can be assessed up to one year of delinquency, upon which the calculation of penalties shall stop. 38 Baker & McKenzie 6.4 Collection procedures The tax authorities enjoy extensive powers with regard to collecting taxes. The main collection acts are as follows: (i) Arrest and attachment of a taxpayer’s property (ii) Sale of such property in a public auction (iii) Arrest and attachment of a taxpayer’s bank account Additionally, tax authorities may seek provisional measures in courts to ensure the proper payment of taxes. Transfer Pricing Handbook – Belgium Baker & McKenzie 39 Belgium Gery Bombeke, Partner Géry Bombeke is a member of the Firm’s Tax Practice Group. He advises clients on corporate and international tax planning and is specialized in transfer pricing. Géry was admitted to the Brussels bar in 2001 and joined Baker & McKenzie in 2004. Before joining the Firm, Géry was active with a Big 4 firm and a Belgian law firm as a tax consultant and tax lawyer, respectively. He became partner in 2010. [email protected] Tel: +32 2 6 39 36 11 Matthias Doornaert, Associate Matthias Doornaert advises clients on corporate income tax law, with a special interest in (cross-border) corporate restructurings and real estate transactions. He further specializes in transfer pricing. Matthias also has a particular interest in international and EU tax law. [email protected] Tel: +32 2 6 39 36 11 Baker & McKenzie CVBA/SCRL Louizalaan 149 Avenue Louise Eleventh Floor Brussels 1050 Belgium 40 Baker & McKenzie 1. Statutory Rules and Administrative Regulations 1.1 General In 2004, the arm’s length principle was introduced in Belgian tax law by means of Article 185 (2) of the Belgian income tax code (ITC). This article is equivalent in content to Article 9 (1) and (2) of the OECD Model Tax Convention. Consequently, Belgian corporate taxpayers’ tax liabilities can be subject to upward adjustments if they entered into transactions that are not at arm’s length. Article 185 also allows for a downward corresponding adjustment if laid down in an advance ruling from the Belgian Office for Advance Decisions (informally called the “Ruling Commission”), or following the application of the EU Arbitration Convention or double tax treaties. Additionally, the ITC contains a number of other provisions that are relevant from a transfer pricing perspective, and of which the most important are Article 26 ITC and Article 79 juncto 207 ITC. These provisions are based on the Belgian variant of the arm’s length principle, i.e., the concept of “abnormal or gratuitous advantages.” While Article 26 ITC can result in a tax adjustment if a Belgian taxpayer has granted an abnormal or gratuitous advantage to a foreignrelated company or individual, Article 79 juncto 207 ITC deny the offset of certain tax deductions against any abnormal or gratuitous advantages received by a Belgian company from a related party. Based on the Belgian tax authorities’ interpretation of the latter provisions, a Belgian corporate taxpayer’s tax liability cannot be lower than the amount of any abnormal or gratuitous advantage received even if the taxpayer is in a loss (carried forward) position. Belgian tax law also contains specific and transfer pricing-related antiabuse provisions to counter payments to tax havens. 1.2 Administrative guidelines The Belgian tax authorities have published several administrative circulars with guidelines on transfer pricing: Transfer Pricing Handbook – Belgium Baker & McKenzie 41 (i) A circular of 1999 regarding transfer pricing audits and commentaries on the 1995 OECD Transfer Pricing Guidelines (the “1999 TP Circular”) (ii) A circular of 2000 (amended in 2003) regarding the EU Arbitration Convention (iii) A circular of July 2006 on the interpretation of Article 185 (2) ITC (the “Article 185 (2) Circular”) (iv) A circular of July 2006 on the formation of a transfer pricing audit team (v) A circular of November 2006 on transfer pricing audits, transfer pricing documentation and the transfer pricing code of conduct (the “November 2006 TP Circular”) 1.3 Scope of the rules According to Article 185 (2) Circular, Article 185 (2), ITC only applies to transactions between: (i) a Belgian company and a foreign company of the same multinational enterprise (MNE); (ii) a Belgian permanent establishment (PE) and a foreign PE of another company of the same MNE; (iii) a Belgian company and a foreign PE of another Belgian company of the same MNE; (iv) a Belgian PE and its foreign head office; and (v) a Belgian PE and a foreign PE of the same company. Transactions not covered by Article 185 (2) ITC (e.g., domestic controlled transactions, transactions between a Belgian head office and its foreign PE, cross-border transactions between a company and an individual, or between individuals and transactions between non-associated companies) may nevertheless fall within the scope of Article 26 ITC or other transfer pricing provisions laid down in Belgian domestic tax law or double tax treaties concluded by Belgium. 42 Baker & McKenzie 1.4 Related party To qualify as a member of the same MNE for purposes of Article 185 (2) ITC, the relevant taxpayers must be associated. A company is considered to be associated with another company if: (i) it controls such other company; (ii) it is controlled by such other company; (iii) it is part of the same consortium; and (iv) the other company is, to the knowledge of the company’s directors, controlled by a company mentioned under (i), (ii) and (iii). “Control” should be interpreted as the legal or de facto power to exercise a decisive influence on the appointment of the majority of the company’s directors or managers, or on their management. Other transfer pricing provisions (e.g., Article 26 and Article 79 as qualified by Article 207 ITC) also apply to transactions between related parties and may have a broader scope. 1.5 Time limits for assessment The general statute of limitation rules apply equally to transfer pricing matters. In general, the Belgian Tax Authorities can make additional assessments during a period of three years following the closing of the accounting year. In case of fraud, the limitation period of three years is extended by an additional four years (i.e., seven years in total), provided that the tax authorities can establish serious indications of fraud and inform the taxpayer in advance. In specific cases, the tax authorities are authorized to issue an assessment even after the expiration of the abovementioned three- or seven-year statute of limitation periods. 1.6 Attribution of profit The Belgian Tax Authorities generally adhere to the OECD Report on the Attribution of Profit to Permanent Establishments and tend to apply the arm’s length principle to certain dealings between the head office and the permanent establishment. Traditionally, the Belgian Tax Authorities follow a limited separate entity approach under which certain internal dealings are disregarded but are, in principle, prepared to apply a fully functional separate entity approach if the other country involved does the same. Typically, no deduction is allowed for Transfer Pricing Handbook – Belgium Baker & McKenzie 43 internal interest payments between PE and head office, with the exception of interest payments within financial institutions. 1.7 Advance pricing agreements The Ruling Commission provides unilateral advance pricing agreements (APAs). Bilateral and multilateral APAs have to be applied for with the Department of International Relations of the Federal Service Finance, which cooperates with the Ruling Commission in this respect. APAs are provided on an individual and case-specific basis. 2. Transfer Pricing Methods 2.1 General acceptance of OECD guidance Although the OECD Transfer Pricing Guidelines are not incorporated as such in Belgian tax law, they are generally accepted and endorsed by the Belgian Tax Authorities. This is explicitly confirmed in the administrative circulars (see Section 1.2). 2.2 Selection of method Taxpayers should use the transfer pricing method, which is the most appropriate in a given case, and they should be able to support the choice for that method. There is no best method rule and taxpayers are, as such, not required to apply more than one method. All methods described in the OECD Transfer Pricing Guidelines are accepted for Belgian tax purposes. Conceptually, the Belgian Tax Authorities prefer the use of transaction-based methods in assessing the arm’s length nature of intercompany pricing. However, the application of profit-based methods is accepted if the facts and circumstances of a given case do not allow for the use of transactional methods and the taxpayer is able to demonstrate this. APA practice shows that the use of the transactional net margin method (TNMM) and other profitbased methods has become the rule rather than the exception. 44 Baker & McKenzie 2.3 Contemporaneous information In the 1999 TP Circular, the Belgian Tax Authorities acknowledge that the use of hindsight is inconsistent with the arm’s length principle. Hence, only information that was available to the parties at the time of the transaction and circumstances or events that could reasonably have been foreseen at such time should be taken into account to determine the arm’s length nature of the intercompany transaction. Additionally, Belgian legislation does not include a commensurate-with-the-income-type rule. 2.4 Pricing adjustments The Ruling Commission generally accepts adjustments at year-end, both to bring the remuneration of the relevant Belgian taxpayer within a pre-determined arm’s length range or to adjust it to a specific level as determined in a benchmarking report. The Belgian Ruling Commission will, in principle, not grant a positive ruling for retroactive adjustments with respect to financial years for which the relevant accounts are already finalized and approved by the general shareholders’ meeting. In exceptional cases, the Ruling Commission seems nevertheless willing to accept adjustments for previous years when such adjustments are made on the basis of invoices or credit notes that can still be accounted for in the accounts of a subsequent financial year that is not yet closed. 2.5 Business restructurings The Belgian tax authorities follow the OECD guidance on business restructurings. 2.6 Safe harbors There are no safe harbors or other rules of thumb in Belgian transfer pricing. It should nevertheless be noted that the Ruling Commission accepts certain types of activities and services (e.g., distribution, logistic activities and order collecting) that taxpayers only perform a limited transfer pricing study to set arm’s length intragroup pricing. The Ruling Commission is also prepared to follow the EUJTPF Transfer Pricing Handbook – Belgium Baker & McKenzie 45 Guidelines on low value-adding services and often accepts a 5 percent mark-up for these services. 3. Transfer Pricing Documentation and Filing Requirements 3.1 Administrative regulations No statutory requirement exists in Belgium to prepare advance and/or contemporaneous transfer pricing documentation. However, following the 1999 TP Circular, it is clearly recommended that Belgian taxpayers prepare the necessary documentation in order to demonstrate that their transfer pricing policy complies with the arm’s length principle. It is recommended that such documentation include the following: (i) A description of the activities of the group (including market position, economic circumstances, business strategies, etc.), the identification and characterization of intercompany transactions and the contractual relationships among affiliates (ii) A functional analysis (including an overview of the relevant functions, risks and intangibles), a justification of the transfer pricing methods used and an economic analysis (iii) In the November 2006 TP Circular, the Belgian tax authorities have listed further documentation, which is recommended to be prepared by Belgian taxpayers. 3.2 Form and depth of documentation In the November 2006 TP Circular, the Belgian tax authorities confirm that they follow the Code of Conduct on transfer pricing documentation for associated enterprises in the European Union (EUTPD) and its recommended approach on transfer pricing documentation. It is indicated that taxpayers who wish to take a proactive approach toward transfer pricing documentation should act as a “prudent business manager” (i.e., a dedicated business manager 46 Baker & McKenzie acting according to economic standards and striving to adhere to the arm’s length principle). The Circular also states that tax authorities, in requesting information, should carefully balance the requested documentation against the costs or administrative burdens for the taxpayer in producing or submitting such documentation. The tax authorities should therefore refrain from excessive documentation requests. The tax authorities perceive the EUTPD as the maximum level of documentation needed for a transfer pricing audit. This does not, however, necessarily prevent additional requests for information. 3.3 Recordkeeping and retention period Pursuant to the general provisions relating to keeping records and documentation for income tax purposes, taxpayers are required to retain all documentation useful to determine the taxable profit until the end of the seventh year following the taxable period to which it relates. This also includes the accounting documents. 3.4 Deadline to submit documentation Given the absence of any legal requirement for transfer pricing documentation, there is no deadline for its preparation. It is, however, recommended that each transaction be documented at the time it is executed, as a Belgian taxpayer must, under general tax rules, provide the Belgian tax authorities with all relevant information to determine its taxable income. 3.5 Language The November 2006 TP Circular acknowledges that transfer pricing documentation within an MNE will often be produced in a language other than one of Belgium’s official languages (Dutch, French and German). Tax inspectors are urged to accept, as much as possible, documents submitted in a foreign language and to apply the necessary diligence when requesting translations of documents submitted. In practice, Belgian tax authorities accept transfer pricing documentation Transfer Pricing Handbook – Belgium Baker & McKenzie 47 drafted in English, particularly for pan-European or worldwide transfer pricing studies, group transfer pricing policies and intracompany contracts involving foreign entities. 3.6 Due date of tax return The statutory filing date for submitting corporate income tax returns is determined on an annual basis and is normally between six to 10 months as from the end of the accounting period. It is recommended to have sufficient transfer pricing documentation available at that time. 3.7 Reviewing and updating documentation It is recommended to periodically review the transfer pricing documentation in order to determine whether historical, functional and economic analyses are still relevant. 3.8 Returning information There are no specific disclosure requirements for transfer pricingrelated information. Under Belgian accounting law, however, companies are required to provide certain transfer pricing information in the notes to their statutory annual accounts, such as: (i) information regarding certain relevant off-balance sheet arrangements; and (ii) material transactions with associated parties that cannot be considered at arm’s length. Noncompliance may result in the director’s liability. Belgian tax law also provides for certain reporting requirements with respect to payments to tax haven companies. 4. Tax Audit Procedures 4.1 Selection of companies for an audit he 1999 TP Circular instructs tax officials conducting a routine tax inspection to carry out an in-depth transfer pricing audit when one or more of the following risk indicators are present: 48 Baker & McKenzie (i) The company provides vague, unsuitable or insufficient information concerning its transfer pricing. (ii) Certain financial ratios derived from the company’s accounts differ substantially from those customary in the company’s sector. (iii) The company enters into transactions with companies located in low-tax jurisdictions or companies with substantial and/or recurrent losses. The 2006 TP Circular has further complemented the 1999 Circular and provides for an additional and non-exclusive list of circumstances that can give rise to a transfer pricing audit: (i) The use of tax havens when little or no economic value is added (e.g., re-invoicing activities) and (in)direct payments to entities in tax havens (commissions, royalties, management fees, etc.) (ii) The use of back-to-back structures to conceal the true nature of the transaction (iii) Complex arrangements and circular structures that add little or no economic value (iv) Belgian group entities incurring structural losses (v) Company restructurings and delocalization of entities, particularly with respect to the valuation and compensation of intellectual property (IP) such as patents, know-how and goodwill as well as with respect to the legal and economic ownership of the IP (vi) Invoices for the provision of intercompany services (management fees) at year-end Transfer Pricing Handbook – Belgium Baker & McKenzie 49 4.2 Transfer pricing audit A dedicated transfer pricing audit team exists within the Belgian Tax Administration. This team specializes in carrying out transfer pricing audits and assists in transfer pricing audits carried out by local tax inspectors. The transfer pricing audit team is in principle informed of every transfer pricing audit performed by other departments of the Belgian Tax Administration, and should ensure consistency in the administrative approach to increase legal certainty for taxpayers. As of 2013, the audit activity of this transfer pricing unit significantly increased since it was reinforced with local tax inspectors. Since then, the transfer pricing unit launches about 300 transfer pricing audits at the beginning of each calendar year. Such audit mostly takes about one to one-and-a-half years. 4.3 Burden of proof In principle, the tax authorities bear the burden of proof, although in practice, this is somewhat shifted to the taxpayer. The tax authorities often ask taxpayers to demonstrate that the transfer pricing methodology adopted is at arm’s length. In this respect, Belgian tax law allows all means of evidence except for the oath. The 1999 TP Circular states that evidence of non-arm’s length situations will predominantly follow from presumptions made on the basis of factual evidence. The taxpayer is expected to cooperate with the tax authorities in case of a transfer pricing audit. 4.4 Request for information A transfer pricing audit typically starts with a standard written request for information. In principle, the taxpayer is required to provide the requested information within a one-month period. Failure to provide the requested information in time may result in an ex officio assessment. In practice, tax inspectors will often extend this deadline upon request by the taxpayer, provided that a longer period is required to gather all requested information (e.g., because information needs to be obtained from foreign group companies). The November 2006 TP 50 Baker & McKenzie Circular acknowledges this fact and instructs tax inspectors to show the necessary flexibility when receiving a reasonable request to extend the deadline for answering the request for information. 4.5 Pre-audit meeting The November 2006 TP Circular encourages tax inspectors to hold a pre-audit meeting with the taxpayer concerned to discuss: (i) the scope of the transfer pricing audit; (ii) the transfer pricing policy of the group; and (iii) the level of transfer pricing information readily available. This is aimed at avoiding unnecessary or irrelevant requests for information and minimizing the cost for the taxpayer concerned. Most taxpayers request for such pre-audit upon receipt of a request for information as referred to under 4.4. 4.6 Revised tax assessment and appeal Upon completion of a transfer pricing analysis, the tax inspector may propose an amendment of the corporate income tax return in a notice of amendment. This notice must set out the reasons for the proposed amendment. The taxpayer then has one month to oppose such an adjustment, in which period he or she must also set out the arguments against it. Subsequently, the tax inspector will issue a tax assessment in which the taxpayer’s arguments may or may not be taken into account. The taxpayer has six months to appeal the tax assessment before the regional tax director. The decision of the regional tax director may further be appealed before Belgian courts. 4.7 Tax authorities’ current focus Currently, the Belgian tax authorities appear to focus on the transfer pricing of IP-related transactions (e.g., payment of royalties) and management fee structures, financial transactions (including thin-cap) and business restructurings. Transfer Pricing Handbook – Belgium Baker & McKenzie 51 5. Dispute Resolution 5.1 Domestic appeal procedure The taxpayer has six months to appeal against a tax assessment before the regional tax director. The decision of the regional tax director may further be appealed before the competent Belgian Court of First Instance. Subsequently, further appeals are possible before the competent court of appeal and the Belgian Supreme Court. 5.2 Domestic remedies against double taxation Article 185 (2) ITC allows for downward corresponding adjustments similar to what is provided for in Article 9 (2) of the OECD Model Tax Convention. 5.3 Mutual agreement procedure (MAP) Most of the tax treaties concluded by Belgium provide for a MAP. The Belgian tax authorities adhere to the principle that an upward transfer pricing adjustment in one contracting state should result in a corresponding downward transfer pricing adjustment in the other contracting state. However, the MAP in most of Belgium’s double tax treaties does not impose an obligation to eliminate double taxation. The only requirement is for competent authorities to endeavor in good faith to reach an agreement. Furthermore, as generally no deadlines are imposed, this procedure can last many years before an actual remedy is obtained. It should be mentioned that Belgium’s model tax convention also contains a compulsory arbitration clause. Such a clause was inserted in the 2006 Belgium-US double tax treaty. 5.4 The European Arbitration Convention The European Arbitration Convention installs a procedure on the basis of which EU member states are required to eliminate double taxation on the basis of mutual agreement. In a circular of 2000 (amended in 2003), the Belgian tax authorities have provided guidance on the application of the EU Arbitration Convention. 52 Baker & McKenzie 6. Interest and Penalties 6.1 Interest Additional corporate income tax that becomes due following a transfer pricing adjustment, will in principle give rise to a tax increase as insufficient tax prepayments were made. Late payment interest only becomes due after the issuance of the additional tax assessment. 6.2 Penalties Belgian tax law does not provide for any specific transfer pricingrelated penalty. For an incorrect tax return, the tax due on the nonreported income may be increased by a penalty ranging between 10 percent and 200 percent of the amount of tax due, depending on the nature and seriousness of the infringement committed by the taxpayer. Additionally, administrative and penal fines may become applicable. 6.3 Amount of penalty in transfer pricing matters In practice, the Belgian tax authorities usually impose penalties of 10 percent of the tax due in transfer pricing matters. As the penalties depend on the type of infringement and on the company’s possible negligence, they can be avoided and/or minimized if the taxpayer can demonstrate its good faith and intent to establish transfer prices in accordance with the arm’s length principle (e.g., through its documentation effort). 7. Advance Pricing Agreement Procedures (APAs) 7.1 Restrictions An APA must relate to an actual and fully disclosed transaction or situation that has not yet produced any effects from a tax perspective (i.e., in general for as long as the tax return for the relevant financial year is not yet filed, which is normally six to 10 months after the financial year-end). Theoretical or hypothetical applications are not permitted. Additionally, no ruling is possible with respect to operations that have no economic substance in Belgium or Transfer Pricing Handbook – Belgium Baker & McKenzie 53 transactions with tax havens. Finally, an APA cannot be obtained with respect to transactions that are the subject of a pending tax dispute. 7.2 Formal requirements The APA request must be filed in writing with the Ruling Commission (or the Department of International Relations of the Federal Service Finance for bilateral and multilateral APAs) by or on behalf of a Belgian taxpayer. Anonymous filing is not possible. The Ruling Commission shows a strong preference for paperless filing (email). Until the APA is granted, all new information relating to the transaction must be added to the APA request. A copy of all APAs concerning the same transactions that have been requested and obtained from tax authorities of EU member states or states with which Belgium has a double tax treaty on the same subject must be added to the ruling request. No fee is charged for the request and/or grant of an APA. 7.3 Pre-filing meetings Prior to submitting an official APA request, it is customary to have a pre-filing meeting (which can take place on an anonymous basis) with the Ruling Commission. During this pre-filing meeting, the taxpayer can get a feel of whether or not the APA request will be successful and what information will be required. 7.4 Procedure The APA request procedure is as follows: • Usually, a pre-filing meeting is organized to discuss the transaction (possible on a no-names basis). Such a pre-filing meeting is preceded by a written pre-filing meeting request in which the transactions and the transfer pricing are described; Pre-filing meetings are often organized on the basis of a slide presentation. • A formal ruling request is filed. 54 Baker & McKenzie • Within five working days, the receipt of the APA request is acknowledged and the names and contact details of the officials responsible for the APA request are communicated. • A first internal meeting is, in principle, organized within 15 days of the receipt of the APA request. During this meeting, the APA request is analyzed to see whether it contains all necessary information and what time frame is required to take the decision. • Following the first meeting, the Ruling Commission further examines the APA request and may ask for additional information. • There is no formal time limit for granting the APA but it generally takes up to six months or more (four months for less complex APA requests). 7.5 Information required Taxpayers are expected to provide the Ruling Commission with the identity of all parties involved, a detailed description of the applicant’s business activities, a complete and accurate description of the relevant transaction, a fully detailed functional and risk analysis, a benchmarking study to support the arm’s length nature of the transfer prices, and the legal basis on which the ruling should be granted. 7.6 Legal validity of APAs An APA binds the Belgian tax administration. However, an APA will not be binding if, among others, the description of the envisaged transaction was incomplete or incorrect, if essential elements of the transaction were not carried out in the way in which they were presented in the APA request, or if the terms and conditions of the APA were not respected. The taxpayer is not bound by an APA and there is no obligation on his or her part to implement the envisaged transaction or operation on which an APA was obtained. Transfer Pricing Handbook – Belgium Baker & McKenzie 55 7.7 Term and renewal of APAs An APA is valid for the period as determined in the APA. Typically, this term is five years. APAs are renewable if the facts and circumstances on the basis of which the APA was granted remain unchanged. 7.8 Publication APAs are, in principle, published on an anonymous basis. A request for non-publication based on valid economic or business reasons is possible. 8. Thin Capitalization 8.1 General 5:1 debt/equity ratio Belgium has adopted a general thin cap rule providing for a 5:1 debtto-equity ratio. Any interest paid on the amount of the debt exceeding said ratio is not deductible. The thin cap rule applies to: (i) all loans under which the beneficiary of the interest is not subject to income tax or subject to a tax regime clearly more favorable than the Belgian tax regime; and (ii) all intragroup loans. Debt does not include bonds and other debt instruments issued through public offering and loans granted by financial institutions. Equity is defined as the sum of the retained earnings at the beginning of the taxable period and the paid-up capital at the end of the taxable period. The thin cap rule excludes certain companies from its scope of application, i.e., leasing and factoring companies, and companies involved in a public-private partnership. Treasury centers are, under certain conditions, allowed to net the intragroup interest paid against the intragroup interest received before applying the thin cap rule and the limited interest deduction resulting therefrom. The thin cap rule contains a specific anti-abuse provision to avoid channeling. 56 Baker & McKenzie 8.2 Financing arrangements Article 55 ITC is a specific transfer pricing provision for interest payments. It states that interest paid will only be tax-deductible if the interest rate does not exceed normal market rates, taking into account, among others, the financial status of the debtor. 8.3 Related party loans A 1:1 debt-to-equity ratio applies to interest paid on loans granted by individual shareholders or by directors, managers, liquidators and the like. Interest relating to debt in excess of this ratio is recharacterized into a (non-deductible) dividend. The same goes for interest paid on such debt in excess of the arm’s length standard. Transfer Pricing Handbook – Czech Republic Baker & McKenzie 57 Czech Republic Pavel Fekar, Partner Pavel Fekar practices in the area of tax law and is a member of the International Fiscal Association. In 2003, Mr. Fekar served as a member of the Working Party established by the Czech Ministry of Finance and the Czech Chamber of Tax Advisors to harmonize local income law with the EC law. He was later appointed by the Czech Minister of Finance to the Expert Committee for the Reform of the Direct Tax System in the Czech Republic. Mr. Fekar also chaired the subgroup responsible for corporate-shareholder taxation, consolidation regimes, holding taxation regimes, taxation of collective investment vehicles and international tax aspects. Mr. Fekar has more than 13 years of experience advising on tax issues, focusing on corporate income tax, international tax planning and transactional tax advice, particularly in relation to mergers, acquisitions and corporate restructuring. [email protected] Tel: +420 236 045 001 Baker & McKenzie s.r.o., advokátní kancelář Praha City Center Klimentská 46 Prague 110 02 Czech Republic 58 Baker & McKenzie 1. Statutory Rules and Administrative Regulations 1.1 Existence of the arm’s length principle The Czech Republic has been a member of the OECD since 1995 and has adopted the OECD transfer pricing principles (OECD Guidelines). Czech transfer pricing legislation uses the arm’s length principle as a main approach to transfer pricing matters. Section 23(7) of the Czech Income Tax Act (“ITA”) contains the codification of the arm’s length principle and requires that prices determined for transactions between associated entities should correspond to prices that independent parties would agree on in commercial transactions in comparable circumstances. Effective since 1 January 2014, the provisions in the ITA have been changed to provide for a shift in responsibility for the correct application of the arm’s length principle and the calculation of transfer prices from the tax authorities to the taxpayer. Hence, as of January 2014, the responsibility for the correctness of the applied transfer prices for related party transactions is on the taxpayer. Section 23(7) of the ITA also requires that the tax base be determined based on the accounting results of the company, unless when the ITA provides for specific adjustments or when a tax liability is avoided by the taxpayer. This provision can, in theory, be regarded as an antiavoidance clause, since it constitutes the basis for the allocation of income in situations of tax avoidance. Furthermore, this rule allows tax authorities to apply penalties to excessive reductions of taxable profits with the sole purpose of avoiding tax using artificial transactions or extraordinary transactions. In such cases, the tax authorities may adjust a taxpayer’s reported profit or loss. As the rules do not prescribe a particular method or approach for the adjustment, this rule gives tax authorities the discretion to exercise the allocation of income or a formulary apportionment approach. Transfer Pricing Handbook – Czech Republic Baker & McKenzie 59 In 2010, the Ministry of Finance issued three decrees (Decrees D-332, D-333 and D-334) with general recommendations containing updated transfer pricing rules for the Czech Republic. The decrees confirm the application of the 2010 update of the OECD Guidelines in Czech law and provide recommendations for their implementation in practice. However, as the OECD Guidelines are not specifically implemented in Czech law, these guidelines are referred to as “soft-law.” No specific deviations from these guidelines have been developed in domestic guidance for transfer pricing purposes. 1.2 Transactions in scope The ITA did not determine the exact scope of the transfer pricing rules and therefore, the scope is sufficiently broad to apply these rules to different types of transactions. Furthermore, there is no limitation to the location of the transaction so therefore, both domestic as well as cross-border transactions are covered by the Czech transfer pricing rules. The scope of the transfer pricing rules pertains to both legal entities and their branches or permanent establishments. 1.3 Documentation Requirements The Act of Tax Administration (“ATA”) in the Czech Republic does not provide any legally binding rules regarding the preparation of transfer pricing documentation. However, the Czech tax authorities may request transfer pricing documentation during the course of an audit. In recent years, the number of companies being subject to audit procedures has increased significantly. In addition, when a taxpayer should request an official ruling for transfer pricing purposes, transfer pricing documentation is typically required and must be submitted together with the request for a ruling. The general administration requirements in Czech tax law apply to documentation containing evidence of the arm’s length nature of prices agreed for transactions between related entities. 60 Baker & McKenzie Decree D-334 provides general recommendations on documentation requirements and states that documentation should follow the guidelines set by the EU for transfer pricing documentation. Effective as of January 2014, the Czech tax administration added a new attachment to the Corporate Income Tax Return that taxpayers have to prepare. According to this attachment, companies are required to report the intercompany transactions to which they are a party as of the fiscal year 2014. The requirement applies to companies that meet at least one of the criteria that trigger compulsory statutory audit and that are, in addition, engaged in cross-border intercompany transactions, have incurred losses or have received investment incentives that have led to a tax relief for the company. The attachment does not request full transfer pricing documentation. Rather, companies are required to disclose details on each type of intercompany transaction they are engaged in, including the related party’s country of residence, the nature of the transaction, the volume of the transaction (in terms of profits and costs) as well as an overview of the receivables and liabilities the company has vis-à-vis the related party. 1.4 Associated enterprises definition The determination of associated enterprises is similar to the definition of associated enterprises laid down in the OECD Model Tax Convention on Income and Capital. In addition to the definition in the OECD Model Tax Convention, Section 23(7) of ITA also covers definitions of “related persons” and “persons that have created a relationship mainly for the purposes of tax avoidance (by reducing the tax base or increasing tax losses).” The ITA includes clear definition of “related persons.” In practice, legal entities can be considered related persons if one entity has direct or indirect ownership of more than 25% of the (share) capital or voting rights of another entity or if the entity participates in the management of or has control over the other entity. Transfer Pricing Handbook – Czech Republic Baker & McKenzie 61 1.5 Transfer pricing adjustments Taxpayers should use transfer prices that are established based on the arm’s length principle for their accounting and tax accounts. When transfer prices deviate from an arm’s length remuneration, adjustments should be imposed on the tax base. Based on experience from case laws in the Czech Republic, the Czech tax authorities may be required to use objective, fair and reviewable methods for the determination of an arm’s length method. In addition, the tax base should be adjusted only to reflect the bottom level of the range of comparables and not the average. Furthermore, the general provisions of the ITA also apply to transfer pricing adjustments. The general statute of limitation for tax adjustments is three years from the date when the deadline for the submission of a tax return expires, or when the tax liability becomes due. This period may, in some cases, be extended to 10 years. 2. Transfer Pricing Methods 2.1 General guidance of the OECD and allowed methods The Czech Republic is a member of the OECD and generally follows the framework of the OECD Guidelines. The description of the transfer pricing methods is contained in Decree D-332. The transfer pricing methods as described by the OECD are applicable in the Czech Republic. Hence, a taxpayer may use either one of the three traditional methods (i.e., the Comparable Uncontrolled Price [CUP] Method, the Resale Price Method and the Cost Plus Method) or one of the two profit-based transaction methods (i.e., the Transactional Net Margin Method and the Profit Split Method). When it is not be possible to determine the arm’s length principle using the transfer pricing methods determined by the OECD, Section 23(7) of the ITA provides that transfer prices may, in addition, be determined in accordance with the Property Valuation Act. This act 62 Baker & McKenzie allows taxpayers to use a sixth transfer pricing method, which is based on the determination of the fair market value of property by an independent expert’s valuation. The fair market value of a property, to be determined by this independent expert, is defined as the price that would be obtained when a similar asset or service is sold under typical conditions in the relevant Czech market. The circumstances influencing the price should be taken into account, with a few exceptions (i.e., extraordinary market circumstances, a personal situation of the seller or buyer or any special preferences of the seller or buyer). 2.2 Acceptability and hierarchy of methods In line with Chapters 1 to 3 of the OECD Guidelines, the Czech Republic does not impose a rigid hierarchy of methods. Decree D-332 confirms that all transfer pricing methods may be used and that taxpayers should use a comparability analysis to select the most appropriate method for the transaction in scope. The most appropriate method depends on the availability of data on comparable transactions and the extent to which it is possible to impose necessary adjustments to establish an arm’s length price. In practice, however, the tax authorities prefer the CUP method, because it is easy to apply and comparability data can often be obtained from the taxpayer itself or other taxpayers. The sixth method, by which transfer prices may be determined under the Property Valuation Act, may only be used in exceptional cases where the arm’s length price cannot be determined. Hence, this method should be used as a last resort. 2.3 The use of comparability adjustments Decree D-332 states that it may be necessary to make comparability adjustments when an uncontrolled transaction is not fully comparable to the controlled transaction in scope. However, the decree does not indicate what type of adjustments may be made and what method Transfer Pricing Handbook – Czech Republic Baker & McKenzie 63 should be used for these adjustments. In any case, the preference of the tax authorities would be to perform a careful selection of the comparables to make sure that comparability adjustments are not required in the first place. Working capital adjustments are not commonly used in the Czech Republic. Decree D-332, however, contains an example of an adjustment that may be made. This pertains to the situation where a transfer price for a controlled transaction includes transportation costs to the customer. If prices applied in uncontrolled transactions by comparable companies do not include transportation costs, a comparability adjustment may be made to exclude transportation costs from the transfer price determined by comparison with the uncontrolled transaction. 2.4 Deviations from an arm’s length price According to Section 23(7) of the ITA, transfer prices may deviate from the arm’s length price as determined by the tax authorities, if the taxpayer can argue that there are proper justifications for this deviation. In general, taxpayers may calculate a range of arm’s length prices and if the transfer price applied by the taxpayer falls within such range, the transfer price may be accepted by the tax authorities. Moreover, when the tax authorities impose adjustments to the tax base, the tax authorities will take into account all circumstances of the taxpayer and may adjust the tax base to the endpoint of an arm’s length range that is most beneficial to the taxpayer. 2.5 Timing issues Decree D-332 confirms the use of a multiple-year analysis, which is also allowed in the OECD Guidelines. The decree suggests that multiple-year data may be used for the calculation of, for example, profit development in recent years. This multiple-year data may be used as a reference when examining whether the transfer price applied in a certain year is set on an arm’s length basis or not. Multiple-year 64 Baker & McKenzie data should only be used when such data is available at the moment of the conclusion of a contract. Hence, estimated data for future years may not be used for the determination of arm’s length prices in earlier years. 2.6 Safe harbor The Czech Republic adheres to the OECD Guidelines and in consequence, to the arm’s length principle. In addition, effective as of January 2013, the Czech tax authorities have published decree D-10, which provides a safe harbor that applies to the remuneration for intra-group low value-added services. Decree D-10 was prepared in accordance with the OECD Guidelines and the recommendations contained in the report published by the European Joint Transfer Pricing Forum covering the remuneration for Low-Value-Adding Intragroup Services. The safe harbor applies when the cost-plus method is used and allows for an acceptable markup percentage in the range between 3% and 7%. 3. Transfer Pricing Documentation and Filing Requirements 3.1 Documentation requirements As mentioned, the ATA does not provide any legally binding rules for the preparation or the availability of transfer pricing documentation. General rules for tax proceedings set out in the ATA apply to the substantiation of prices agreed in dealings with related entities. However, when a taxpayer should request an official ruling for transfer pricing purposes, transfer pricing documentation is essential and must be submitted together with the request for a ruling. Since no transfer pricing documentation requirements are laid down in legal guidance, taxpayers have no certainty of the required documents Transfer Pricing Handbook – Czech Republic Baker & McKenzie 65 and any specific format in which transfer pricing documentation should be prepared. However, Decree D-334 includes general recommendations for transfer pricing documentation that will most likely be required by the tax authorities. The decree states that documentation should closely follow the provisions stated in the EU transfer pricing documentation requirements. Furthermore, some references are made to the ATA, which contains general administrative requirements that may also apply to transfer pricing documentation. Section 92 of the ATA provides a general obligation of the taxpayer to provide all relevant facts when such facts are not available from publicly available evidence. The ATA may also impose the obligation on the taxpayer to keep (and retain) records in specific cases. According to Decree D-334, documentation should include separate documentation for the group in general and for country-specific documentation. The general documentation, i.e., the master-file part should include information on the overview of the multinational group of companies as well as the economic facts to which the group is subject. Furthermore, an overview and an explanation of the intra-group commercial transactions should be provided. The master-file should specifically include inter alia the following information: • A general description of and information on related entities involved in intra-group transactions • Information on the transaction, including the functions performed and risks assumed by the parties, as well as any changes in the functions and risks compared to the previous year 66 Baker & McKenzie • Information about the prices and relevant circumstances of the transaction such as the ownership of any (intangible) assets, the group transfer pricing policy, an overview of existing costsharing agreements, rulings, etc. The local-file part of the documentation should specifically include the following information: • General information on the taxpayer, i.e., the business activities it is performing and corporate strategies the taxpayer is subject to, information on the ownership of the taxpayer and its shareholders, the corporate structure, etc. • A description of the business relationship relating to the intragroup transaction (e.g., the economic and business circumstances governing the transaction, a description of the relevant agreements concluded between the relevant parties and the volume of transactions the taxpayer is involved) • Information on other circumstances that have an influence on the relevant transaction (e.g., factors influencing the group’s transfer pricing policy, a justification of the transfer pricing method used, the marketing strategy of the taxpayer, the market circumstances for the transaction, specific legal requirements of the market and information that may be available on internal or external data on comparability for the tested party) The language in which the documentation should be prepared is not explicitly regulated, as the transfer pricing documentation is also not a legal requirement. However, all other documents that are used as evidence in administrative matters in the Czech Republic should be prepared in Czech. Hence, a taxpayer should also have transfer pricing documentation available in Czech. If the documents are not prepared in the Czech language, the taxpayer should be able to provide the official translation of the documentation to the tax authorities. Transfer Pricing Handbook – Czech Republic Baker & McKenzie 67 3.2 Filing requirements Transfer pricing documentation in the Czech Republic is not a legal requirement. Therefore, such documentation is not subject to any filing requirements for transfer pricing documentation upon the filing of a tax return. There are also no requirements on whether taxpayers must have contemporaneous documentation available. However, since tax authorities generally assess each tax period separately, it is advised to annually have updated information on the establishment of arm’s length prices. 3.3 Penalties Since documentation is not legally required, there are no specific penalties applicable in the Czech Republic for the absence or late filing of transfer pricing documentation. However, there are general statutory penalties that apply to situations where a taxpayer fails to present (general) documentation as evidence to justify the facts declared in the tax return. Such penalties may also apply when transfer pricing documentation provides tax authorities insufficient information on the establishment of arm’s length prices. Consequently, the tax authorities might increase the tax liability and the late payment interest can be assessed. In addition, the absence of sufficient evidence upon the filing of a tax return may shift the burden of proof from the tax authorities to the taxpayer in case the tax authorities impose adjustments. 4. Tax Audit Procedures With respect to transfer pricing, tax audits are carried out by local tax authorities, led by the regional tax office that is the competent authority for the specific region of the taxpayer. 68 Baker & McKenzie There is a specialized tax office (Specialized Financial Office) located in Prague, which is handling tax audits specifically for financial institutions and companies with revenues of more than CZK2 billion. 4.1 Selection of companies or transactions for an audit Controversies in transfer pricing in the Czech Republic often relate to functional analyses performed or the taxpayer’s choice of a transfer pricing method. Tax authorities have, in the past, focused mainly on situations of tax avoidance through, for example, the use of exceptional or artificial transactions or on cases where the transfer price applied by the taxpayer was deviating from a CUP. In addition, services fees, advertising expenses and market research expenses have been typically subject to audit review. The tax authorities would typically request evidence in such cases that the concerned activity has actually been performed and is not just a payment of a fee from one entity to another. In general, the deductibility of expenses charged by related parties may be subject to audits. Furthermore, any changes in the transfer pricing policy of a multinational group or deviations in charges applied in a certain year are likely to be challenged by tax authorities. If, for example, a company performed activities by itself at first and later outsources these activities to a related party, for which significantly higher costs are incurred, such changes may be targeted by tax authorities. Last, companies either within a multinational group or not, that are continuously reporting losses may be subject to audit review. The tax authorities may investigate in such cases, for example, whether the ongoing losses may be caused by transactions with related parties that are not at arm’s length. Transfer Pricing Handbook – Czech Republic Baker & McKenzie 69 4.2 Administrative proceedings: duties and rights of the taxpayer in the course of an audit, burden of proof, etc. (a) Duties and rights Czech taxpayers must submit obligatory records and documentation regarding the audited transactions, upon request of the tax authorities. Tax authorities may request further oral or written explanation in addition to any documents that the taxpayer has readily made available in its administration. Furthermore, according to Section 92 of the ATA, the taxpayer must provide evidence supporting any statements it makes during the course of an audit. According to Section 92 of the ATA, the taxpayer has the right to submit additional evidence that the tax authorities did not request. In addition, the taxpayer may propose additional evidence that it does not have at its disposal, but which can be obtained by the tax authorities. If the tax authorities reject such request, they should have solid grounds for the rejection. Furthermore, according to Section 92 of the ATA, the taxpayer must be able to attend discussions involving its employees and to ask questions to witnesses and experts that are interviewed during oral discussions. The taxpayer may object to a course of action taken by the officers in charge. According to Section 88 of the ATA, a competent officer should prepare a report stating the facts gathered during the audit, which serves as the basis for the tax assessment. Before the completion of the audit, the taxpayer must be given the opportunity to propose any changes to the report according to its own opinion. The taxpayer may also provide additional evidence supporting such statements. (b) Burden of proof At first, the burden of proof for tax matters rests (primarily) with the taxpayer. The tax authorities may request the taxpayer to document the transfer prices it has applied. After which, the taxpayer will have a 70 Baker & McKenzie reasonable period to prepare and submit such documentation. Once the taxpayer has submitted the relevant transfer pricing documentation, the burden of proof shifts to the tax authorities. In practice, specifically for transfer pricing purposes, the burden of proof is often on the tax authorities. In order to challenge the transfer price applied by the taxpayer, the tax authorities must first assume that the taxpayer did not use arm’s length prices and hence, did not pay an appropriate amount of tax. The burden of proof rests on the tax authorities to argue that the transfer prices applied by the taxpayer do not constitute an arm’s length remuneration and that they themselves would come to different arm’s length prices. If the tax authorities indeed establish an arm’s length price that differs from the transfer price applied by the taxpayer, the burden of proof is on the taxpayer to argue that its prices are indeed at arm’s length. However, sometimes the tax authorities will submit general requests to taxpayers to justify the difference between the transfer prices applied and the fair market price, without any specification of why the transfer prices applied by the taxpayer are incorrect. In such cases, the taxpayer has the right to request the tax authorities for further evidence for their conclusion. 4.3 Tax appeals procedures (a) Appeal procedures The taxpayer may appeal to an assessment made to the transfer pricing policy it applied, in accordance with the general administrative and judicial proceedings that are applicable to tax assessments in general. According to Section 109 of the ATA, the taxpayer has a period of 30 days from the delivery of the assessment to file an appeal. (b) Statute of limitation The general statute of limitation is three years, as mentioned in Section 148 of the ATA. However, if the tax authorities carry out acts Transfer Pricing Handbook – Czech Republic Baker & McKenzie 71 related to a tax audit, the statute of limitation will be extended to 10 years. In addition, if an action is considered a tax fraud according to legitimate decision of the Court of Justice, the tax can be assessed by the end of the second year following the year in which the decision of the Court of Justice became effective, regardless of whether the time limit for tax assessment (mentioned in previous paragraphs) expired or not. The taxpayer should retain its relevant administration and documents during the retention period of 10 years. If the taxpayer does not retain the relevant documents, the tax authorities may impose fines or penalties and this gives them the right to assess the tax liability using other methods or comparable information they have made available or that they can obtain from their own or other sources. 4.4 Recent Developments The Czech tax administration announced very recently on 8 February 2015 that the Specialized Financial Office launched a nationwide enforcement action to assess the transfer pricing policies of multinational companies and their related parties. The action is well-timed with the recent BEPS initiatives launched by the OECD and several unilateral measured taken by other countries to prevent base erosion and profit shifting. In particular, the Czech initiative aims to prevent the following: • Tax abuse or the accidental outflow of profits from the Czech Republic abroad • Improper profit distribution among Czech subsidiaries and their foreign parent companies While the existing approach of the Czech tax authorities for the selection of companies that will be subject to audits is to select 72 Baker & McKenzie companies randomly, the tax authorities will from now on base their decision on a risk analysis. As such, the Czech tax administration conducted an inspection of taxpayers last year, for which it has performed a questionnaire survey. The data gathered by the Specialized Financial Office during this survey has led to the selection of a number of companies that are now subject to further investigation to prevent the abovementioned items. 5. Dispute Resolution 5.1 Mutual agreement procedures under a bilateral tax treaty The Czech local law has not adopted any guidance or specific regulations regarding Mutual Agreement Procedures (MAP). The Czech Republic did, however, include Article 25 of the OECD Model Tax Convention concerning MAP’s in most of the bilateral treaties it has conducted. Therefore, a person/company that is resident in the Czech Republic for tax treaty purposes and who is subject to economic or legal double taxation is allowed to invoke competent authority proceedings under an applicable bilateral tax treaty that includes this article. As mentioned, there are no specific regulations adopted in local law. Therefore, the methods for MAP are not established. Some additional guidance is expected to be published in the Czech Republic on the application of this procedure in practice. The competent authority for performing the MAP is the Ministry of Finance while for matters specifically for transfer pricing, the competent authority is the General Directorate of Taxes. No fees are charged to a taxpayer that is involved in the MAP. 5.2 Arbitration under the European Arbitration Convention Currently, there is no specific arbitration procedure available in the Czech Republic. The bilateral treaties that the Czech Republic has Transfer Pricing Handbook – Czech Republic Baker & McKenzie 73 concluded at this moment do not contain an article on arbitration either. However, the Czech Model Convention is amended recently to include such a clause that may include treaties that are conducted in the future. The Czech Republic is a member of the EU and did ratify the EU Arbitration Convention that is used to resolve disputes between two states, which the states themselves were unable to resolve by mutual negotiations between the competent authorities within the specified time. The disputes that are resolved under this convention are transfer pricing disputes between associated enterprises that are resident within an EU member state. The double taxation is typically resulting from an adjustment of the taxable profit of the group in one state, where the other state did not accept such adjustment and therefore did not apply a corresponding adjustment to alleviate the double taxation. The Arbitration Convention has a significant advantage over regular double taxation treaties in the sense that it applies to situations including permanent establishments of EU companies in other EU states as well. The Arbitration Convention guarantees the removal of double taxation within a certain period. However, the scope of the EU Arbitration Convention is narrower than the scope of the MAP. Whereas the EU Arbitration Convention relates solely to transfer pricing disputes, the MAP is applicable to all double taxation cases that are not in accordance with the provisions of that specific tax treaty. Under the EU Arbitration Convention, member states are given two years to resolve double taxation through the MAP. The commencement of the two-year period is subject to the vision of the respective member state and the Czech Republic has not published any guidance on this matter yet. If EU member states have not reached an agreement to eliminate double taxation after the commencement of this two-year period, the 74 Baker & McKenzie case must be referred to an arbitration committee. This committee has to present its advice within six months. After the arbitration committee has given its advice, the competent authorities of the member states are obliged to resolve double taxation within six months. Otherwise, the advice of the arbitration committee becomes final. 5.3 Litigation If a taxpayer does not agree with the outcome of a tax audit or a tax assessment for example, the taxpayer may appeal the outcome of such procedure to the appellate financial office in Brno. If the outcome of such administrative procedure is not satisfactory, the taxpayer has the option to appeal to the Regional Court and, in addition, to the Supreme Administrative Court. As the abovementioned courts do not have any significant experience resolving transfer pricing matters yet and because of the high costs and long period incurred, taxpayers would usually try to avoid litigation. 6. Advance Pricing Agreement Procedures 6.1 Legal framework The ITA was amended in 2006 and included Section 38nc, which allows taxpayers to request an advance pricing agreement (APA) for Czech tax purposes. Decree D-333 contains further details and recommendations on methods and procedures during the APA process. The methods and procedures are in line with the procedures and recommendations provided by the OECD Guidelines, the results of negotiations of EU authorities and, in particular, the conclusions of the EU Joint Transfer Pricing forum on the procedures for APA’s. Upon the request of a taxpayer, the tax authorities will assess whether the taxpayer has selected a transfer pricing policy or method that will lead to fair allocation of profits between the associated entities. When Transfer Pricing Handbook – Czech Republic Baker & McKenzie 75 the APA is granted, the tax authorities will consider the applied transfer prices to represent an arm’s length remuneration during the period for which the APA was determined, provided that the facts that influence the transfer pricing method do not significantly change during this period. According to Section 133 of the ATA, the tax authorities may “cancel” the APA if they ascertain that the information provided by the taxpayer in the APA request is inaccurate, incomplete or not true, or if the tax law based on which the APA was granted changed. 6.2 Availability of unilateral, bilateral and multilateral APA’s The local Czech law does not provide any guidance on the possibility to request for bilateral or multilateral APA’s, but Decree D-333 does provide practical guidance on such APA’s, which, therefore, acknowledges the possibility to apply for such APA’s. 6.3 Term of APA’s, rollback and extensions An application for an APA is usually filed for one specific transaction. In specific cases where transactions are interrelated, it may be more appropriate to consider the commercial relationship as a whole and the tax authorities may also accept one APA request for multiple transactions. The tax authorities may issue an APA that applies to a transaction that occurs in the given taxable period or for future transactions. It is not possible to request for an APA regarding past transactions. Decree D-333 further suggests that when a transfer pricing method applied by the taxpayer is accepted in an APA for the future and the taxpayer has consistently applied this method in the past, then the APA may be applied for past transactions and may likewise be accepted by the tax authorities. 76 Baker & McKenzie An APA is valid for the period determined in the document. However, the APA expires automatically after a period of three years from the date on which the APA has become final and conclusive. 6.4 Time frame to conclude an APA The estimated time to conclude an APA is six months. However, in practice the actual period to obtain an APA is around eight months. For bilateral APA’s, there is no estimated time period, since the duration will depend on the speed and cooperation of the competent authorities of the other country. There is no time limit or deadline for the issuance of an APA by the tax authorities. However, the tax authorities must issue the APA without undue delay, as it is unacceptable for the tax authorities to postpone the date of the admittance due to their failure to act. With specific reasons why the tax authorities cannot decide upon an APA, the period of the APA may be delayed. 6.5 Fee The taxpayer must pay an administration fee of CZK10,000, which is payable before the issuance of an APA. The tax authorities will not issue an APA until after the payment is received by the tax authorities. 6.6 APA requests There is no prescribed form for an APA request. Nevertheless, the application should at least contain the following minimum content: • Names, addresses and tax ID numbers of all the parties involved in the assessed transaction, including those of nonresidents • A description of the organizational and/or corporate structure, including the elements of the structure located abroad • A description of the commercial transactions that would be covered by the ruling Transfer Pricing Handbook – Czech Republic Baker & McKenzie 77 • The tax period for which the request is filed • A description and documentation of the method, through which the transfer price was established, including all facts relating to the commercial transaction (For facts that are assumed for the future, the estimated values and assumptions should be disclosed too.) • The proposed wording of the ruling The application for the APA should be submitted in the official language. 6.7 Revocation, revision or renewal of the APA When a taxpayer applies for the cancellation of an APA due to changes in facts and circumstances, the taxpayer may apply for a new ruling to be applicable on the concerned transaction with the new circumstances. There are no obligatory rules with regard to the annual compliance of the taxpayer. However, if the tax authorities discover that the conditions and circumstances for which the APA was granted have changed during the period to which the APA applies, the tax authorities have the right to withdraw the APA. 6.8 Disclosures and statistics The Czech tax authorities provided estimates of the statistics regarding the amount of APA requests and the number of APA’s granted during the period from 2006 to 2011, as stated in the table below. (Please note that for 2012, the number provided below is still a tentative estimate). 78 Baker & McKenzie Requests Received APA’s approved Requests declined Withdrawn/ Not under discussion In progress 2006 - 2011 98 49 23 8 18 2012 (tentative) 24 11 3 5 Total 122 60 26 23 The APA is granted and delivered to the requesting parties of the APA and other involved parties. As a result of the automatic exchange of information initiatives, the tax authorities have the right to also pass the ruling to the competent authorities of the other state(s), provided that this is allowed under the respective treaty or any other instrument. Transfer Pricing Handbook – Denmark Baker & McKenzie 79 Denmark Anders Oreby Hansen, Equity Partner Anders Oreby Hansen has more than 20 years of legal experience and primarily represents US, EU and Scandinavian multinational groups as well as high-net-worth individuals investing or conducting business in Denmark. He advises on M&A tax planning, group restructuring, transfer pricing, international taxation and corporate consultancy matters. Anders is an accomplished author and editor. He is author/co-author of five books, including one on Danish Transfer Pricing, and numerous articles on various taxation issues. He is chief editor of the commentary to Denmark’s tax treaties and sits on the executive editorial boards of the leading Danish publications on international and Danish taxation, as well as the executive tax boards of the Danish Bar Association and the Confederation of Danish Industry. [email protected] Tel: +4572273602 (direct) +4525263602 (mobile) Bech-Bruun Law Firm Langelinie Alle 35 2100 Copenhagen Denmark 80 Baker & McKenzie 1. Statutory Rules and Administrative Regulations 1.1 Introduction Denmark’s transfer pricing legislation and administrative regulations follow the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the “OECD Guidelines”). The Danish rules apply to “Controlled Transactions,” which means pricing and terms in commercial or financial transactions between two persons, including legal entities, where those persons are under common control or management. The pricing and terms must be identical to what could have been achieved if the transaction had occurred on arm’s length terms. 1.2 Meaning of transactions The Danish transfer pricing rules pertain to all commercial and financial relations between controlled or controlling persons. Thus in a Supreme Court ruling (“SKM 2012.92 HR”), it was confirmed that the timing of an interest payment can also be subject to the transfer pricing rules. 1.3 Meaning of “control” Control exists for transfer pricing purposes, where either one person controls the other or the same person controls both parties in the transaction. Control can be direct or indirect (e.g., through the attribution of rights of connected parties), and controlling persons can be partnerships or individuals as well as companies. “Control” means ownership of or disposal of voting rights to the extent that the controlling party, directly or indirectly, owns more than 50 percent of the share capital or disposes of more than 50 percent of the voting rights. Furthermore, shares and voting rights that are held by other persons, but with whom the controlling company has an agreement over the exercise of common control, are included. Transfer Pricing Handbook – Denmark Baker & McKenzie 81 1.4 Scope of the rules Denmark’s transfer pricing rules apply to transactions where both parties are Danish tax residents, as well as to transactions where one party is a Danish resident and the other is not. In practice, there will only be an issue with Danish transactions where the results of the parties cannot be consolidated for tax purposes or if, for example, an adjustment means that one party is unable to use a carried-forward loss. The rules apply to a wide range of related party transactions, including goods and services and financing transactions, as well as the licensing and sale of intellectual property. Tax haven transactions are not exempt from the transfer pricing rules. 1.5 Compliance Self-assessment applies to Danish corporation taxpayers who must decide whether the taxable profits they enter on their self-assessment returns reflect an application of the arm’s length principle where relevant. 1.6 Time limits for assessment The Danish tax authorities normally have up to five years and four months from the end of the relevant accounting period in which to raise a corporation tax assessment, unless there has been gross negligence or intentional behavior on the part of the taxpayer, in which case the limit may be up to 10 years from the date on which the correct tax amount should have been paid. 1.7 Attribution of profit As a main principle, the Danish rules follow the OECD Report on the Attribution of Profit to Permanent Establishments, which describes how profits should be attributed to permanent establishments in accordance with the OECD Model Tax Convention’s tax treaty provisions. The Danish practice is broadly consistent with OECD’s described method. 82 Baker & McKenzie 1.8 Advance pricing agreements (APAs) The Danish legislation offers unilateral APAs where there is no bilateral APA regime in place. The Danish tax authorities have negotiated a few bilateral APAs and are currently looking to expand this number. Denmark has, as the first EU member state, concluded a bilateral APA with China. 2. Transfer Pricing Methods 2.1 General acceptance of OECD guidelines Danish transfer pricing legislation was enacted through a referral to the OECD Guidelines and, accordingly, the OECD Guidelines are generally accepted in Denmark. 2.2 Selection of method In accordance with the OECD Guidelines, the transfer pricing method selected should be the most appropriate method in the circumstances of the case. However, where a transaction-based method (comparable uncontrolled price or CUP, resale price or cost plus) and a profit method (profit split or transactional net margin method) are both equally valid in the circumstances, the transaction method is preferable. Similarly, where a CUP method and another transfer pricing method are both equally reliable, the CUP method should be used. The consideration of what method to apply from a Danish perspective should therefore always begin with a consideration of whether any CUPs, either internal or external, are available. 2.3 Contemporaneous information Hindsight cannot be used to determine whether a price was at arm’s length; only information that was available to the parties at the time (including reasonably foreseeable information) can be relied upon. Also, Danish legislation does not include a commensurate-with-theincome-type rule. Transfer Pricing Handbook – Denmark Baker & McKenzie 83 2.4 Pricing adjustments Year-end and retrospective pricing adjustments may, according to Danish administrative regulations, be acceptable; for example, to take into account actual circumstances that have occurred where only budgeted indicators were initially used to set transfer pricing policies. Other factors (for which adjustments need to be made) may also be relevant, such as indirect taxes. 2.5 Working capital/inventory Denmark does not generally require the calculation of comparability adjustments to ascertain levels of working capital/inventory when comparing equivalent business activities. Adjustments may, however, be required in the event of, for example, differences in payment terms and thus, differences in working capitals. 2.6 Business restructurings The recent addition of guidance on business restructurings to the OECD guidelines is also critical in determining the Danish transfer pricing approach and the impact of changes in functions, risks and assets of Danish taxpayers. 2.7 Safe harbors Denmark does not have any formal safe harbors. 3. Transfer Pricing Documentation and Filing Requirements Statutory rules and administrative regulations - The Danish Tax Control Act contains an obligation for Danish taxable entities to prepare and keep transfer pricing documentation in connection with submitting the tax return for the year in question. The Tax Control Act authorizes the Ministry of Tax to issue administrative regulations and, according to the 2014 regulations, the following documentation must be available upon request from the tax authorities (in practice, this will also be what the tax authorities will request): 84 Baker & McKenzie • A description of the group and the business activities. This includes: (i) a description of the legal and organizational group structure, including the group’s primary business activities; (ii) an overview of the last three years’ key financials for all entities involved; (iii) a historical description of the group, including that with regard to restructurings and functional changes; and (iv) a description of the industry in which the group operates, including its competitive parameters. • A description of controlled transactions. This includes a description of each intercompany transaction, including identification of the parties, as well as of the types of goods, services, assets or intangibles transferred and their volume. Furthermore, this description must include an analysis of functions undertaken, assets owned and risks borne by the parties involved in the transactions; as well as an analysis of the contractual terms, economic circumstances and business strategies employed. Any cost-sharing agreements must be included in this description. • A comparability analysis. Businesses must have evidence to show that pricing was at arm’s length at the time of the transaction. This requires a description as to why the business believes that the pricing was at arm’s length, which should be supported by the business’s own transactions with unrelated parties, transactions between unrelated parties and transactions between group companies and unrelated parties. This comparability analysis does not include conducting a database analysis unless the business has already compiled such analysis or unless the tax authorities request that such an analysis be made. • An implementation statement. This includes an overall statement of how the arm’s length principles have been used in the business’s pricing. Any pricing adjustments must also be described. Transfer Pricing Handbook – Denmark Baker & McKenzie 85 • Written agreements. This includes a copy of all written agreements regarding controlled transactions as well as a copy of all written agreements that have been concluded by the taxpayer and/or related parties with foreign tax authorities regarding controlled transactions. • Reduced documentation requirements. Small- and mediumsized businesses (those with less than 250 employees and either total assets of less than DKK125 million or approximately EUR16.6 million, or an annual turnover of less than DKK250 million or approximately EUR33.2 million) shall only prepare and keep transfer pricing documentation for controlled transactions with related entities in countries that are outside the EU/European Economic Area (EEA) or countries with which Denmark has no income treaty. After having received the transfer pricing documentation, the Danish Tax Authorities may, if they have reason to believe that the documentation is inadequate, request that a business submit an auditor´s assurance report on transfer pricing matters. This request may be directed to businesses that have carried out transactions with group-related parties that are also residents in non-EU/non-EEC jurisdictions with which Denmark has not concluded tax treaties, or businesses that, over a four-year period, have suffered operating losses. In the assurance report, the auditor must state that no evidence has been found to suggest (i) that the prepared transfer pricing documentation is not true and fair; (ii) that the documentation has not been prepared according to Danish requirements; and (iii) that the transfer pricing policy should not be in compliance with the arm’s length principle. Due to independence requirements, the regular auditor cannot issue the assurance report if he or she has assisted the business with the preparation of the transfer pricing documentation. Only if the transfer 86 Baker & McKenzie pricing documentation has been prepared by an independent tax adviser may the regular auditor issue the certificate. 3.1 Timing of evidence and analysis The position of the Danish Tax Authorities is that the deadline for preparing the transfer pricing documentation is similar to the deadline for filing the tax return. The statutory filing date for a corporate tax return is six months from the end of the accounting period. If the Danish tax authorities require an auditor’s assurance report on transfer pricing matters, this must be provided within at least 90 days from the date of the request (which cannot be issued less than seven days after the tax authorities received the transfer pricing documentation). If the Danish tax authorities request that a database analysis be conducted, this must be done within 60 to 90 days from the date of request. The documentation must be submitted upon request (with a 60-day notice period). 3.2 Recordkeeping duration Records must be preserved for at least five years from the end of the accounting year in question. 3.3 Reviewing and updating documentation Documentation should be reviewed on a current basis to determine if historical, functional and economic analyses are still relevant; however, there is no requirement to update formal documentation. 3.4 Language of documentation The documentation must be made in Danish, Swedish, Norwegian or English. 3.5 Returning information The taxable entity must, on a schedule to the tax return (Form 05.021 in Danish or Form 05.022 in English), disclose information on all Transfer Pricing Handbook – Denmark Baker & McKenzie 87 controlled transactions and whether the taxable entity is eligible for reduced documentation requirements (see above). 4. Tax Audit Procedures 4.1 Selection of companies for an audit Each year, the Danish Ministry of Tax issues an “Action Plan.” The “Action Plan” for 2014 was published in February 2014. In relation to transfer pricing, the focus in 2014 was on intangibles, group financing, non-profitmaking and non-taxpaying entities, major transactions and companies dealing with procurement in Switzerland. The “Action Plan” for 2015 was published in February 2015. Multinational enterprises should be aware that there is a general risk of a transfer pricing audit, and a particular risk in the areas mentioned. There is an ongoing cooperation between Nordic countries that has led to a number of coordinated pan-Nordic audits. 4.2 Tax audit and appeals procedures The tax authorities will only initiate a transfer pricing audit following both a manual and an automatic review of financials. Accordingly, the financial statements of companies with an annual turnover of more than DKK3 billion (approximately EUR403 million) will be manually reviewed. The financials of the remaining companies will be automatically reviewed in order to, primarily, identify companies that are constantly non-profitable. Those companies will be manually reviewed. If the manual and automatic review leads to the need for an audit (because there have been significant transactions with foreign group companies), such audit will often begin with a request from the Danish tax authorities to provide the transfer pricing documentation mentioned above. If the analysis of the documentation gives the authorities reason to expect that a correction is justified, a notification letter stating the authorities’ intention to reassess the taxpayer will be submitted no later than 1 May in the sixth year after the end of the income year. This 88 Baker & McKenzie notification letter will include a request for comments from the taxpayer and a statement that a ruling will be made in accordance with the request unless comments are received within a certain deadline, which can never be less than 15 days. If the comments from the taxpayer do not give the authorities reason to rule differently from the intended ruling, the decision will be made and the taxpayer can then appeal the ruling to the National Tax Court within three months. 4.3 Administrative proceedings The tax authorities will have the burden of proof that the transfer prices were not on arm’s length terms. Accordingly, it is not a legal presumption that related parties have not transacted on arm’s length terms. The taxpayer will have access to all documentation that form part of a transfer pricing audit. In principle, this access right also pertains to confidential information (e.g., about competing businesses, unless those competing businesses might suffer damages if right of access is granted). Internal working papers from the authorities are normally not included in the access right. 4.4 The transfer pricing group of the Danish tax authorities The Danish tax authorities have six audit teams (and one competent authority body) that work only with transfer pricing matters. Currently, it consists of approximately 120 full-time employees supplemented by specialists from other sectors. It is anticipated that the authorities will maintain and strengthen their transfer pricing capacities in the coming years. 4.5 Current focus of the tax authorities Key areas of transfer pricing focus for the Danish tax authorities include the following: • The identification of intangible assets and determination of whether an intangible asset has been transferred (e.g., in a business restructuring) Transfer Pricing Handbook – Denmark Baker & McKenzie 89 • Whether a particular company is in a constant loss-making position • Major transactions • Companies dealing with procurement in Switzerland 4.6 The information powers of the Danish tax authorities The Danish tax authorities are allowed, under their general information powers, to require a person or a business entity, including third parties, to provide information or documents if the Danish tax authorities consider that such information is of substantial importance for a tax assessment. The Danish tax authorities may enter business premises and inspect any documents on the premises. This right does not include a right to search private homes. The police may assist tax authorities in gaining access to business premises. 4.7 Transfer pricing information The type of information available to the Danish tax authorities might include the company’s transfer pricing documentation, everything that the company has prepared for its corporation tax self-assessment for transfer pricing purposes, any further evidence of arm’s length pricing, the company’s transfer pricing manual, and budgets for each function and management accounts. In assessing the company’s position, the Danish tax authorities may also include, in their business case, sensitive or confidential information that the company has not itself provided to the Danish tax authorities. The Danish tax authorities may use national and international databases (primarily Amadeus) as well as comparables from other businesses in order to benchmark the transactions under review. 5. Dispute Resolution 5.1 Mutual agreement procedures In the case of a transfer pricing adjustment with an international perspective, the taxpayer risks double taxation if a foreign tax 90 Baker & McKenzie adjustment does not correspond to the Danish tax adjustment. This issue can be resolved by a request for a corresponding adjustment in the Danish tax return. In principle, such a request should not be subject to any statute of limitations. The request can be made by either the taxpayer or by the tax authorities. However, the request must be submitted no later than six months following the foreign tax adjustment. It is a condition for a corresponding adjustment that the Danish tax authorities recognize the foreign tax adjustment. If the Danish tax authorities do not recognize the foreign tax adjustment (the “primary adjustment”), a Danish corresponding correction will be refused. The potential double taxation must then be resolved under the mutual agreement procedure (MAP) in a double tax treaty. Denmark has a significant number of double tax treaties, almost all of which contain a MAP article. The taxpayer will address the acting Danish competent authority, which is the central office of the Danish tax authorities (Large Companies, Office of International Company Tax), in order to request that a MAP be initiated. The MAP may also be requested if the Danish tax authorities have made the primary adjustment. The extent to which the MAP is available is largely dependent upon the discretion of the competent authority. The decision of the competent authority is not appealable. The treaty will generally require the competent authorities to endeavor to apply the MAP in such a way that double taxation is eliminated, and this result will be achieved in a majority of cases. There is no formal statutory method to set a case in motion. By the end of 2013 (latest official statistics), Denmark had 89 ongoing MAPs, and it completed 17 MAPs during that year. 5.2 Interaction of MAP and domestic transfer pricing enquiry Any request to initiate MAPs should not delay the progress and settlement of a domestic transfer pricing enquiry. The trigger for a MAP claim would normally be the finalization of the transfer pricing enquiry, which results in double taxation. Transfer Pricing Handbook – Denmark Baker & McKenzie 91 5.3 The European Arbitration Convention The Arbitration Convention is a potentially useful mechanism that might be used as an alternative to the MAP. As opposed to the MAP, the Arbitration Convention requires that the authorities reach a result within a two-year period. If a result is not reached, an advisory commission will be established and will issue its opinion on the matter within six months. Six months after that, the final decision on the matter must be made. 5.4 Recent transfer pricing litigation in Denmark. SKM 2012.92 HR: The Supreme Court ruled that a correction of the timing of an interest payment in a loan agreement between a Danish company and its US parent was subject to the six-year statute of limitations as a “controlled transaction.” There will be some significant cases coming to court in the near future, arising from the fact that the Danish tax authorities in 2013 carried out 77 transfer pricing audits where the taxpayers’ incomes were increased, with a total of DKK17.4 billion (approximately EUR2.3 billion). Of those 77 audits in 2013, 16 percent concerned income increases of more than DKK100 million (approximately EUR13.4 million) per audit. 6. Interest and Penalties 6.1 Interest Where additional corporation tax becomes due following a transfer pricing adjustment, a variable non-deductible surcharge (4.6 percent for the income year 2014) on all adjustments of prior years’ corporate taxes will be levied. Additionally, non-deductible interest of 0.8 percent (for the income years 2010-2014) for each month calculated from the due date of any corporation tax will be imposed. 6.2 Penalties The fine for reporting transfer pricing issues incorrectly in the income tax return may be fixed, either on the basis of the annual turnover of the business or on the basis of the number of employees. 92 Baker & McKenzie • A fine based on the annual turnover will be fixed at 0.5 percent of the turnover, up to an amount of DKK500 million (approximately EUR67.2 million); 0.1 percent of the turnover between DKK500 million and DKK1 billion (approximately EUR134.4 million); and 0.05 percent of any turnover exceeding DKK1 billion. • A fine based on the number of employees will be fixed at DKK250,000 (approximately EUR33,600) for each of the 50 employees. If the number of employees exceeds 500, the fine will be fixed at DKK2 million (approximately EUR267,000). The fine levied will be the highest amount possible and may never be set below DKK250,000 per company/entity per year. If the incorrect reporting made is deemed to be part of a systematic violation of tax legislation, the fine may be increased by up to 50 percent. This will be the case if, for example, it turns out that the taxable income of the business is to be amended significantly. A fine will be levied for each income year in which reporting has not been made correctly. Alongside the increase in the fines for incorrect reporting in the income tax return, the bill introduces minimum fines for failure to prepare transfer pricing documentation when required to do so. A fine, generally fixed at DKK250,000, will, as of 1 January 2013, be levied when transfer pricing documentation has not been prepared. Until 31 December 2012, the fine was set to match the supposed savings obtained by not preparing the transfer pricing documentation. The system applying to income years commencing before 1 January 2013, according to which an additional fine of 10 percent of any increase in the taxable income resulting from transfer pricing adjustments is levied, is to be preserved. Transfer pricing fines were rare before 2012, but will be a real threat in relation to income years commencing 1 January 2013. Transfer Pricing Handbook – Denmark Baker & McKenzie 93 In relation to income years commencing on or after 1 January 2013, the fines described above will apply. 7. Advance Pricing Agreement Procedures 7.1 Availability of unilateral/bilateral APAs The Danish legislation provides for unilateral APAs only. Accordingly, there is no national bilateral APA regime in place and the taxpayer will, therefore, not have a right to obtain an APA. The bilateral APA procedure follows the OECD Transfer Pricing Guidelines or the EU Joint Transfer Pricing Forum’s “Guidelines for Advance Pricing Agreements within the EU.” 7.2 Procedure While there is no formal requirement for an application for an APA, the procedure for obtaining an APA is as follows: • The potential applicant makes an expression of interest to the Danish tax authorities (pre-filing). • A formal application is made and a time schedule is agreed. • The Danish tax authorities appoint a team to take responsibility for the APA and the process. • The Danish tax authorities commence their fact-finding task. • Position papers are exchanged, assessed and negotiated between the Danish and foreign tax authorities. • The taxpayer is informed about the agreed position. • A formal agreement is made. • The Danish tax authorities aim to complete APAs within 18 to 24 months from the receipt of the application. 94 Baker & McKenzie 7.3 Fees There is no fee payable to the tax authorities for obtaining an APA. 7.4 Country-specific experiences with APA procedures The number of APAs completed by the Danish tax authorities is still not substantial (21 have been finalized from 2009 to 2013). The current number of APA procedures with a Danish party was 11 by the end of 2013. In 2013, the Danish tax authorities completed five APAs. It is expected that the number of APA procedures will increase significantly over the coming years, partly because the Danish tax authorities have published a strategy to resolve transfer pricing issues in advance through guidance rather than through audit. 8. Other Subjects - Trends - Thin Capitalization 8.1 Introduction In recent years, the Danish legislator has focused on tax strategies by capital funds (meaning broadly, highly leveraged corporate acquisitions) and zero-tax paying companies. This focus has prompted legislation on the financing of Danish companies, thereby supplementing a long-standing thin capitalization for safe harbor. 8.2 Safe harbor Denmark’s statutory safe harbor for thin capitalization purposes has a debt-to-equity ratio of 4:1, representing an arm’s length level of debt. 8.3 Interest ceiling and EBIT rules Under the Interest Ceiling Rule that applies to controlled as well as non-controlled debt, net financing costs (for example, interest expenses) of a Danish company are only deductible to the extent that they do not exceed a standard interest rate calculated by reference to the taxable value of the company’s assets. The taxable value of the company’s assets is defined as the acquisition price (after tax depreciations) on assets. The standard interest rate is currently 4.2 percent. The Interest Ceiling Rule will not affect the deductibility of Transfer Pricing Handbook – Denmark Baker & McKenzie 95 net financing costs, which do not exceed DKK21.3 million (approximately EUR2.8 million). The EBIT Rule states that a Danish company’s taxable income before net financing costs cannot be reduced by more than 80 percent as a consequence of its net financing costs (after these financing costs have been limited, according to the Interest Ceiling Rule). Similarly to the Interest Ceiling Rule, the EBIT Rule will only affect net financing expenses above DKK21.3 million. 8.4 Recharacterization Interest paid by a thinly capitalized entity will not be recharacterized as a dividend, but a deduction may be disallowed in whole or in part. Transfer Pricing Handbook – Finland Baker & McKenzie 97 Finland Janne Juusela, Partner Janne is the head of Attorneys at Law Borenius’ tax group. He advises on matters related to corporate and cross-border taxation including transfer pricing. Janne is ranked as a leading tax lawyer in Finland. Janne has diverse experience in dealing with transfer pricing issues concerning both Finnish and international groups of companies. Recently, he has assisted companies in major transfer pricing related tax audits and tax disputes. Janne is a Doctor of Laws and he defended his doctoral thesis on international tax law in 1998. He has written books on tax law and has published several articles in Finnish and international publications in the field. [email protected] Tel: +358 9 6153 3431 Attorneys at law Borenius Ltd Yrjönkatu 13 A, 00120 Helsinki VAT FI01034608 Finland 98 Baker & McKenzie 1. Statutory Rules and Administrative Regulations 1.1 Introduction Finland’s transfer pricing regulation and tax practice generally follow the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the “OECD Guidelines”). The Finnish documentation rules also conform to the principles established in the Code of Conduct for Transfer Pricing Documentation in the European Union. The Finnish Act on Tax Assessment 1558/1995 (ATA) contains provisions concerning the arm’s length principle, as well as the transfer pricing documentation that have been in effect since 1 January 2007. Additionally, the Finnish Tax Administration has published tax administration guidelines dealing especially with transfer pricing documentation. Section 31 of the ATA enacts the arm’s length principle for related party transactions. It applies where a taxpayer and a related party have agreed on or defined terms that are different from what would have been agreed upon by independent parties and, in consequence, the taxable income of the taxpayer is less or the taxpayer’s loss is more than what it would have been using arm’s length terms. Where the rule applies, the taxable income can be increased to the amount that it would have been if the terms had been the same as would have been agreed upon by independent parties. 1.2 Meaning of “transaction” The definition of “transaction” is general in nature and includes all kinds of measures. In this respect, the tax administration’s guidelines refer to Article 9 of the OECD Model Tax Convention. 1.3 Meaning of “control” Related party transactions are defined on the grounds of direct or indirect control. According to Section 31 of the ATA, a company controls another company if it has: Transfer Pricing Handbook – Finland Baker & McKenzie 99 • direct or indirect ownership of more than 50 percent of the share capital; • direct or indirect ownership of more than 50 percent of the voting power; • a direct or indirect right to appoint over 50 percent of the members of the board or members of a corresponding body with the power; or • joint management with another party or any other method of factual control over the entity. 1.4 Scope of the rules Finland’s transfer pricing legislation applies to transactions where both parties are Finnish tax residents, as well as to transactions where one party is a Finnish resident and the other is not. The legislation also applies to transactions between a foreign parent company and its permanent establishment in Finland. The transfer pricing rules apply to a wide range of commercial and financial transactions, including transactions with goods, provision of services, payment of fees for immaterial rights, and the provision of financial services. Tax haven transactions are not exempt from the transfer pricing rules. 1.5 Compliance Finnish corporate taxpayers are required to file an annual income tax return where they have to declare whether they have had related party transactions during the tax year in question and whether they are obligated to maintain transfer pricing documentation provided for in Section 14b of the ATA. If the corporate taxpayer is obligated to prepare transfer pricing documentation, it also has to file a special transfer pricing-related Form 78 (Explanation of Transfer Prices) as part of the annual tax return. However, corporate taxpayers are not required to enclose the documentation with the income tax return. Most commonly, the 100 Baker & McKenzie Finnish Tax Administration asks a taxpayer to present the documentation in connection to a tax audit. 1.6 Time limits for assessment The tax administration may reassess taxation under the conditions mentioned in the ATA. In cases where taxpayer has failed to file the tax return, or the return is erroneous or incomplete, tax assessment may take place within five years after the end of the tax assessment year. When reason for reassessment is miscalculation, misspelling or other corresponding errors made by the tax administration or erroneous information received from third parties, correction to the detriment of the taxpayer may be made within two years after the end of the tax assessment year. In other cases, errors in the decisions can be corrected within one year after the end of the tax assessment year. 1.7 Attribution of profit In Finland, the rules concerning profit attribution follow the OECD Report on the Attribution of Profit to Permanent Establishments, which describes how profits should be attributed to permanent establishments in accordance with the OECD Model Tax Convention’s provisions. As a general rule in Finland, the attribution is based on financial accounts prepared by the permanent establishment. 1.8 Advance pricing agreements (APAs) There are no specific rules concerning APAs in Finland. However, advance pricing arrangements can be conducted under the Mutual Agreement Procedure (MAP). A taxpayer may also request a binding advance ruling about income taxation in general, as well as one about transfer pricing questions (please see Section 7 below). The Ministry of Finance is preparing the APA legislation rules, but the timetable for the Government Bill is open at the moment. Transfer Pricing Handbook – Finland Baker & McKenzie 101 2. Transfer Pricing Methods 2.1 Understanding the legislation The Finnish legislation is interpreted in a way that best ensures consistency with the OECD Guidelines. In practice, tax administration follows the OECD Guidelines quite carefully. 2.2 Selection of method In Finland, the transfer pricing methods are applied in line with the OECD Guidelines. The OECD Guidelines provide that the transfer pricing method selected should be the most appropriate method in the circumstances of the case. However, where a transaction-based method (comparable uncontrolled price or CUP, re-sale price or cost plus) and a profit method (profit split or transactional net margin method) are both equally valid in the circumstances, the transaction method is preferable. The CUP method is primary, when applicable, because it is deemed to best correspond to the arm’s length principle. 2.3 Contemporaneous information As a general rule, taxpayers and tax administration cannot use hindsight to determine whether a price was at arm’s length. The pricing should be based on current information at the time of the transaction. If the pricing method adopted by the taxpayer is challenged by the authorities, and it later becomes clear that the original pricing was at arm’s length, it should be possible to appeal against the tax assessed. 2.4 Pricing adjustments Year-end pricing adjustments and adjustments that are made to correct previous years are generally acceptable, depending on the circumstances. 102 Baker & McKenzie 2.5 Business restructurings Awareness of transfer pricing issues in business restructurings has increased during the past years due to, among others, the economic depression and the transfer pricing documentation requirements that came into force in 2007. There is no special regulation related to transfer pricing in intragroup business restructurings in Finland (excluding general tax rules relating to mergers, divisions, transfers of assets and exchange of shares). Accordingly, the intragroup business restructuring process must be executed in accordance with the arm’s length principle. 2.6 Safe harbors The tax law of Finland does not include any safe harbors or rules of thumb under which transfer prices, meeting certain requirements, would be accepted as meeting the arm’s length test. 3. Transfer Pricing Documentation and Filing Requirements 3.1 Recordkeeping Finnish companies have to prepare transfer pricing documentation on the transfer pricing applied in transactions with foreign related parties. According to Section 14b of the ATA, the transfer price documentation should include the following information: • Description of business • Description of related parties • Information on transactions between related parties • Functional analysis of transactions between related parties • Comparability analysis, including information on comparables • Description of the pricing method and its application Transfer Pricing Handbook – Finland Baker & McKenzie 103 It is permissible to deviate from the order specified in Section 14b. The structure and content of the documentation do not have to necessarily follow the provisions of Section 14b if another set of rules has been followed instead, such as the Code of Conduct for Transfer Pricing Documentation in EU or the transfer pricing documentation rules of another country. Nevertheless, the facts and information required in Section 14b have to be submitted to the tax administration and if required in any particular case, further documentation must be provided on request. Relief from the transfer pricing documentation requirement applies to small- and medium-sized enterprises. These enterprises do not need to prepare transfer pricing documentation, although they are required to comply with the arm’s length principle. The definition of small- and medium-sized enterprise is as follows: • The company has less than 250 employees. • The company’s turnover does not exceed EUR50 million or its balance sheet does not exceed EUR43 million. • The company meets the criteria of small- and medium-sized enterprises in the European Commission’s recommendation 2003/361/EC. Moreover, if dealings with associated entities are small in scale, less extensive documentation is required. This is the case if total transactions between two parties during a fiscal year stay below EUR500,000. 3.2 Timing of evidence and analysis Corporate entities have to file their income tax returns within four months after the closing date of their accounting period. During the tax year, pricing of related party transactions should follow the arm’s length principle and evidence for compliance of arm’s length pricing should be prepared continually. There is, however, no requirement for real-time documentation. 104 Baker & McKenzie 3.3 Recordkeeping duration Since retrospective adjustments to taxation can be made during five years after the end of the tax assessment year, records should be kept at least until the end of this period. However, the Finnish Tax Administration recommends that records be kept even thereafter because questions about transfer pricing can also be raised by tax administration of counties where group companies are resident. 3.4 Reviewing and updating documentation Documentation should be reviewed annually to determine whether historical, functional and economic analyses are still up-to-date, but there is no statutory requirement to amend documentation each year. 3.5 Form and depth of the documentation The Finnish documentation rules do not impose any specific format for the documentation. Consequently, taxpayers can choose the most appropriate format. When interpreting Sections 14a - 14c of the ATA, it should be kept in mind that transfer pricing documentation requirements should not impose unreasonable administrative burdens on taxpayers. Documents written in Finnish, Swedish or English are accepted. If considered necessary by the Finnish Tax Administration, taxpayers have to present a Finnish or Swedish summary translation of a documentation written in English. 3.6 Returning information Taxpayers who have obligation to prepare transfer pricing documentation are also required to submit an additional tax return form (Form 78 Explanation of Transfer Prices) describing crossborder intra- group transactions and their volumes. Taxpayers are not expected to enclose the documentation with the income tax return form. Most commonly, the Finnish Tax Transfer Pricing Handbook – Finland Baker & McKenzie 105 Administration asks taxpayers to present the documentation in connection to a tax audit. Transfer pricing documentation has to be submitted to the Finnish Tax Administration only by request. According to Section 14c of the ATA, documentation should be submitted to the administration within 60 days from a request. In spite of this, transfer pricing documentation cannot be requested to be submitted earlier than six months after the end of the accounting period in question. 4. Tax Audit Procedures 4.1 Risk assessment A tax audit’s scope may include all areas of taxation or only some of them. Consequently, transfer pricing may only be one of the topics considered in an ordinary tax audit, or the tax audit may cover only transfer pricing issues. In previous years, transfer pricing has been one of the main focus areas in tax audits. In practice, the tax administration carries out a risk assessment and if transfer pricing is potentially considered to include risks of material importance, transfer pricing may be included in the scope of the tax audit. Companies are selected for the tax audit based on their line of business or on specific tax risk criteria developed by the tax administration. 4.2 Indicators of high level of risk In Finland, the tax administration does not publish information relating to their tax risk analysis process. In general, the tax administration tries to audit the largest companies every five to six years. 106 Baker & McKenzie 4.3 Types of risk Various types of risk are considered as a whole when determining whether a transfer pricing audit is initiated (e.g., value of the tax at risk, behavior risk for the company in question and transaction risk related to the nature of transactions). 4.4 Commencement of enquiry The preliminary scope of a tax audit is determined based on initial information on a taxpayer. This information includes documents and data provided by the taxpayer, tax returns, payment control data, comparison data, reports on previous tax audits and advance rulings from the tax administration. Additionally, information from various public sources and tax practice and case laws relevant to the taxpayer’s industry or line of business are reviewed. Taxpayers are usually informed in advance about tax audits. If possible, taxpayers’ wishes are taken into consideration when the decision is made on commencement of the audit. When there is a special reason, a tax audit can also be carried out without advance notification. 4.5 Transfer pricing program From the beginning of 2012, the tax administration has established a special transfer pricing program that focuses solely on transfer pricing issues. This program is established in the Large Taxpayers’ Office and it is responsible for all transfer pricing-related activities in the Finnish tax administration. The program currently has 37 full-time employees, out of which 22 are tax auditors. The number of transfer pricing-related tax audits has increased significantly after initiation of the program. The main focus areas in tax audits have been intangibles, intragroup finance and business restructurings. As of January 2015, the transfer pricing program is reorganized as a permanent unit of Large Taxpayers’ Office. Simultaneously, the Transfer Pricing Handbook – Finland Baker & McKenzie 107 Finnish Tax Administration intends to shift their point of emphasis in transfer pricing matters from tax audits to preemptive measures. 4.6 Progress of enquiry Whenever possible, a tax audit starts with an initial meeting with the taxpayer. At this meeting, aims and procedure of the tax audit and any further actions are discussed. The tax auditing team also seeks to build a comprehensive picture of the taxpayer’s business operations, accounting and management of tax affairs. In the actual audit, the following issues are subject to auditing: correspondence between business operations and accounting records; correspondence between tax returns and accounting records; and compliance with tax laws. Taxpayers have right to be heard during the tax audit process. The tax auditors prepare a tax audit report based on the information they have gathered from the taxpayer and other sources. In the tax audit report, the tax audit process and potential findings are described in detail. Measures to be taken as a result of the findings also have to be proposed in the report. A local tax office makes the effective reassessment decision and imposes potential additional taxes on the basis of the tax audit report. As a main rule in the Finnish tax practice, the burden of proof resides with the tax administration to demonstrate that there is a significant deviation from the arm’s length principle by the taxpayer. ATA has a special provision stipulating that the party who can best provide the required evidence should provide it. Considering a taxpayer’s broad duty to provide additional information, in practice the burden of proof rests generally with the taxpayer. Therefore, if the arm’s length nature of the transaction is questioned by the Finnish Tax Administration, the taxpayer has to generally provide evidence to prove that the allegations are unfounded. 108 Baker & McKenzie 4.7 Tax administration’s current focus The tax administration has had a strong focus on transfer pricing for some years. Key areas of transfer pricing focus for the tax administration include the following: • Loss-making subsidiaries and permanent establishments • The pricing of service fees charged from Finnish companies • Business restructurings, especially in situations where the taxable income of the Finnish company decreases • Transfers of intangible assets • Intragroup financing arrangements • The quality of comparables, the selected comparable companies and the application of comparables, as well as the selected transfer pricing method Recently, the Finnish Tax Administration has indicated that it will shift the focus in transfer pricing matters towards preemptive measures, and it intends to enhance cooperation with taxpayers. 4.8 Information powers According to Section 14 of the ATA, the taxpayer’s duty to disclose information for the purposes of a tax audit is quite extensive. Besides actual accounting records, all other information that might have bearing on taxation must be disclosed. Accounting records and other materials subject to disclosure must be provided in a tax audit, even if they contain confidential business information from the taxpayer’s point of view. Any third party that receives an information request from the tax administration or a tax office is required to provide the information needed for the taxation of another taxpayer. Transfer Pricing Handbook – Finland Baker & McKenzie 109 Tax auditors must comply with the confidentiality provisions that bind civil servants. Accordingly, tax documents may not be revealed to third parties unless law allows it. 4.9 Transfer pricing information The type of information available to the tax administration might include the company’s transfer pricing documentation and other transfer pricing related documents, materials prepared for corporate income tax purposes and any further information on related party transactions, business operations and compliance with arm’s length principle. In the assessment, the tax administration may also take into account case-specific and confidential information that the company has not itself provided to them. 5. Dispute Resolution 5.1 Finland’s domestic appeal process An appeal may be lodged against any transfer price adjustment in the same way as against an ordinary tax assessment. As a general rule, an adjustment request must first be submitted to an assessment adjustment board. If the taxpayer is dissatisfied with the decision concerning the adjustment request, the taxpayer may appeal to an administrative court. Finally, the administrative court’s decision may be appealed to the Supreme Administrative Court if permission is granted. In addition, taxpayers may request the tax administration to grant partial or total relief on Finnish tax in situations where the same income has already been taxed abroad and the assessment of Finnish tax would lead to double taxation. The relief is discretionary and in practice, rarely applied. 5.2 Mutual agreement procedure Finland has concluded approximately 80 double tax treaties, almost all of which contain a MAP article (Article 25 of the OECD model). In transfer pricing issues, the competent authority is the Ministry of 110 Baker & McKenzie Finance, but it has delegated the powers to tax administration, where the Large Taxpayers’ Office is largely responsible. A taxpayer may present his or her case to the competent authority and ask for it to be resolved by MAP if the actions of the contracting states would lead to double taxation. The taxpayer, however, may not force the authority to invoke MAP. Entering into negotiations and granting an exemption depends on a case-by-case consideration of the authorities, and MAP cannot be considered as standard practice in Finland. Finland has implemented the article on transfer pricing adjustment procedure in some of the recent tax treaties (Article 9.2 of the OECD model), including, among others, those with Australia, Canada, China and the USA. 5.3 Interaction of MAP and domestic transfer pricing enquiry Any request to initiate MAP should not delay progress and settlement of a domestic transfer pricing dispute. A trigger for a MAP claim would normally be the finalization of domestic procedure, resulting in the settlement of the tax liability, although MAP can be initiated already before the double taxation occurs. 5.4 The European Arbitration Convention The EU member states have entered into a multilateral convention on the elimination of double taxation in connection with the adjustment of profits of related enterprises (the “EU Arbitration Convention”). The EU Arbitration Convention establishes a procedure to resolve disputes, where double taxation occurs between enterprises of different member states as a result of an upward adjustment of profits of an enterprise of one member state. In practice, the EU Arbitration Convention has been applied in Finland. Transfer Pricing Handbook – Finland Baker & McKenzie 111 5.5 Recent transfer pricing litigation in Finland The Finnish supreme administrative court (SAC) has issued several rulings on topical transfer pricing issues. Some of the recent rulings that are of general interest include the following: • SAC 2014:119 on recharacterization of a financial instrument • SAC 2014/493 on valuation of transferred shares • SAC 2013/36 on location savings • SAC 2010/3092 on the pricing of intragroup loans • SAC 2009/1702 on the application of provisions on transfer pricing adjustment 5.6 Current areas of potential transfer pricing litigation in Finland In recent times, issues such as recharacterization of related party transactions, pricing of intangible property, intra- group finance, business restructurings and allocation of profit to Finnish branches or permanent establishments have been subject to litigation in Finland. 6. Interest and Penalties 6.1 Interest due to delay If additional corporation tax becomes due following a transfer pricing adjustment, any corporation tax paid late will carry interest. 6.2 Penalties The tax administration may impose a punitive tax increase due to a fault committed by the taxpayer, either regarding the tax assessment procedure in general or with regard to transfer pricing documentation. A tax increase may be assessed if the information (e.g., the tax return) given by the taxpayer is incomplete or late, erroneous or if the required information is not given at all. The amount levied in each 112 Baker & McKenzie individual case depends on the degree of fault attributed to the taxpayer. 6.3 Meaning of “incomplete”/”erroneous” The meaning of incomplete or erroneous information is defined by case law and guidelines issued by the tax administration. Small mistakes in the reporting obligations or tax return forms do not necessarily lead to penalties. 6.4 Amount of penalty Special penalties relating to transfer pricing documentation is set out in the Sec. 32(4) of the ATA. A maximum tax increase of EUR25,000 may be imposed if the transfer pricing documentation or requested additional information is not submitted within the time limit, or the documentation or information submitted are essentially incomplete. In addition, the ordinary tax penalties, i.e., tax increases, are typically imposed in connection with transfer pricing related reassessments. A punitive tax increase can amount up to 30 percent of the adjusted income and currently, the late penalty interest rate is 7.5 percent. 7. Advance Pricing Agreement Procedures Taxpayers may request a binding advance ruling concerning transfer pricing issues. The advance rulings are binding on the tax administration if the request is made by the taxpayer. 7.1 Who can apply for an advance ruling? A resident or non-resident taxpayer can apply for advance ruling from the regional tax offices. In addition, the Central Tax Board issues binding advance rulings. In practice, most of the advance rulings on transfer pricing are issued by the tax offices. Transfer Pricing Handbook – Finland Baker & McKenzie 113 7.2 Advance rulings by the tax offices Tax offices issue advance rulings concerning income taxation, covering, among others, transfer pricing matters, valuation issues and questions related to tax avoidance. The tax offices do not issue advance rulings on matters pending in the Central Tax Board or on ones already decided by it. Taxpayers may appeal against a tax office’s advance ruling concerning transfer pricing. 7.3 Advance rulings by the Central Tax Board The Central Tax Board issues advance rulings on matters that are of general interest, either for the purpose of applying the law in similar situations or for the coherence of tax practice. As a general rule, the Central Tax Board does not give advance rulings on valuation issues or the potential application of tax avoidance legislation. Advance rulings by the Central Tax Board can be appealed by the taxpayer to the Supreme Administrative Court, a specific body within the tax administration and the municipality in question. 7.4 Term of an advance ruling and fees Advance rulings by the Central Tax Board and tax offices are issued for a fixed term. Typically, the ruling is applied for the fiscal year in question and the following year. Currently, the fee for an advance ruling by the Central Tax Board is EUR2,080 or EUR3,470, depending on how much time the matter in question requires. The fee for an advance ruling by a tax office is currently EUR1,040 or EUR2,080, depending on how much time the matter in question requires. 8. Thin Capitalization 8.1 Current situation Finland has introduced a regulation that limits the deductibility of interest expenses in business taxation. The limitations will be applied 114 Baker & McKenzie only if the interest expenses exceed the interest income received by the company, i.e., if the company has net interest expenses. Interest may become non-deductible if the net interest expenses exceed 25 percent of the company’s adjusted business profits (i.e., taxable business profits adjusted with the aggregate amount of interest costs, depreciations, losses and change in value of financial assets and group contributions received, deducted with the amount of group contributions paid). The regulation contains a general safe haven of EUR500,000. If the net interest expenses (including third-party and related-party interests) exceed EUR500,000, the interest limitation will be applied to the entire amount. Interest payments for third-party loans will not be affected. However, third-party loans will be deemed intragroup loans if a related party pledges to an unrelated party a receivable as security for the loan and the unrelated party provides a loan to another related party, or the loan from an unrelated party is de facto a back-to-back loan from a related party. Further, the interest expenses will remain fully deductible if the equity ratio of the company is equal to or higher than the consolidated equity ratio of the group. The regulation allows an indefinite carry forward of non-deductible interest expenses and deduction of such interest expenses, provided that the limitations are not exceeded. The limitations are applicable as of tax year 2014, and they have a significant impact on domestic and cross-border financing structures in Finland. 8.2 Recharacterization As a main rule, interest paid by a thinly capitalized entity will not be recharacterized as a dividend, but a deduction of the interest expenses may be disallowed in whole or in part. Transfer Pricing Handbook – Finland Baker & McKenzie 115 In the recent case law (SAC 2014:119), SAC ruled that disregarding the business transaction agreed upon by the parties and recharacterizing the transaction would have required an explicit authorization for recharacterization under a specific regulation of ATA. As Section 31 (1) of the ATA concerning transfer pricing adjustments did not contain such a rule, SAC ruled that the recharacterization may not be done based on it. Instead, recharacterization shall be made under the general antiavoidance rule set out in Section 28 of the ATA. Moreover, it was stated that OECD transfer pricing guidelines may be used as indicative guidance in transfer pricing related matters, but re-classification shall be based on a specific section in Finnish law. 8.3 Factors to be taken into account It should be kept in mind that thin capitalization and transfer pricing constitute separate sets of rules. As a consequence, compliance with these regulations should be assessed separately. The general anti-avoidance provision, the provision on transfer pricing adjustments and the provision on hidden dividend distributions in the Finnish domestic law may possibly be applied to deny the tax deductibility of interest. The factors to be taken into account include all aspects of the loan arrangement (purpose of the loan, term, interest level, and collateral and repayment conditions, among other things). Transfer Pricing Handbook – France Baker & McKenzie 117 France Caroline Silberztein, Partner Caroline Silberztein is the head of the Baker & McKenzie French Transfer Pricing and International Tax group. She assists multinational enterprises from a range of industry sectors with risk assessment, design and implementation of transfer pricing policies, tax audits, tax litigation, mutual agreement procedures and advance pricing arrangements, on a local and a global basis. Caroline joined Baker &McKenzie in September 2011 and chairs the Firm’s Global Transfer Pricing Group. She was the Head of the OECD Transfer Pricing Unit from 2001 to 2011 and led the 2010 update of the OECD Transfer Pricing Guidelines. She is a member of the United Nations Sub-Committee on Transfer Pricing. [email protected] Tel: +33 1 44 17 53 54 Benoît Granel, Associate Benoît Granel has been practicing in the Tax Group of Baker & McKenzie in Paris since 2013. He advises on international tax matters and transfer pricing, planning and defense. Benoît holds a postgraduate diploma in Comparative Law from the University College London, as well as a postgraduate degree in Law and Corporate Taxation and a Magistère in Business Law, Taxation and Accountancy from the University of Aix en Provence. [email protected] Tel: +33 1 44 17 65 14 118 Baker & McKenzie Laura Nguyên-Lapierre, Senior Associate Laura Nguyên-Lapierre joined Baker & McKenzie SCP in 2010. She practices in the Tax Group in Paris. She advises on international tax matters, transfer pricing and tax litigation. She assists clients with the implementation of transfer pricing policies and transfer pricing documentation, advance pricing agreements and mutual agreement procedures, tax audits and structuring of R&D financing. Laura graduated from HEC Business School (Master of Science in Management specializing in International Tax and Legal Strategy) and holds a postgraduate degree in International Taxation from the Paris II Panthéon - Assas University. [email protected] Tel: +33 1 44 17 59 94 Baker & McKenzie SCP 1 rue Paul Baudry 75008 Paris France Transfer Pricing Handbook – France Baker & McKenzie 119 1. Statutory Rules and Administrative Regulations 1.1 Introduction French statutory and administrative approaches to transfer pricing are generally consistent with the principles set out by the OECD. Article 57 of the French Tax Code (FTC) allows the French Tax Administration (FTA) to adjust the profits of a French enterprise in the case where the latter has indirectly transferred profits to a foreign associated enterprise by an increase or decrease in purchase or sale prices or by any other means. In the case where it lacks precise elements to support the assessment, the FTA determines the taxable profits by comparison with those of similar enterprises exploited “normally.” 1.2 Meaning of “control” Article 57 of the FTC applies in the case of transfer of profits by a French enterprise that either controls, is controlled by, or is under the same control as a foreign enterprise. The notion of dependence is not further defined in Article 57. It follows from case law and administrative guidelines that cover situations of legal dependency, either direct or indirect, such as where: • an enterprise holds a predominant part of the capital of a company in the other country or the absolute majority of the voting rights; or • an enterprise exercises, directly or indirectly, decision-making powers in the other. It also covers situations of “de facto control,” i.e., where one enterprise is under the control of the other one, either as a result of contractual provisions or because the actual conditions of their relationships are such that the first enterprise has the power to impose unfavorable economic conditions on the other. 120 Baker & McKenzie The FTA does not need to establish the existence of a control between the French and the foreign enterprise if the latter is established in a foreign country or territory with a privileged tax regime, or in a noncooperative state or territory (see hereinafter). The privileged tax regime criterion is regarded as met in cases where the foreign enterprise is subject to corporate tax at a rate lower than 50 percent of the corporate tax, which would have been applied if the enterprise had been taxable in France.1 1.3 Specific rules for Non-Cooperative States and Territories (NCSTs) Non-Cooperative States and Territories (NCSTs) are defined as states or territories that do not belong to the European Union, do not have an administrative assistance convention with France allowing exchange of information as needed to apply the tax legislation of the parties, and have not signed such conventions with at least 12 states or territories.2 The French list of NCSTs relies on the work of the OECD Global Forum and is updated every year. As of January 2014, the list includes: Botswana, Brunei, Guatemala, Marshall Islands, Montserrat, Nauru, Niue and the British Virgin Islands Payments made to NCSTs are subject to restricted deductibility conditions and increased withholding taxes as well as other unfavorable measures, including more stringent transfer pricing documentation requirements (see Section 3). 1.4 Meaning of transfer of profits abroad Administrative doctrine and case law have constantly interpreted Article 57 of the FTC as embodying the arm’s length principle. In order to make an assessment under Article 57 of the FTC, the FTA needs to demonstrate that the transaction has been concluded on terms that are “unusual.” The unusual or abnormal term may be the price or another condition of the transaction (e.g., payment terms). There is a rebuttable presumption of transfer of profits abroad once the FTA 1 Article 238 A of the FTC. 2 Article 238-0 A of the FTC. Transfer Pricing Handbook – France Baker & McKenzie 121 establishes the existence and amount of an advantage granted to a foreign associated enterprise. 1.5 Scope of the rules French transfer pricing rules apply to: (i) enterprises subject to income tax (impôt sur le revenu) or corporate income tax (impôt sur les sociétés); and (ii) cross-border transactions between French and foreign enterprises The rules apply to all commercial and financial transactions, including the sale of goods, the transfer (via sale, leasing/licensing or otherwise) of tangible, intangible or financial assets, the provision of services, financing transactions (e.g., interest rate on loans, cash deposits or advances, guarantees), business restructuring, etc. 1.6 Time limits for assessment Article L 169 of the French Tax Procedure Code (FTPC) allows the FTA to adjust the profits of a given fiscal year until the end of the third fiscal year following the one for which the tax was due. Article L 187 provides for an additional two-year period (i.e., up to a total of five years) where fraudulent acts are discovered and a complaint has been filed. Article L 188A of the FTPC provides for an extended statutory period where the FTA has requested information from the competent authority of another country, e.g., in order to obtain any information relating to a taxpayer3 ; in such cases, the standard statutory limitation period may be extended until the end of the year following the one during which a response is received from the foreign competent authority, and at the latest until the end of the third 3 The scope of Article L. 188 A of the FTPC was extended by the law on tax evasion and serious economic and financial crime entered into force on 8 December 2013. 122 Baker & McKenzie year following the one during which the initial limitation period expired.4 1.7 Attribution of profit to a permanent establishment (PE) France has a territorial tax system. The rules governing the territoriality of corporate income tax are set forth in Article 209-1 of the FTC, which provides that the following can be subject to corporate income tax in France: i) the profits earned by enterprises exploiting 4 These provisions, modified by the law on tax evasion and serious economic and financial crime, which entered into force on 8 December 2013, apply to requests for information made after that date. Example: Under the standard limits, FY2012 can be re-assessed until 31 December 2015 (assuming there is no loss carry forward). In case a request for information is sent by the FTA to a foreign competent authority in December 2015, then FY2012 can be reassessed: • until 31 December 2016, if the foreign competent authority’s answer is received before 31 December 2015; • until 31 December 2017, if the foreign competent authority’s answer is received between 1 January and 31 December 2016; or • until 31 December 2018, if there is no foreign competent authority’s answer or this one is received after 31 December 2016. In addition, the FTA may audit the origin of and reassess tax losses which are carried over to a year that is still open to tax examination. Transfer Pricing Handbook – France Baker & McKenzie 123 their activity in France; ii) French source real estate income and profits; and iii) profits for which a double tax treaty allocates the right of taxation to France. In the absence of a tax treaty, French domestic law does not provide for clear rules concerning the allocation of profits to a French PE of a foreign enterprise. The FTA guidelines indicate that where an enterprise carries out activities both in France and abroad, it is, in principle, necessary to allocate its global income on the basis of its accounting.5 Where it is not possible to segregate the revenues and expenses related to the operations in France and the operations outside France, respectively, it can be envisaged to use either: • an apportionment method, consisting in an apportionment of the total profits of the enterprise (or of certain items such as overhead expenses), using an allocation key, generally the ratio of sales made in France/outside France; or • a comparison method, consisting of comparing the PE with a distinct and similar enterprise carrying out its activity in similar circumstances and engaged in a similar economic process. Where a tax treaty is in force between France and the residence country of the company, the provisions of the relevant treaty supersede domestic law. The FTA guidelines6 note that the central directive for the attribution of profits to a PE is intended to be the principle of tax independence of the PE. Under this principle, the profits of the PE must be determined as if the PE was a separate and independent enterprise. The profits to be attributed to a PE are those which it would have made if, instead of dealing with the rest of the enterprise, it had been dealing with an entirely separate enterprise under conditions and at prices prevailing in the ordinary market. In line with the pre-2010 Commentary on 5 BOI-IS-CHAMP-60-10-40 n°230 and following. 6 BOI-INT-DG-20-20-10. 124 Baker & McKenzie Article 7 of the OECD Model, the FTA guidelines indicate that, because the branch and the head office are part of the same legal entity, notional royalties and interest payments by a French branch to its foreign head office are not tax-deductible. PE assertion audits are becoming increasingly frequent in France, especially in the Internet and high technology industry. France has expressed views in favor of recognizing a virtual permanent establishment in the Internet area. Commissionaire arrangements are also often challenged despite taxpayer favorable case law from the Supreme Court (Conseil d’Etat).7 1.8 Advance pricing agreements (APAs) See Section 7. 2. Transfer Pricing Methods 2.1 General acceptance of OECD guidance The OECD Transfer Pricing Guidelines are soft law and are not directly binding under French law. However, the FTA generally follows the OECD guidance. In particular, the five OECD-recognized transfer pricing methods are accepted and used by the FTA. The FTA increasingly refers to the OECD Transfer Pricing Guidelines in its published doctrine as well as in tax audits.8 2.2 Selection of methods There is no specific French guidance concerning the selection of the most appropriate transfer pricing method to the circumstances of the case. Generally, traditional methods (and in particular the comparable uncontrolled price method) are preferred, although there is no definitive rule in this respect. 7 CE 31 mars 2010, n° 304715, Sté Zimmer Limited. 8 See in particular BOI-BIC-BASE-80-10-20. Transfer Pricing Handbook – France Baker & McKenzie 125 In an ABB France case,9 the FTA rejected the transfer pricing method and the comparables selected by the taxpayer and substituted to them a profit margin split method, which resembled the profit split method, based on a functional analysis, which led it to consider that the French entity performed most of the functions and bore most of the risks within the group. The Lyon Administrative Appeal Court cancelled the reassessment on the basis that the FTA had not justified the use of a method different from the one used by the taxpayer, and had not supported the application of its alternative method with appropriate comparables. In a Novartis case,10 the FTA regarded as excessive the price paid by a French company to its Swiss parent for an active ingredient, which was used by the French company to manufacture finished products. The FTA relied on the fact that the resulting allocation of the combined profit margin of the two companies was disproportionate to the costs incurred by each of them. The Administrative Appeal Court of Paris did not support the FTA, noting that it had failed to compare the transfer price paid by the French entity with the price paid for comparable products sold by similar enterprises and that it had not produced any analysis concerning the nature of the product or its production and commercialization conditions, which would support an allocation based on relative costs incurred. In the Man Camions et Bus case,11 the Administrative Appeal Court of Versailles rejected the reassessment made by the FTA because it was based on European “comparables,” without demonstrating that the markets where they operated were comparable to the French market in which the taxpayer operated while the taxpayer argued that the markets were not comparable, and without producing a functional analysis for the proposed “comparables.” 9 CAA Lyon, 5e ch., 30 September 2010, n° 09LY00303, SAS ABB France. 10 CAA Paris, 2e ch., 25 June 2008, n° 06PA02841. 11 CAA Versailles, 3e ch., 5 May 2009, n° 08VE02411. 126 Baker & McKenzie In Nestlé Entreprises, 12 the Administrative Appeal Court of Versailles upheld the reassessment made by the FTA concerning the price at which mineral water bottles were sold by the French entity to its affiliated Japanese distributor. The FTA noted that the transfer price led the Japanese distributor to earn a 33 percent net profit margin while the other affiliated distributors were attributed a 6 percent net profit margin. The taxpayer argued that the 33 percent net profit margin was a temporary situation and that the FTA did not establish why it would not be at arm’s length. The FTA produced comparables to support an arm’s length range between 7.5 percent and 9.5 percent, which was adjusted up to 19 percent to take into account additional functions performed by the Japanese distributor as well as the higher resale price of the water bottles in the Japanese market. The court regarded the FTA analysis as valid. In Société Unilever France Holdings, 13 the question was the acceptability of a cost plus determination based on standard manufacturing costs, which were lower than the actual manufacturing costs of the French plant. The Administrative Appeal Court of Versailles considered that the FTA could not adjust the price of the manufactured products without taking into account market conditions. In the case at hand, the use of standard rather than actual costs was not regarded by the court as an abnormal decision of management for the French manufacturer, as it enabled it to cover its fixed costs pending better plant efficiency. In Nestlé Entreprises, 14 the Administrative Appeal Court of Versailles ruled that the fact that the association by the company Aquarel Europe of the brand “Nestlé” with the brand “Aquarel” did not procure any benefit to the company, due to the costs of the necessary investments and low sales, was insufficient to demonstrate the lack of use value of the “Nestlé” brand in a market penetration phase. Thus, the court considered that the lack of profitability of the exploitation of a brand 12 CAA Versailles, 1e ch., 27 March 2012, n°10VE01171. 13 CAA Versailles, 16 May 2013, n°11VE03123. 14 CAA Versailles, 18 February 2014, n°11VE03460 (definitive decision). Transfer Pricing Handbook – France Baker & McKenzie 127 does not necessarily lead to the conclusion that it lacks use value and invalidated the FTA’s reassessments. 2.3 Transfer pricing adjustments There is neither specific guidance in the French legislation nor administrative guidelines related to year-end or post-year-end transfer pricing adjustments. Based on discussions at the EU Joint Transfer Pricing Forum, such adjustments are allowed by the FTA provided that they comply with the arm’s length principle and that the transfer price used for tax purposes is in line with the price effectively applied for the considered transaction between associated enterprises.15 The adjustment should be related to a flow of products or services and should be materialized by invoices. In practice, it is recommended that the adjustments be supported by pre-existing contractual provisions. In addition, the adjustment should ideally be finalized before the closing of the statutory books and filing of the tax returns. For secondary adjustments, see Section 6.3. 2.4 Working capital/inventory There is neither specific guidance in the French legislation nor administrative guidelines related to comparability adjustments. However, comparability adjustments including working capital adjustments are generally well accepted by the FTA in practice to the extent that they improve comparability. 2.5 Business restructurings The FTA carefully reviews the tax and transfer pricing consequences of business restructurings in tax audits, questioning notably whether the French restructured entity should be indemnified for a transfer of intangible assets, for termination of existing contractual relationships, and/or for loss of “profit potential,” or in order to cover restructuring 15 EU Joint TP Forum, member states’ responses to questionnaire on compensating adjustments or year-end adjustments, meeting of 26 October 2011. 128 Baker & McKenzie costs incurred in France. In this context, the FTA is increasingly focusing its attention on the identification and remuneration of transfers of intangibles, going concerns or clientele. The FTA guidelines provide for a definition of going concern that is in line with French legal principles: a universality of tangible and intangible rights and values used for the operation of a business, amongst which the main element is a clientele.16 From a tax standpoint, the Supreme Administrative Court has ruled in a Bosc Développement Loire case that the notion of going concern corresponds to an activity exercised autonomously, at the risk of the enterprise and through the use of proper means.17 The clientele is also defined as the potential or probable relationships with persons who may purchase products or services.18 In a Nestlé Finance International case,19 the Administrative Appeal Court of Paris examined the claim by the FTA that the intragroup transfer by the French company Nestlé Finance France to its Swiss related company Nestlé Treasury Center Europe of its cash pooling activity without remuneration constituted an “indirect transfer of profits abroad,” to be reassessed under French transfer pricing rules. The Administrative Appeal Court of Paris ruled against the FTA. However, it did not address the question whether there was a taxable transfer of activity that should have been compensated at arm’s length, but simply invalidated the assessment proposed by the FTA on the grounds that the comparability analysis performed by the FTA was not reliable. In a Microsoft France case,20 a French enterprise acting as a distributor was converted into a commercial agent of an Irish related entity, compensated with commission fees calculated as a percentage 16 BOI-ENR-DMTOM-10-10-10 n°1 and following. 17 CE 17 February 2010 n° 31-1953 Eurl Bosc Développement Loire. 18 BOI-ENR-DMTOM-10-10-10 n°10. 19 CAA Paris, 5 February 2013, n°11PA02914. 20 CAA Versailles, 16 February 2012, n°10VE00752. Transfer Pricing Handbook – France Baker & McKenzie 129 of sales (25 percent) or a reimbursement of its costs plus 5 percent, whichever was higher. The 25 percent rate was replaced with a decreasing rate and reduced after a period of five years (but the cost plus 5 percent guaranteed remuneration remained unchanged). The FTA challenged this decrease in the French agent’s commission rate. The Administrative Court of Versailles cancelled the reassessment, ruling that a mere decrease in the commission rate did not justify a reassessment. The court also rejected the comparables that were proposed by the FTA because they related to companies that assumed significantly greater risks than Microsoft France. In a SA SOPEBSA case,21 it was considered that the conversion of a distributor into a commissionaire did not entail a transfer of clientele. 2.6 Safe harbors France does not have any published safe harbors for transfer pricing purposes. For intercompany low-value services, the EU Joint Transfer Pricing Forum has published guidelines that include a reference to mark-ups usually applied for routine services (3 percent to 10 percent, often 5 percent).22 In practice, such mark-up rates are often accepted for low value-added services, although they have not been officially recognized as providing a safe harbor and should be applied only after careful review of the nature of the services. 21 CE 9 April 2014, n° 366493 and CAA Versailles 12 June 2014, n° 11VE00643. 22 Communication 2011/16 from the Commission on the work of the JTPF from April 2009 to June 2010 including proposed guidelines on low-valueadding intragroup services. 130 Baker & McKenzie 3. Transfer Pricing Documentation and Filing Requirements 3.1 Documentation obligations French transfer pricing documentation requirements result from the combination of the provisions of Articles L 13AA, L 13 AB, L 13B of the FTPC and Article 223 quinquies B as explained below. 3.1.1. Requirement for large enterprises (enterprises falling within the scope of Article L 13 AA of the FTPC) 3.1.1.1. Requirement to maintain a complete transfer pricing documentation The provisions of Article L 13 AA of the FTPC apply to legal entities established in France that meet any of the following thresholds: a) Annual sales revenue or total gross assets on the balance sheet equal to or higher than EUR400 million b) Ownership at the end of the fiscal year, directly or indirectly, of more than 50 percent of the capital or voting rights of a legal entity – legal person, organization, trust or comparable institution, whether established or constituted in France or outside France – which meets one of the conditions set forth under paragraph a c) More than 50 percent ownership of the capital or voting rights at the end of the fiscal year, directly or indirectly, by a legal entity meeting one of the conditions set forth under paragraph a d) Benefitting from the French worldwide tax consolidation regime; in such cases, all the enterprises taxable in France that are included in the consolidation scope23 23 This regime, subject to a ruling procedure, ceased to apply for fiscal years closed as from 6 September 2011. Transfer Pricing Handbook – France Baker & McKenzie 131 e) Membership to a French tax consolidated group where such tax consolidated group includes at least one legal person meeting one of the conditions set forth under paragraph a, b, c or d Enterprises that meet one of the above-listed criteria should keep at the disposal of the FTA documentation to justify the transfer pricing policy applied for transactions of any nature carried out with foreign associated enterprises. The outline of the transfer pricing documentation required under Article L 13 AA is very similar to the EU model.24 Specifically, the French documentation report should include the items listed in Section 3.1.1.3. When the documentation has not been established or when it is incomplete, the tax authorities send a formal notice to provide or complete the documentation within 30 days (tax authorities may grant, upon the taxpayer’s request, an additional period to answer, which cannot exceed two months). 3.1.1.2. Requirement to file a transfer pricing disclosure form In addition to the obligation to maintain a complete transfer pricing documentation, Article 45 of the law on tax evasion and serious economic and financial crime25 (new Article 223 quinquies B of the FTC) created an obligation for large enterprises (enterprises falling within the scope of Article L 13 AA of the FTPC; see Section 3.1.1.) to file every year a transfer pricing disclosure form within six months of the due date for filing the income tax return (the latter being generally three months after the close of the fiscal year; see Section 3.7). French administrative guidelines admit however that companies within the scope of Article L 13 AA are not required to file a transfer pricing disclosure form if they do not have any transaction with foreign associated enterprises. 24 Code of Conduct on Transfer Pricing Documentation for Associated Enterprises in the European Union (COM [2005] 543–1). 25 Entered into force on 8 December 2013. 132 Baker & McKenzie The disclosure form consists of a table to be filled in, with very limited write up. Only cross-border transactions whose aggregated amount by type of transactions exceeds EUR100,000 should be reported in the transfer pricing disclosure form. Information to be provided includes items listed in Section 3.1.1.3. There is no requirement to provide benchmarks in this transfer pricing disclosure form. The objective is to allow the French tax administration to do a better risk assessment before the audit starts. 3.1.1.3. Summary of the list of information to be provided under the requirements set out in Article L. 13 AA of the FTPC and Article 223 quinquies B of the FTC Documents TP documentation (Art. L 13 AA of FTPC) TP disclosure form (Art. 223 quinquies B of FTC) 1° General information on the group of associated enterprises A general description of the activity of the group, including the changes that took place during the year under examination A general description of the legal and operational structures of the group, including the identification of the associated enterprises involved in controlled transactions with the French taxpayer X A general description of the functions performed and risks assumed by the associated enterprises, insofar as they affect the enterprise under examination X A list of the main intangible assets owned, in particular patents, trademarks, trade names and know- (Only the nature of the main intangibles, Transfer Pricing Handbook – France Baker & McKenzie 133 Documents TP documentation (Art. L 13 AA of FTPC) TP disclosure form (Art. 223 quinquies B of FTC) how, in relation to the enterprise under examination not a detailed list) A general description of the transfer pricing policy of the group + Changes that took place during the FY 2° Specific information on the enterprise under examination A description of the activity of the enterprise, including the changes that took place during the year under examination A description of the transactions carried out with associated enterprises, in particular royalties, with their nature and amounts List and amount of transactions if their aggregated amount by nature exceeds EUR100,000 A list of cost contribution arrangements and a copy of Advance Pricing Arrangements, and transfer pricing rulings that affect the results of the audited enterprise X A presentation of the selected transfer pricing method(s) complying with the arm’s length principle […] Indicate the main selected method and the changes that took place during the year. […] including an analysis of the functions performed, assets used and risks assumed as well as an X 134 Baker & McKenzie Documents TP documentation (Art. L 13 AA of FTPC) TP disclosure form (Art. 223 quinquies B of FTC) explanation of the selection and application of the selected transfer pricing method(s) If required under the selected method, an analysis of comparable data that the enterprise considered to be relevant X 3° Decisions of the tax administrations26 All decisions of the same nature as interpretations, guidelines and circulars mentioned in Article L. 80 A of the FTPB given by foreign authorities to any related company X 3.1.2. Enterprises not falling within the scope of Article L 13 AA of the FTPC Article L 13 B of the FTPC applies to enterprises that do not fall within the scope of Article L 13 AA. It provides that if during a tax examination the FTA gathers elements that entail a presumption that an enterprise has transferred profits abroad within the meaning of Article 57 of the FTC, it may request information and documents specifying: 1. the nature of the relationships falling within the scope of Article 57 of the FTC between this enterprise and one or several enterprises exploited outside France or companies or groupings established outside France; 26 Added by Article 98 of the Finance Act for 2014. The exact scope of this obligation is still unclear. Transfer Pricing Handbook – France Baker & McKenzie 135 2. the method applied to determine the pricing of industrial, commercial or financial transactions, which it carries out with the enterprises, companies or groupings mentioned under item 1 and supporting elements as well as the counterparts granted, if any; 3. the activities performed by the enterprises, companies or groupings referred to under item 1 in connection to transactions mentioned under item 2; and 4. the tax regime of the transactions mentioned under item 2 and carried out by enterprises exploited abroad, or companies or groupings mentioned under item 1 in which it owns, directly or indirectly, the majority of the capital or of the voting rights. Requests by the FTA should be precise, and explicitly indicate, for each activity or product, the country or territory concerned, the enterprise, the company or the grouping concerned, as well as, where applicable, the amounts at stake. They should, in addition, specify to the enterprise under examination the deadline by which it has to respond. This deadline, which cannot be shorter than two months, may be extended upon substantiated request, without exceeding a total duration of three months. If the enterprise responds with incomplete documentation, the FTA will send a formal notice to complete the documentation within 30 days, specifying the additional information still to be submitted. This formal notice must indicate the applicable penalties in case of failure to respond. 3.1.3. Provision of analytical accounting Article 99 of the Finance Act for 2014 created a new obligation for large companies (not the same definition as under Article L 13 AA of the FTPC) that maintain cost accounting and/or prepare consolidated accounts to provide them to the French tax authorities in the course of tax audits. It is applicable for tax audit notices sent as from 1 January 2014. 136 Baker & McKenzie 3.1.4. Country-by-country reporting The law on separation and regulation of banking activities27 created the obligation, applicable to credit institutions, financial companies, mixed financial holding companies and investment firms, to publish the following in the appendices to the annual accounts or at the latest six months after the end of the financial year for each state or territory (aggregated data, except for 1°): 1. Name of establishments and type of activity 2. Net banking income and turnover 3. Headcounts in full-time equivalent 4. Pre-tax profit or loss 5. Corporate income taxes due by the establishments 6. Public subsidies received As regards information 1° to 3°, the first publication concerning 2013 had to be made in 2014. For information 4° to 6°, the first publication will be in 2015, which concerns 2014. Large nonfinancial companies (specific thresholds to be established by decree) will also in the future have to publish country-by-country information. However, the entry into force of that general obligation outside the financial sector is suspended until the adoption of a similar measure by the EU. 3.1.5. Transactions with NCSTs When transactions of any nature are carried out with one or several associated enterprises established or constituted in an NCST (see Section 1.3), the documentation required under Article L 13AA 27 Dated on 26 July 2013. Transfer Pricing Handbook – France Baker & McKenzie 137 should also include all the documents that are required from companies subject to French corporate income tax, including the balance sheet and P&L accounts of the NCST entity determined in accordance with French tax rules. 3.2 Penalties For taxpayers falling within the scope of Article L 13 AA of the FTPC, the following are penalties for failure to comply with the obligation to file: • A complete transfer pricing documentation (as explained in Section 3.1.1.1.) will entail the application of a penalty, which cannot be less than EUR10,000, of the greater of the following two amounts, taking into account how serious the failure to respond or incomplete the response is: o 0.5 percent of the amount of the transactions still insufficiently documented after the formal notice o 5 percent of the amount of the transfer pricing reassessments (Art. 1735 ter of the FTC)28 • A transfer pricing disclosure form (as explained in Section 3.1.1.2.) will entail the application of general penalties of EUR150 for late filing and EUR15 per omission or inaccuracy, up to a maximum of EUR10,000 (Art. 1729 B of the FTC). The penalty for noncompliance with the obligation to provide analytical accounting (as explained in Section 3.1.3) is currently limited to EUR1,500. 28 This penalty was modified by the Finance Act for 2015 and applies to audits for which a tax audit notice is sent as of 31 December 2014. For prior tax audits, the penalty could be up to 5% of the profits transferred within the meaning of Article 57 of the FTC. 138 Baker & McKenzie 3.3 Statutory documentation retention requirement The FTPC provides that books, records and related accounts and vouchers must be maintained for a minimum of six years. However, under commercial law, books and records must be maintained for 10 years. 3.4 Language of documentation The FTA may request that documents in a foreign language be translated into French. In practice, however, documentation in English is generally accepted, especially when the audit is performed by the international tax brigade (see Section 4.1). 3.5 Frequency of documentation update In principle, the documentation should be prepared every year. The French administrative guidelines admit that when the conditions of the activity remain unchanged, the comparable analysis could be updated only on a three-year basis but financial data must be updated every year. Any change in the business model should be documented. 3.6 IC transaction/other disclosure filed with tax returns Several statements regarding specific payments and transactions such as commissions, fees, dividends, interest and loans must be filed with the FTA. 3.7 Due date of tax returns Corporate income tax returns (Form no. 2065 and appendices) are to be filed within three months of the year-end. Enterprises closing their fiscal year on 31 December benefit from an extended deadline until the second working day following 1 May. Transfer Pricing Handbook – France Baker & McKenzie 139 4. Tax Audit Procedures 4.1 FTA international tax brigade The head office of the FTA is located in Paris. It has regional and district tax offices located in different centers throughout France. Audits are conducted by the district tax offices. Transfer pricing issues are audited by local tax audit teams or by the Direction des Vérifications Nationales et Internationales (DVNI), which has jurisdiction over companies whose turnover exceeds EUR152.4 million (goods) or EUR76.2 million (services), or any company that belongs to a group in which one company exceeds one of those thresholds. The DVNI has several audit departments, specialized by industry areas. The FTA has an international tax brigade, which assists field inspectors with significant transfer pricing and international tax issues. Also, it is common practice for tax inspectors involved in transfer pricing audits to rely heavily on the assistance of tax inspectors specialized in information systems and electronic data processing to help them understand pricing and intercompany relations through a review of information systems procedures, software and equipment, and data extractions and treatment (for instance, in order to determine the profit margins earned by the audited taxpayer per product, supplier or client). Since 1 January 2014, companies keeping their accounts using computerized systems are required to provide them in a dematerialized form in case of tax audit. 4.2 Selection of companies for an audit Enterprises are audited on a discretionary basis. In practice, large companies are generally audited about once every three years, which corresponds to the standard statute of limitations. The FTA conducts risk assessment analysis and may decide to audit some taxpayers on a more frequent basis. European and other tax assistance and cooperation programs may lead to the sharing of intelligence between tax administrations and may result in joint or coordinated tax audits. 140 Baker & McKenzie 4.3 Tax audit At the beginning of the tax audit, the taxpayer receives a notice stating the scope of the audit and the period to be audited. During the first meeting with the auditor, the terms of the audit are discussed and an audit schedule is established. The preliminary stage of an audit includes fact gathering, verification and enquiries. This stage is followed by an evaluation of the findings and an identification of the issues. At the start of the audit, tax inspectors can ask to be provided with transfer pricing documentation, where applicable, on the basis of Articles L 13 AA and L 13 AB of the FTPC (see Section 3.1). For companies that are not within the scope of the transfer pricing documentation requirements, tax inspectors can use the procedure of Article L 13 B of the FTPC, provided the FTA has sufficient information to show that a company has indirectly transferred profits within the meaning of Article 57 of the FTC. After discussion meetings and negotiations with the taxpayer, a closing meeting is scheduled during which the tax inspector indicates what reassessments he or she intends to notify, and gives the taxpayer an opportunity to provide additional explanations. In case of tax reassessment, a formal notice is mailed to the taxpayer. There has been an increasing use of search and seizure procedures in France (Article L 16 B of the FTPC) within the context of tax audits of big enterprises, notably in cases where the FTA tries to demonstrate the existence of a taxable PE of a foreign company in France. These procedures have been used in particular against big players in the ecommerce industry. Under Article L 16 B, the FTA can be granted a right of search and seizure for the research of evidence of fraudulent acts with respect to direct taxes or VAT. 4.4 Appeal procedures Several administrative appeals are available to the taxpayer in case of tax reassessment: (i) The chief inspector, a former field inspector who has taken responsibility over a brigade – He or she has generally Transfer Pricing Handbook – France Baker & McKenzie 141 monitored the tax audit operations and provided support to the field inspector. (ii) The departmental chief (Interlocuteur départemental), who has responsibility for all the brigades in a given area – He or she is generally the person entitled to make settlement proposals to solve the cases. (iii) The tax committee (Commission départementale/ nationale des impôts directs et des taxes sur le chiffre d’affaires), which is only consultative (i.e., its opinions do not have binding power on the tax audit team), and which is composed of three representatives of the taxpayer: one person from the chamber of commerce, one representative from a professional organization and one certified public accountant; and three representatives of the tax authorities, and is chaired by a professional administrative judge – Even if the opinions of the committee are not binding on either party, a positive opinion can constitute a strong argument before the courts if litigation is initiated. If a hearing before the tax committee is requested, the collection of the adjusted amount of tax is postponed until the decision of the tax committee has been delivered. 4.5 Burden of proof The burden of proof depends on the nature of the dispute and on the reassessment procedure. As a general principle, the FTA bears the burden of proof when it intends to reassess the tax liability of a taxpayer. On the other hand, the taxpayer must prove that he or she has complied with its legal filing obligations and that book entries are accurate. In some specific cases, the burden of proof may be reversed to lie on the taxpayer. In transfer pricing matters, case law has established that the FTA must prove that there has been an indirect transfer of profits and that the 142 Baker & McKenzie transfer was “abnormal.” In a Cap Gemini case of 2005,29 the French Administrative Supreme Court considered that the FTA had not proven a transfer of profits abroad since it had not compared the taxpayer’s controlled transaction with unrelated party transactions. The mere reference to a difference in the conditions between French and non-French subsidiaries was not considered sufficient. In the above quoted Sté Man Camion et Bus case, an Administrative Appeal Court restated the general principles concerning the burden of proof and stated that the existence of multiple year losses was not sufficient to demonstrate that profits had been transferred.30 The principle of the allocation of the burden of proof between the FTA and the taxpayer was restated by the Paris Administrative Appeal Court in the Sté Eduard Kettner case31 and by the Versailles Administrative Appeal Court in the abovementioned Microsoft France case; it is up to the FTA to ground the reassessment in specific elements drawn from the French company’s accounting and on relevant comparisons. Conversely, in the abovementioned Nestlé Entreprise case, the court noted that while the burden of proof concerning the existence of an advantage granted to a foreign party rests with the FTA, once the existence of such an advantage has been established by the FTA, in particular based on comparables, it is up to the taxpayer to challenge the presumption of transfer of profits by demonstrating the existence of a sufficient counterpart. 4.6 Recent audit developments and experiences • Loss-making companies, especially when losses are incurred during several years while the group as a whole is profit-making • Situations where a company’s transfer prices are assessed on the basis of a bundled approach encompassing several transactions, 29 CE 7 November 2005, n° 266436. 30 The general principle regarding the burden of proof was recently restated in a Carrefour decision of the Administrative appeal court of Versailles (CAA Versailles, 3e ch., 8 July 2014, n° 11VE01187 - definitive decision). 31 CAA Paris, 29 March 2012, n° 10PA04193. Transfer Pricing Handbook – France Baker & McKenzie 143 if analysis shows that certain transactions, taken on a standalone basis, are loss-making • Compensation paid to commissionaires or limited risk distributors • Foreign companies operating on a remote basis to make sales in the French market; disputes over the existence of a PE in France • Disputes over PE in the case based on whether a French entity has and exercises the power to conclude contracts in the name of a foreign company; allocation of profits to such PEs • Deductibility of management fees charged to French affiliates; disputes concerning the benefits expected or derived by the French entity and the value of the services • Management fees charged by French entities to foreign affiliates; disputes concerning the non-recharged costs (shareholder services) • Business restructurings: o Indemnification (closure of manufacturing facilities, termination of commercial arrangements, etc.) o Identification and remuneration of transfers of business or of intangible property, notably in cases of implementation of foreign principal structures • Financial transactions: interest on loans, interest free advances, guarantees, hybrid instruments Cooperation between the FTA and foreign tax administrations has increased over the past years, with more frequent and more diligently exploited exchanges of information. Similar and simultaneous 144 Baker & McKenzie reassessments have been observed in several subsidiaries of the same groups established in different jurisdictions. 5. Dispute Resolution 5.1 Mutual agreement procedures (MAPs) France has concluded over 120 bilateral tax treaties containing a MAP article. For transfer pricing matters resulting in double taxation, a MAP can also be initiated under the European arbitration convention.32 The opening of both procedures can be requested in parallel. The French competent authorities may refuse to open a MAP in the following cases: • Where the taxpayer does not demonstrate the reality of the double taxation suffered; in effect, the French authorities do not want to create a “double non-taxation” situation. • Where the assessment that creates the double taxation is subject to serious penalties that are not litigated or have been confirmed by the court • Where the taxpayer has self-adjusted the double taxation without going through the bilateral treaty mechanism; for instance, assume Company A is subject to a transfer pricing adjustment in a foreign country with respect to transactions with a French associated enterprise Company B. Assume that Company A charges the amount of the assessment to Company B that deducts it from its taxable result in France in order to eliminate economic double taxation. Assume that such charge is denied by the FTA that regards it as unjustified in the context of an audit of Company A. 32 Convention 90/436/EEC on the elimination of double taxation in connection with the adjustment of profits of associated enterprises signed on 23 July 1990. Transfer Pricing Handbook – France Baker & McKenzie 145 Depending on the applicable bilateral tax treaty, the deadline to request the opening of a MAP ranges from three months to three years of the measure that leads to double taxation. In some bilateral tax treaty, no deadline is specified. In practice, it is generally recommended to request the opening of a MAP soon after the administrative appeals are exhausted (see Section 4.4). MAP procedures that were opened before 31 December 2013 suspended the tax collection until the expiration of a three-month period after the notification to the taxpayer of the position of the competent authorities. This provision was abrogated by the Finance Act for 2014 for MAP procedures opened after 1 January 2014. At the end of 2013, France indicated that it had 618 pending MAP cases and that the average time for completing a MAP case was 30 months33: Year MAP Case was Initiated Operating Inventory on First Day of Reporting Period Initiated During Reporting Period Completed During Reporting Period Ending Inventory on Last Day of Reporting Period Closed or Withdrawn with Double Taxation During Reporting Period Average Cycle Time for Cases Completed, Closed or Withdrawn During Reporting Period (in months) OECD nonOECD OECD nonOECD OECD nonOECD OECD nonOECD OECD nonOECD OECD non-OECD 2006 or prior 23 11 1 0 22 11 0 0 2007 17 4 5 0 12 4 10 0 2008 25 5 5 1 20 4 2 0 2009 51 3 15 0 36 3 0 0 2010 75 3 19 0 56 3 1 0 2011 117 9 33 2 84 7 0 0 2012 173 9 22 1 151 8 0 0 2013 198 18 19 0 179 18 0 0 Total 481 44 198 18 119 4 560 58 4 0 30 33 OECD statistics on MAP, www.oecd.org/ctp/dr. 146 Baker & McKenzie 5.2 Arbitration Under bilateral MAP procedures, the competent authorities are not obliged to reach an agreement. A few tax treaties recently concluded by France include an arbitration clause, consistent with Article 25 (5) of the OECD Model Tax Convention. This is the case, for example, of the 2009 amendment to the tax convention concluded between France and the United States and of the tax convention between France and the United Kingdom. Under the European arbitration convention, the competent authorities have, in theory, a two-year deadline to reach an agreement in MAP. If no agreement is achieved by the end of this period, the competent authorities should, in theory, open an arbitration phase, subject to the taxpayer’s agreement. In such a case, the competent authorities set up an arbitration committee consisting of representatives from the two competent authorities, independent personalities and a chair. The arbitration committee should then give an opinion on the case within six months of the date when it was appointed. The opinion of the arbitration committee must be based on the arm’s length principle. It is not binding on the competent authorities, but if they do not agree on another solution within another six-month period, then the arbitration committee’s opinion prevails. In practice, very few cases have reached the arbitration phase of the European arbitration convention, despite the fact that a significant number of MAP cases are not resolved within the two-year timeframe.34 5.3 Litigation If a case is not settled in administrative appeals, litigation can be initiated as soon as the tax collection notice is received by the taxpayer. A contentious claim should first be filed with the FTA to 34 According to a report by the EU Joint TP Forum dated August 2013 (JTPF/0122013/EN), 157 MAP procedures were pending under the EU arbitration convention as at 31 December 2012. Transfer Pricing Handbook – France Baker & McKenzie 147 request once more the withdrawal of the reassessments (before 31 December of the second year following the one during which the tax collection notice is sent). A suspension of the payment of the reassessments may be granted under certain conditions. It is only upon response by the FTA to such a claim that the case can be brought to court. In this respect, a lack of response from the FTA after a sixmonth period has the same effect as a refusal and allows the action to be initiated with the court. The taxpayer may submit the dispute to the competent Administrative Court within two months from the day the decision of the FTA rejecting the claim was notified. Administrative Court decisions can be further challenged before the competent Administrative Appeal Court, and then the Supreme Administrative Court (Conseil d’Etat). The Supreme Administrative Court decides only about the application of the law and does not consider the facts. 6. Interest and Penalties 6.1 Interest A late interest fee of 0.40 percent per month (4.80 percent per year) is generally due on all late payment of taxes caused by the late filing of tax returns and other assessment documents, underpayments (errors or omissions) and simple late payments. 6.2 Penalties The main tax penalties that may be incurred in addition to late interest are the following: • 40 percent “bad faith” penalty in case of errors or inaccuracies in tax returns resulting from a deliberate failure, increased to 80 percent in case of abuse of law, fraudulent behavior or concealment of price • 10 percent penalty in case of late filing if the late tax return is filed by the taxpayer prior to any notice of the tax authorities or 148 Baker & McKenzie within 30 days after an initial official notice (mise en demeure), increased to 40 percent in case of failure to file within 30 days after the official notice; the penalty may be increased by up to 80 percent in case of concealed activity. 6.3 Secondary adjustments Under French domestic law, transfer pricing adjustments may be regarded as constructive dividends and subject to withholding tax.35 The withholding tax may be reduced by the applicable bilateral tax treaty. The withholding tax may also be eliminated at the taxpayer’s written request in application of a “regularization” procedure,36 if the following criteria are cumulatively met: • The taxpayer’s request is made in writing before the withholding tax collection notice is issued. • In its request, the taxpayer accepts the tax adjustments and related penalties that were categorized as constructive dividends. • The amounts the tax authorities have categorized as constructive dividend are repatriated to the taxpayer, within 60 days following the request. • The beneficiary of the constructive dividend is not located in an NCST. Prior to the implementation of this regularization procedure, the withholding tax could also be eliminated under certain conditions in the case where the adjusted profit was repatriated to France, subject to an agreement with the FTA. 35 Article 111 c of the FTC. 36 New Article L 62 A FTPC created by the Second Amending Finance Act for 2014. This regularization procedure applies as of 31 December 2014. Transfer Pricing Handbook – France Baker & McKenzie 149 7. Advance Pricing Agreement Procedures 7.1 Availability Multinational enterprises can request APAs from the FTA to obtain agreement on the determination of a transfer pricing method over a given period of time for future related party transactions. The FTA has expressed a strong preference for bilateral APAs, especially with the following OECD countries where a similar procedure is available: the United States, the United Kingdom, the Netherlands, Japan, Switzerland, Germany, Spain, Canada and Denmark. The same is true for the following non-OECD countries: Argentina, Brazil and Russia. Bilateral APAs rely on Article 25 (3) of the OECD Model Tax Convention as implemented in the applicable tax treaty. In practice however, almost a third of French APAs are unilateral. Unilateral APAs are especially available in the following cases: • Where there is no available APA program in the other state • Where the relevant business transactions involve a large number of countries (for instance, a French company with a large number of foreign distributors), unless it is possible to request bilateral APAs with the countries where the largest transactions take place • If the transactions relate to a specific problem, which is not complex but gives rise to recurrent disputes, such as invoicing general expenses within a group • When the applicant is a small- or a medium-sized enterprise No unilateral APA is granted for transactions with enterprises situated in countries that do not have a treaty with France and have a privileged tax regime (as defined in Article 238 A of the FTC; see Section 1.2). 150 Baker & McKenzie In an APA, the FTA agrees on the method, not on the price itself. An APA can be requested for all the transactions between a French enterprise and its associated foreign enterprise or dealings between a PE and the rest of the enterprise to which it belongs. It can alternatively be requested for a segment of the enterprise’s activities only, a type of transaction, a function or a product, subject to the FTA agreeing that such a restricted scope is acceptable. A simplified APA procedure exists for research and development centers. 7.2 Application process The APA procedure starts with a pre-filing meeting during which the taxpayer and the FTA discuss the potential scope of the application, the documentation requirements and overall timing. The application should be presented in principle at least six months before the first fiscal year in which the APA would become effective; however, upon express request, the FTA can agree for the APA to apply to the fiscal year during which the application has been filed. The FTA then enters into discussions with the taxpayer and the other tax authority. During the course of the application, access to all necessary documents enabling the FTA to understand the proposed transfer pricing policy must be given to the tax authorities. Its outcome is an agreement between two competent authorities (bilateral APA) or between the FTA and the taxpayer (unilateral APA). The taxpayer is informed of the outcome of the procedure and can agree or not to the proposed terms and conditions. In case of acceptance, the agreement is concluded for three to five years, and can be renewed upon request at least six months before the expiration of the initial agreement. Transfer Pricing Handbook – France Baker & McKenzie 151 8. Thin Capitalization and Interest Deduction 8.1 Interest on shareholder loans In general, interest expenses on shareholder loans are tax-deductible only up to the yearly average of variable rates charged by credit or financial institutions on loans to enterprises with an initial maturity of more than two years (this rate is 2.79 percent for fiscal year ending on 31 December 2013), and provided the share capital of the French paying entity has been fully paid up (Article 39, 1-3° of the FTC). For loans granted by an associated enterprise, however, a higher market interest rate can be accepted, determined by reference to the interest rate that the borrowing enterprise could have obtained from independent credit or financial institutions in comparable conditions (Article 212 (I) of the FTC). In addition to these limitations related to the interest rate, French thin capitalization rules limit the tax deductibility of interest paid to associated enterprises (Article 212 (II) of the FTC; see Section 1.2 for the notion of associated enterprises). The provisions under Article 212 are quite complex and their conditions of application should be assessed on a case-by-case basis. Deduction of interest paid to associated enterprises is limited if the three following ratios are cumulatively exceeded for a given year: • Interest is paid to associated enterprises on an amount exceeding 1.5 times the amount of the net equity of the French company (determined at the beginning or at the end of the fiscal year, at the choice of the company). • Interest payments exceed 25 percent of the borrowing enterprise’s adjusted operating profits before tax (i.e., operating income + financial income + interests paid to associated enterprises + depreciation and pro-rata share of leasing rent). • Interest payments to associated enterprises exceed the amount of interest received from associated enterprises. 152 Baker & McKenzie In such a case, the amount of non deductible interest is equal to the difference between the interest paid and the highest of the three abovementioned ratios. This limitation does not apply if the “excess” interest is less than EUR150,000. The non-deductible interest expense may be carried forward under certain conditions. This provision does not apply to interest paid by a cash pooling master, or by banks and financial institutions (the precise conditions should be checked on a case-by-case basis). Interest paid to a third-party lender can, under certain conditions, be subject to the same limitations when the loan is guaranteed by an associated enterprise. Finally, the above limitation may not apply if the company can prove that its own indebtedness ratio is lower than the one of the whole group to which it belongs. 8.2 Limitation of deductibility of financial expenses related to the acquisition of controlling interests (Article 209 IX of the French tax code) For fiscal years opened as from 1 January 2012, financial expenses incurred in connection with the acquisition of participation shares37 are no longer tax-deductible unless the acquiring company can prove that decisions relating to these shares are effectively made by it or by a French company of the same group that exercises control or influence over the acquired company within the meaning of Article L 233-3 of the French Commercial Code. This provision therefore denies the tax deductibility of financial expenses incurred for the acquisition by a French vehicle of participation shares, which are actually and effectively controlled and managed outside of France, while the corresponding dividend proceeds are not taxable in France. Exceptions to this rule exist and should be checked on a case-by-case basis. 37 Shares of real estate companies are not concerned. Transfer Pricing Handbook – France Baker & McKenzie 153 When the acquiring company is part of a tax consolidation group (intégration fiscale) and acquires the shares of another company from a common shareholder, the deductibility of interest at the group level could be affected. 8.3 General limitation of deductibility of financial expenses Companies subject to corporate income tax are required to add back to their taxable income 15 percent of their net financial expenses for financial years closed starting from 31 December 2012, and 25 percent of net financial expenses for financial years beginning on or after 1 January 2014. This limitation only applies when the total amount of net financial expenses exceeds EUR3 million and after application of the other mechanisms limiting deductions of financial expenses. 8.4 Thin capitalization and transfer pricing The FTA considers that only the determination of an arm’s length interest rate is a transfer pricing issue and not the determination of the arm’s length amount of debt. This position has been supported by the Supreme Administrative Court in its Andritz decision,38 whereby the judge considered that the FTA cannot make use of the provisions of Article 57 of the FTC to challenge the decision of a foreign enterprise to finance its French subsidiary by loan rather than by equity. This position is not consistent with the EU Revised Code of Conduct for the effective implementation of the EU Convention on the elimination of double taxation in connection with the adjustment of profits of associated enterprises,39 which states that “The Arbitration Convention makes clear reference to profits arising from commercial and financial relations but does not seek to differentiate between these specific profit types. Therefore, profit adjustments arising from financial relations, including a loan and its terms, and based on the 38 CE 30 December 2003 n° 233894, SA Andritz. 39 Official Journal C 322 , 30 December 2009 P. 0001 - 0010. 154 Baker & McKenzie arm’s length principle are to be considered within the scope of the Arbitration Convention.”40 Even though the FTA does not consider that the determination of an arm’s length amount of debt is a transfer pricing issue, it carefully reviews financing structures and vehicles. Transfer pricing adjustments are observed on interest-free advances, interest-bearing loans and hybrid instruments. 8.5 Limitation of deductibility of interests paid to associated enterprises The Finance Act for 2014 provides for a non-deductibility of the interests paid to an associated enterprise (within the meaning of Article 39-12 of the FTC), which is not subject for these same interests to corporate income tax in an amount at least equal to a quarter of the corporate income tax under French standard law. This measure applies to domestic and cross-border loans for fiscal years closed since 25 September 2013. 40 France did not make any reservations to this statement. Transfer Pricing Handbook – Germany Baker & McKenzie 155 Germany Stephan Schnorberger, Partner Stephan Schnorberger helps business master the tax challenges in running or changing their international supply chain. He devotes his experience in international tax, transfer pricing and business restructuring to solve issues in tax planning, audit defense, APAs and disputes with tax authorities. He also works heavily in valuations and regulatory economics. His industry experience is diverse and includes automotive, pharmaceuticals, telecommunications, software, financial services, and industrial and consumer products. As a Certified Tax Advisor, Stephan is admitted to the German tax bar. He holds a German doctoral and a master’s degree in business administration as well as a US master’s degree in economics. He is a lecturer at the Federal Finance Academy, the German federal education and training institute for tax auditors. [email protected] Tel: +49 211 31 11 6 152 Baker & McKenzie Partnerschaft von Rechtsanwälten, Wirtschaftsprüfern und Steuerberatern mbB Neuer Zollhof 2 40221 Dusseldorf Germany 156 Baker & McKenzie 1. Statutory Rules and Administrative Regulations 1.1 Existence/arm’s length principle In German transfer pricing law, there is a double theme of the arm’s length principle and the concept of the prudent and diligent managing director of an independent enterprise. In general, the classical arm’s length principle must be applied to cases where empirical data to determine arm’s length prices is available (the “factual” arm’s length test). In contrast, the concept of the prudent and diligent managing director is used to obtain an arm’s length transfer price for intercompany transactions where empirical data with appropriate costs cannot be found (the “hypothetical” arm’s length test). German statutory rules on transfer pricing are not found in one integrated section, but in several provisions in different legislative acts of the German Tax Code. Section 1 of the Foreign Tax Act (FTA – Außensteuergesetz or AStG) is practically the most influential provision for transfer pricing adjustments. Section 1 of the FTA is supplemented by legislative regulations (in particular, the so-called Funktionsverlagerungsverordnung or FVerlV) and by administrative regulations (in particular, the Verwaltungsgrundsätze Funktionsverlagerung). Adjustments under this section will be made beyond, and further to, adjustments under other rules, such as constructive dividend principles (Section 8, Paragraph 3 of the Corporate Income Tax Act (CIT – Körperschaftsteuergesetz or KStG). The Federal Ministry of Finance’s position on specific transfer pricing questions is mainly set out in a number of administrative regulations. These do not have the status of an act of parliamentary law and are therefore only binding on the tax administration. They may be challenged by taxpayers or overruled by tax courts. 1.2 Transactions in scope German transfer pricing rules and principles cover all sorts of business transactions concluded between German taxpayers and their related Transfer Pricing Handbook – Germany Baker & McKenzie 157 parties. In a nutshell, all related party transactions not based on the statutes of association between (direct and indirect) shareholder (or partner) and company (or partnership) are covered. In addition, all transactions between headquarters and permanent establishments are covered, whether they are declared as a dealing or not. Examples are intercompany sales (also of investments) and services, loans or guarantees and IP licensing arrangements, as well as the transfer of functions between related parties. The tax administration often believes that, absent legal or contractual obligations, it is authorized to assume taxable transactions. The extent to which this is legal is unclear and in dispute. 1.3 Obligations (documentation, filing) If a German taxpayer enters into a business transaction with a foreign related party, the German taxpayer is obliged to prepare transfer pricing documentation as stipulated in Section 90, Paragraph 3 of the General Tax Act (GTA – Abgabenordnung or AO) and specified in legislative regulations issued by the Federal Ministry of Finance (the so-called Gewinnabgrenzungsaufzeichnungs-Verordnung). Transfer pricing documentation for ordinary business transactions must be submitted within 60 days upon request, usually in the course of an audit. Extraordinary business transactions have to be documented contemporaneously, that is, at the latest, six months after the end of the business year in which the transaction took place, and documentation has to be submitted within 30 days upon request. When a taxpayer realizes or ought to realize that transfer prices are not at arm’s length, he/she is obliged to set this straight in the tax return position. This may imply adjustments of income or corrections on various levels: • When the books of the respective entity are not yet closed, possibly a book adjustment 158 Baker & McKenzie • When the books are closed but the tax returns are not yet filed, an out-of-book adjustment • When the tax return has already been submitted, a filing of corrected tax returns Increasingly, such adjustments/corrections have become a delicate matter as they raise questions of personal responsibility of individuals in charge of taxes. 1.4 Related party definition In principle, there is no specific percentage of shareholding required to qualify as a “related party” under German transfer pricing rules and regulations. Only for specific adjustments does Section 1, Paragraph 2 of the FTA provide for a minimum direct or indirect shareholding of 25 percent. However, if this threshold is not met, transfer pricing adjustments can nevertheless be applied under the principles of constructive dividends or deemed capital contributions, etc. So far, German transfer pricing rules and regulations do apply to transactions between the entity taxable in Germany and its direct or indirect shareholders. The definition of a “related party” under Section 1 of the FTA also includes other parties that are in a position to exert influence on the company or that have an interest in the income generated by the other party, where that interest goes beyond the contractual relationship. 1.5 Statute of limitation for transfer pricing adjustments For transfer pricing adjustments, the general rule of limitation for tax assessments applies. This is for four years starting after the end of the calendar year in which the relevant income was generated (see Section 169, Paragraph 2 No. 2, and Section 170, Paragraph 1 of the GTA). However, the start of the limitation period is deferred in cases where a tax declaration has to be submitted (see Section 170, Paragraph 2 no. 1 of the GTA) as is the case for corporations (refer to Section 31 of the CIT, Section 25 of the Income Tax Act [ITA – Transfer Pricing Handbook – Germany Baker & McKenzie 159 Einkommensteuergesetz or EStG]). In this case, the limitation period starts after the end of the calendar year in which the tax declaration has been submitted, and at the latest three years after the end of the calendar year in which the relevant income was generated. In Germany, taxpayers generally have to file their tax returns five months after the end of each calendar year (i.e., the deadline is 31 May of the following year). If the tax return is prepared by a certified tax consultant, the tax administration generally extends the term to 31 December. Only if the taxpayer can demonstrate significant reasons, the local tax office may – as a matter of exception – extend the deadline even further. As an example, if a tax declaration for 2006 has only been submitted in 2008, the limitation period would expire at midnight of 31 December 2012. German tax authorities usually issue provisional tax assessments to corporate taxpayers, reserving the right to further review (see Section 164 of the GTA – Steuerfestsetzung unter Vorbehalt der Nachprüfung). In this case, tax assessment is open to further modifications until the end of the limitation period, that is, if the tax declaration for 2006 has been submitted in 2008, there could be modifications until 31 December 2012. If the tax authorities then start a tax field audit before the normal end of the limitation period, the running of the limitation period is further suspended (see Section 171, Paragraph 4 of the GTA). 1.6 Relationship to permanent establishment’s allocation of profits provisions In October 2014, the Federal Ministry of Finance published the legislative regulation for determining the profits of PEs using the arm’s length standard. The legislative regulation is intended to implement the statutory provision on the “authorized OECD approach” (see Section 1 of the International Transactions Tax Act). It provides in detail how taxpayers should allocate and document functions, assets, risks, opportunities and unspecified advantages. The legislative regulation leads to drastic changes in the taxation of PEs. 160 Baker & McKenzie Businesses will be charged with extensive documentation obligations, which also apply for undeclared PEs. The risks from unintended profit realizations and undeclared permanent or agency establishments are likely to increase. The legislative regulation is applicable for fiscal years starting from 1 January 2015. 1.7 Advance pricing agreements (APAs) and other ruling procedures Bilateral or multilateral APA procedures are available in Germany, based on double tax treaty rules on mutual agreement procedures (MAPs). The national tax provision governing APAs is Section 178a of the GTA. With regard to unilateral rulings on transfer pricing-related questions, the German tax administration follows the policy that such rulings will only be granted if no double taxation agreement is in place. 2. Transfer Pricing Methods 2.1 General acceptance of OECD guidance Neither the German tax administration nor the German tax courts are legally bound by the OECD commentary on the Model Convention or by the OECD Transfer Pricing Guidelines. However, OECD guidance constitutes a relevant source of interpretation that can be used to determine arm’s length prices. In fact, taxpayers can sometimes use OECD text as a moral and professional authority, putting a certain pressure on tax authorities. However, in recent years, tax authorities have turned the role of OECD text around by using it to support aggressive legislation and enforcement of such. 2.2 Acceptability and hierarchy of methods, best method rules In the past, German transfer pricing rules were mainly governed by non-statutory interpretations of the arm’s length principle, as outlined by the German tax courts in case law. Since 2008, the German legislator has introduced into statute detailed guidance on the Transfer Pricing Handbook – Germany Baker & McKenzie 161 application of the arm’s length principle and the concept of the prudent and diligent managing director of an independent enterprise. Section 1, Paragraph 3 of the FTA provides for the statutory priority of the comparable uncontrolled price (CUP), as well as of the resale minus and cost plus methods (the so-called standard methods) in determining transfer prices. If – possibly after adjustments – the values obtained are fully comparable with the tested transaction prices, the full range of such arm’s length values can be used. If such fully comparable arm’s length values cannot be determined, the use of a suitable transfer pricing method must be based on partly comparable values after appropriate adjustments. If the values obtained are only partly comparable, the range must be narrowed. To narrow the range, based on current administrative guidelines, appropriate methods or the interquartile range may be used. If the actual transfer price is outside of the full or narrowed range, adjustments are made to the median of the range. As outlined, methods other than the traditional transactional priority methods (e.g., TNMM or Residual Profit Split method), may be used in order to determine partly comparable arm’s length values. According to administrative regulations, the TNMM can only be accepted if the transaction in question qualifies as a limited risk “routine” transaction (e.g., low-risk service provider). In practice, however, German tax authorities will often accept transfer prices determined using the TNMM (e.g., when the TNMM is used to determine arm’s length compensation for a German distribution subsidiary). Transfer pricing methods that are based on global profit apportionment, such as the CPM, are not accepted in Germany. If neither fully nor partly comparable arm’s length values can be found, the taxpayer must apply a hypothetical arm’s length range. The range is derived from the maximum price acceptable for the payer (buyer) and the minimum price to be charged by the payee (seller). 162 Baker & McKenzie The potential profits reasonably expected by the payer indicate the maximum price, while the potential profits reasonably expected by the seller yield the minimum price. Once a range between maximum and minimum prices has been established, the price that is most likely to be at arm’s length should be applied. The default value within the range is the midpoint value between maximum and minimum prices. The determination of profit potentials and of maximum and minimum prices must be made under the assumption that both parties have full and complete information, as well as knowledge as to the other party’s situation. In the case of a hypothetical arm’s length analysis, an adjustment “may” be waived even if the actual transfer price is not the most likely arm’s length value nor the midpoint value of the deal range. It may be waived if the actual price is within the “correct” arm’s length deal range. There are doubts, however, on the constitutionality of some of these rules. The German legislator has also introduced special rules for determining a hypothetical arm’s length price for the transfer of functions (business restructurings in OECD terminology) that is popularly called “exit tax.” According to these rules, if no empirical arm’s length values for the function transferred (in particular, CUPs) can be identified, the hypothetical arm’s length transfer price has to be determined based on the value of the function as a whole “transfer package.” The transfer package consists not only of the single asset(s) associated with the production and the sales or service function transferred, but also includes business opportunities, risks and potential location savings, as well as synergy effects. 2.3 Relevant level of knowledge and timing (e.g., knowledge at the time the transaction takes place or objective facts that came to the knowledge of the parties at a later stage) Section 1 of the FTA provides that the parties to the transaction are assumed to have complete knowledge of all the facts and circumstances of the case. The legislative materials relating to the new Section 1 of the FTA state that the provision is intended to ensure that not only the German Transfer Pricing Handbook – Germany Baker & McKenzie 163 party’s position is taken into account when determining a hypothetical arm’s length price, but that also the position of the prudent and diligent business manager of the foreign party is taken into account. There is the risk that German tax authorities will try to impose their hypothetical views on arm’s length behavior over empirical and objective data. 2.4 Acceptability of year-end adjustments and retroactive adjustments Until 11 October 2012, there was a longstanding line of case law in the German Federal Tax Court, according to which business transactions between a corporation and its majority shareholder had to be based on clear, precise agreements, which are legally valid and concluded in advance. If these conditions were not met, the full consideration – not only the amount that was excessive from an arm’s length perspective – was taxed as constructive dividend. In a landmark decision dated 11 October 2012, the Federal Central Tax Court dropped this jurisdiction for cases where an applicable tax treaty’s profit adjustment clause also covers a related company’s capitalization. While individual tax treaties have to be analyzed, this change of jurisdiction should preclude formality-based profit adjustments in many cases. In their administrative regulations, the Federal Ministry of Finance has taken the position that year-end adjustments are, in principle, only acceptable if they are linked to uncertain external price components, like interest rates or the development of price indices for raw materials. The regulations explicitly state that year-end adjustments based on target operating profits would not be acceptable. In practice, however, German tax authorities have been successfully persuaded to accept specific non-arbitrary year-end adjustments. Based on recent information, we expect a more restrictive acceptance of year-end transfer pricing adjustments. 164 Baker & McKenzie 2.5 Calculation of comparability adjustments (e.g., working capital/inventory) According to Section 1 of the FTA, appropriate adjustments must be performed when using imperfect comparables if the adjustments increase the comparability in view of the functions exercised, assets used, and opportunities and risks taken. In line with the legislative regulation, any such adjustments must be documented. The administrative regulation further notes that transfer prices may be adjusted if the taxpayer does not use possible adjustments on partially comparable third-party data. That being said, there are no precise rules on the calculation of comparability adjustments (e.g., to ascertain levels of working capital/inventory or on the type of interest rate to use). In general, adjustments are stated to be acceptable and may be required if and to the extent they increase the comparability of the arm’s length values with the tested margins or prices. 2.6 Commensurate-with-income rules and regulations Section 1 of the FTA contains a German variant of the US commensurate-with-income standard. The rule applies to transfers of functions or business restructurings and to regular/other intercompany transactions if they include transfers or uses of major intangible assets. An upward commensurate-with-income adjustment is made if the actual timeline of profits departs significantly from the timeline of profits anticipated at the time of the transaction. If within 10 years after the transaction a significant deviation of profits occurs, the law provides for a one-time adjustment of the initial transfer price. The adjustment is made for the year subsequent to the deviation. A taxpayer can refute an adjustment by showing that unrelated parties would not have agreed on such an adjustment. According to the administrative regulations, a deviation is treated as “significant” if the arm’s length transfer price calculated using the actual timeline of profits falls outside the arm’s length range Transfer Pricing Handbook – Germany Baker & McKenzie 165 calculated using the anticipated timeline of profits. The legislative regulations also permit a downward income adjustment to the benefit of the taxpayer. The commensurate-with-income rules shall not be applicable if the parties agree on a profit- or revenue-based license fee (see Section 9 of the legislative regulation). 2.7 Safe havens and rules of thumb In line with international standards, taxpayers in Germany cannot rely on any transfer pricing safe havens stipulated in German tax law. Arm’s length transfer prices have to be determined on a case-by-case basis, taking into account all facts and circumstances of the respective case. In practice, there are certain rules of thumb that may possibly be applied by taxpayers and tax auditors to cross-check transfer prices: • Even though it has been dismissed many times by academic commentators, there is still a rule of thumb that is applied in practice, which is called the “Knoppe-Formula” and which has parallels with the rule of thumb put forward by the US Licensing Executives Society. The Knoppe-Formula provides that the royalty should not exceed 33 percent but not be below 25 percent of the incremental licensee operating profit from using the licensed IP. The Knoppe-Formula has been formulated for technical intangibles, but has, at times, also been applied to marketing intangibles. As expectations for demonstrated comparability of stated arm’s length prices increase, exclusive reliance on the Knoppe-Formula can be expected to become a more challenging position. • According to the administrative regulations on the attribution of profits between headquarters and PEs, a profit markup of 5-10 percent on costs for services rendered by the PE should be acceptable from an arm’s length perspective. In practice, this rough guideline is also applied by tax auditors on intercompany 166 Baker & McKenzie dealings, that is, putting additional pressure on taxpayers to justify markups that fall outside of this range. These rules of thumb should only be applied after a careful analysis of the case at hand and only in exceptional cases will it practically be enough, for the purposes of German transfer pricing documentation standards, to simply refer to them. 3. Transfer Pricing Documentation and Filing Requirements 3.1 Statutory rules and administrative regulations In 2003, the German legislator introduced a statutory obligation to document transfer prices and their arm’s length nature. The statute provides that taxpayers are required to maintain documentation regarding cross-border transactions with related parties. The documentation requirement also covers headquarters-PE dealings. According to Section 6, Paragraph 2 of the legislative regulations, enterprises with no more than EUR5 million annual consideration for intercompany supplies (paid or received) and not more than EUR500,000 annual services consideration (paid or received) are exempted from any obligation to document and are simply required to answer tax audit requests on time (in some cases, orally). In general, the following documentation should be made available upon request: (a) General information on participating interests held, business activities and organizational structure, in the form of a description of: (i) the shareholding relationships between the taxpayer and affiliates with whom the taxpayer maintains business relations directly or via intermediaries at the beginning of the audit period, as well as any changes occurring before the end of the audit period; Transfer Pricing Handbook – Germany Baker & McKenzie 167 (ii) any other circumstances that might substantiate the existence of an affiliation; (iii) the organizational and operating group structure and changes to it, including PEs and partnership interests; and (iv) the taxpayer’s activities (e.g., services, manufacturing/distribution of assets, and research and development). (b) Business relations with affiliates (i) Description of business relations with affiliates, survey of the type and scope of such business relations (such as purchasing, services, loans and other transfers for use, cost sharing), and an overview of the agreements such business relations are based on, as well as changes to such relations (ii) Schedule (listing) of material intangible assets that the taxpayer owns and uses in business relations with affiliates or which are transferred for use (c) Functional and risk analysis (i) Information on the allocation of functions exercised and risks borne between the taxpayer and his affiliates within the scope of business relations and any changes to such functions and risks, as well as information on material assets employed, the agreed contract terms, the business strategies chosen, and on important market and competitive conditions (ii) Description of the value chain and the taxpayer’s contribution to it, relative to the affiliates with whom there are business relations 168 Baker & McKenzie (d) Transfer pricing analysis (i) Description of the transfer pricing method applied (ii) Justification of the appropriateness of the method applied (iii) Documents evidencing the calculations made in the application of the transfer pricing method chosen (iv) Descriptions of comparables or independent comparables’ financials used in the arm’s length analysis, as well as records of adjustments performed Additional records are required in the case of extraordinary business transactions. Specific documentation obligations exist for a number of situations or transactions, cost allocation/cost sharing arrangements, and research and development activities. Most importantly, tax auditors expect detailed information on the reasons for losses incurred and for transfers of functions. The content, scope and level of detail that are required of transfer pricing documentation have not yet been clarified by the tax courts. In particular, it is unclear whether and to what extent the taxpayer has to document the arm’s length nature of the transfer prices. The majority legal view is that maintaining transfer pricing documentation is sufficient in terms of avoiding penalties, even if its scope and contents are much less than are specified in administrative requirements. In our view, it should be possible to rely on documentation that consists of the following items: • Transaction overview covering at least 50 percent of the intercompany transaction volume • Functional and risk analysis • Description of how transfer prices are set, including details regarding their calculation and treatment for accounting Transfer Pricing Handbook – Germany Baker & McKenzie 169 purposes and a reconciliation with the German financial statements (for German GAAP and tax books) • (Some form of) evidence that the taxpayer exerted reasonable efforts to declare adequate and arm’s length transfer prices Note that: • this is significantly less of a documentation burden than is required by tax authorities in the administrative regulations; • the approach requires a case-by-case analysis and has to be modified, especially in case of transfer pricing risks, such as losses; and • this approach has not yet been tested in court, but has been successfully practiced in tax field audits. 3.2 Contemporaneous documentation In principle, transfer pricing documentation does not have to be prepared contemporaneously and only has to be submitted within 60 days upon request of the tax authorities. This term may be extended in exceptional cases. However, contemporaneous documentation is considered to be generally better and stronger evidence. In addition, planning and budget data used for documentation must exist at the time of the transaction (contemporaneously), even though they can be recorded later. In specific instances, that is, for extraordinary business transactions, contemporaneous documentation is required (at the latest, six months after the end of the fiscal year in which the transaction took place). Such documentation has to be submitted within 30 days upon request. According to legislative regulations, extraordinary transactions are, in particular, transfers of functions, the conclusion and amendment of long-term intercompany agreements and the conclusion of cost allocation agreements. 170 Baker & McKenzie 3.3 Deadline to submit documentation to tax authorities Depending on whether the transfer pricing documentation covers ordinary or extraordinary transactions, it has to be submitted within 60 or 30 days upon request by the tax authorities (see Section 3.2). 3.4 Statutory documentation retention requirement Transfer pricing documentation must be retained in accordance with the general retention requirements of Section 147 of the General Tax Act, and the German tax authorities take the view that transfer pricing documentation has to be retained for 10 years (see Section 3.4.3 of AdminRegs 2005). 3.5 Language of documentation Documentation should be prepared in German. Revenue authorities may grant exceptions from this rule if the taxpayer submits a request before the documentation is prepared or, at the latest, immediately following the tax authorities’ request for the documentation. Usually, the essential parts of the documentation have to be submitted in German. 3.6 Frequency of documentation updates There is no general rule on the required frequency of documentation updates, either in the laws or in legislative or administrative regulations, so the general principles apply. In practice, tax auditors should accept that one documentation report and one arm’s length analysis is sufficient for several years, as long as changes in the group structure, the functional and risk profile, as well as transaction volumes and specific economic circumstances for each year under audit are specified in follow-up reports. As regards comparables analyses, a new study will be needed when the determinants of prices or margins change materially. In general, we recommend, as a practical matter, to replace a comparables study with a new one after three years. Transfer Pricing Handbook – Germany Baker & McKenzie 171 3.7 IC transactions/other disclosures filed with tax returns If the taxpayer is aware of a transaction with a related party (German or foreign) that was not conducted at arm’s length, the taxpayer must declare this in his or her tax declaration (constructive dividend or constructive capital contribution, depending on the group structure or adjustment related to Section 1 of the FTA). According to German accounting rules, companies are, in certain circumstances, obliged to disclose business transactions with related parties. 3.8 Due date of tax returns In Germany, corporate taxpayers generally have to file their income tax returns five months after the end of each calendar year (i.e., the deadline is 31 May of the following year). In cases where the tax return is prepared by a certified tax adviser, the local tax office usually extends the deadline to 31 December. Under special conditions, the deadline may be extended to 28 February of the following year. 4. Tax Audit Procedures 4.1 Selection of companies for an audit The German tax authorities do not usually conduct special transfer pricing audits, but examine transfer prices during the normal course of regular tax audits, which are conducted at regular intervals. There are specific administrative regulations regarding the selection of companies for an audit (tax audit regulations – Betriebsprüfungsordnung or BpO). In principle, the more profits or revenue the company generates, the more frequently it will be subject to an audit. Large companies will be audited on an ongoing basis (i.e., each business year) and corresponding tax returns shall be subject to ex-post verification by the tax authorities. As a rule, the audit period for small and mediumsized companies should not exceed three years. Whether they are 172 Baker & McKenzie selected for an audit depends on various criteria: substantial tax reassessments in the past; ongoing losses; low profits or substantial profit deviations; deficiencies in the accounting system; or notices of control issued by other tax offices or foreign tax authorities, indicating that the tax assessment may be wrong. In addition to this, companies may also be selected on a random basis for audit procedures. The profit and revenue thresholds determining whether a company qualifies as large, medium or small are set by the Federal Ministry of Finance for a period of three years. As of 1 January 2013, for example, retail and wholesale companies qualify as “large” if their revenue exceeds EUR7.3 million or their taxable profit exceeds EUR280,000. Manufacturing companies qualify as “large” if their revenue exceeds EUR4.3 million or their taxable profit is higher than EUR250,000. 4.2 Tax audit and appeals procedures When a company has been selected for a tax audit, the tax office issues a tax audit announcement note. The note has to specify the scope of the audit (e.g., corporate income and trade tax, VAT and wage tax audit) as well as the tax periods under review. In addition, the tax auditor will announce when and where the audit will take place. Large companies are usually audited at their premises and should expect to receive the audit note about four weeks prior to the beginning of the audit. Under standard administrative procedures, the taxpayer is informed of the result of the audit in the course of the so-called final audit meeting (Schlussbesprechung, Section 201 of the GTA). The purpose of the meeting is to have a final discussion of the auditors’ findings, and often, to give the auditor and the negotiator a time a place to negotiate. In practice, it is standard procedure that the tax auditor informs the taxpayer of his or her findings and their tax implications on an ongoing basis, and that there are interim meetings with the auditor in which these issues are discussed. Transfer Pricing Handbook – Germany Baker & McKenzie 173 If the audit results in relevant tax adjustments, the tax auditor will prepare a final audit report in writing, in which the findings are summarized and explained. At the taxpayer’s request, the auditor will send the audit report to the taxpayer for his or her review and comments before submitting it to the tax officer in charge of issuing the adjusted tax assessment notes. This allows the taxpayer to comment on the auditor’s findings and to submit his or her comments to the tax office before the adjusted tax assessment notes are issued and additional tax becomes payable. In case of disputes, the tax office representatives may agree to discuss the unsettled issues in a meeting with the taxpayer and the tax auditor, when all the parties can take a fresh look at the unsettled issues. In such meetings, the tax officials may be prepared to accept settlement proposals that are more favorable to the taxpayer than those achievable in the audit. Once post-audit tax assessment notes have been issued, they usually become “final” according to general rules if they are not appealed by the taxpayer within one month after notification (see Section 347, 355 of the GTA). The appeal can be filed with the tax office that originally issued the tax assessment notice, or it can be filed in the form of a leap-frog appeal with the state fiscal court, subject, however, to the consent of the local tax office. If the appeal is not filed as a leap-frog appeal or the local tax office does not consent to such an appeal, the local tax office will decide on the appeal. If the unsettled issues have already been discussed with the representatives of the local tax office without settlement after the tax audit report was issued, it is generally unlikely that the tax office will decide in favor of the taxpayer. If the decision of the tax office is unfavorable, the taxpayer can then file an appeal with the state fiscal court within one month of notification of the decision. The court will investigate the facts and circumstances of the case de novo and apply the law valid at that time. State tax court procedures can take up to several years before a hearing is finally scheduled and the decision of the court is issued. 174 Baker & McKenzie The right to appeal against a decision of a state fiscal court is very limited and is subject to a detailed set of rules. Where the case involves novel legal questions and is therefore of “general interest,” it is more likely that the state fiscal court would grant leave to appeal, or that an appeal would be accepted by the Federal Fiscal Court. Appeals to the Federal Fiscal Court have to be filed within one month after receipt of the decision of the state fiscal court. The Federal Fiscal Court relies upon the facts developed during the state fiscal court proceedings and only reviews questions of law, substantive or procedural in nature. 4.3 Administrative proceedings: duties and rights of the taxpayer in the course of an audit, burden of proof, among others According to general German administrative tax law, German tax authorities have the duty to investigate the facts and circumstances of the case to the detriment as well as in favor of the taxpayer. The taxpayer has the duty to cooperate and to assist the tax auditor by answering the auditor’s questions in written or oral form, and by making relevant information, notes and documents accessible for inspection. In addition, taxpayers obliged to prepare transfer pricing documentation are usually asked to submit this documentation in the course of an audit. In principle, the burden of proof that transfer prices are not at arm’s length is with the tax authorities. However, if the taxpayer does not fulfill his or her duties of cooperating with the tax authorities, or if transfer pricing documentation is essentially unusable, the tax authorities may estimate the taxpayer’s income based on a rebuttable presumption that transfer prices are not at arm’s length. It is then up to the taxpayer to rebut this presumption. 4.4 Resources available to the tax auditors (e.g., secret comparables and databases) German tax authorities keep expanding their resources in the area of transfer pricing, both in terms of manpower/experience, as well as Transfer Pricing Handbook – Germany Baker & McKenzie 175 from an organizational point of view. Many local tax offices and/or federal states now have dedicated audit teams specifically trained in transfer pricing and international tax matters. Recently, tax authorities have started building up teams of valuation experts. These focus aggressively on valuations of intangibles, functions and businesses, among others. Within the course of a tax audit, the local tax auditor may decide to present the transfer pricing case to such an expert who acts as adviser to him or her in this matter. In matters of international importance, the local tax auditor may also consult auditors of the Federal Central Tax Office and ask for a review. On the level of the Federal Central Tax Office, extensive statistical information on international tax matters and transfer prices are collected. This information is confidential and is only available to tax authorities. In a 2001 decision, the German Federal Fiscal Court ruled that the use of secret or anonymous data does not, per se, violate German tax procedures if the data are presented in a way that allows the taxpayer to assess and comment on the data. This restriction effectively eliminates the tax authorities’ ability to rely on secret comparables in tax administrative and tax court proceedings. The German tax authorities have increasingly moved toward using publicly available databases to cross-check benchmark studies presented by the taxpayer or to conduct their own analyses. 4.5 Recent audit developments and experiences (e.g., focus on specific transfer pricing areas) Nowadays, transfer prices are routinely under scrutiny in Germany so tax auditors ask for transfer pricing documentation as a matter of course. Key areas of interest are, in particular, the following: • German distributors/routine-manufacturers reporting low profits or even incurring significant losses • Low-profit entities • Business changes transfers of functions and intangible migrations 176 Baker & McKenzie • Valuations of compensation for such • Royalty charges • Transfer prices in the context of principal structures • Remuneration of non-routine service activities and allocation of synergies, such as in the context of central procurement companies 5. Dispute Resolution 5.1 MAPs: availability, corresponding adjustments, interaction with legal appeals process Germany has a network of more than 90 valid double tax treaties on income, almost all of which contain a MAP article. Germany’s competent authority is the Federal Central Tax Office. The treaty will generally require that the competent authorities endeavor to eliminate double taxation, and this reportedly is achieved in almost all cases. If the transfer pricing adjustment leading to double taxation has been initiated by the German tax authorities, for example, as a result of a transfer pricing audit, then the German taxpayer may also file a protective action at the state fiscal court. Usually, legal proceedings can be suspended until after the conclusion of the MAP. 5.2 Arbitration: possibility and practice under European Arbitration Convention, treaty developments The EU Arbitration Convention is a potentially useful mechanism to avoid double taxation within the EU. It is also a helpful argument in the course of negotiations with the tax auditors on transfer pricing cases. It does not appear that the inclusion of mandatory arbitration provisions in new treaties is a current priority for Germany, although, for example, the new double tax treaty between Germany and the US includes a so-called baseball arbitration clause. Transfer Pricing Handbook – Germany Baker & McKenzie 177 5.3 Administrative regulations on MAP and EU Arbitration procedures The Federal Central Tax Office has issued administrative regulations offering guidance on both the MAP and the procedure under the EU Arbitration Convention, which clarifies existing practices and approach of the Federal Central Tax Office in these matters. 5.4 Litigation: practice, typical areas of litigation, any major public cases In Germany, transfer pricing cases are usually settled by compromise or negotiation in the course of an audit or in the post-audit appeals stage. This is the reason why there is only limited case law on transfer pricing in Germany. A few of the important transfer pricing rulings of the Federal Fiscal Tax Court since 2000 follow: • In 2000 (I R 12/99), the Federal Tax Court has ruled that royalty charges for the use of the corporate group name may be tax deductible if it is a protected trademark or brand name whose use affords valuable benefits to the licensee. However, a later decision by the Local Fiscal Court of Munich (6 K 578/06) demonstrates that deducting a royalty charge requires effective legal and practical benefits of the licensee. • In a landmark decision of the Federal Fiscal Tax Court in 2001 (I R 103/00), the court clarified important administrative aspects of transfer pricing rules and regulations, such as with regard to the burden of proof, transfer pricing documentation, the taxpayer’s duty to cooperate with the tax authorities and the use of the so-called secret comparables. As a reaction to the ruling, the German legislator introduced important changes in German transfer pricing law (transfer pricing documentation, penalty rules and refinement of the arm’s length principle in Section 1 of the FTA) that partly supersede the court’s decision. 178 Baker & McKenzie • A 2004 decision of the Federal Tax Court (I R 87/02) addresses the arm’s length principle and states that to define an arm’s length price, the positions of both (theoretical) contracting parties, their profit expectations and alternative actions (similar to “options realistically available” in the 2010 Chapter IX of the OECD Transfer Pricing Guidelines) have to be considered. • In 2005 (I R 22/04), the Federal Tax Court confirmed the principles established in prior rulings that losses incurred by a distribution entity over a certain period of time trigger a rebuttable presumption that the transfer prices are not at arm’s length. • In a decision of 2011 (X B 37/11), the Federal Tax Court has confirmed the statutory authority for the tax office to assess penalties between EUR2,500 and EUR250,000 in case a taxpayer does not timely fulfill his cooperation duties (e.g., provision of records or documentation) in a tax audit. 6. Interest and Penalties 6.1 Interest on overdue tax Where adjustments result in increased taxes, non-deductible interest will be assessed at a rate of 6 percent per annum for the period commencing 15 months after the end of the calendar year in which the tax liability arose, and ending on the date when the tax assessment becomes final. 6.2 Penalties If transfer pricing documentation is not put forward or is “essentially unusable,” the statute establishes a rebuttable presumption that the income of the German company under review has been reduced by means of inappropriate transfer prices (see Section 162, Paragraph 3 of the General Tax Act). Transfer Pricing Handbook – Germany Baker & McKenzie 179 Tax authorities may apply Section 162, Paragraph 3 of the GTA if the taxpayer fails to submit (or submits insufficient) documentation, or if extraordinary transactions have not been recorded contemporaneously. German tax authorities are then generally seen as being authorized to adjust transfer prices to the end of the arm’s length range that is the least favorable to the taxpayer. The same holds true where there are indications that the income of a taxpayer has been underreported and, despite adequate documentation from the taxpayer itself, a foreignrelated party does not show sufficient cooperation or information so that the true income cannot be established. If the taxpayer fails to submit documentation, or if the submitted documents are insufficient, the tax authorities have to impose a penalty amounting to at least 5 percent, but not exceeding 10 percent of the income adjustment. However, in any case, the minimum penalty amounts to EUR5,000. Penalties will also be imposed if income adjustments do not result in additional taxes (see Section 162, Paragraph 4 of the GTA), for example, due to losses of the company under review. On failure to submit the necessary documentation on time, the tax authorities may impose late fees/penalties of up to EUR1 million. The minimum penalty is up to EUR100 per day after the expiration of the due date. Penalties may not be imposed if the taxpayer is not responsible (or has only limited responsibility) for the lack of appropriate documentation. These transfer pricing specific penalties can be avoided by handing over suitable and sufficient transfer pricing documentation to the tax auditor. 7. Advance Pricing Agreement Procedures 7.1 Availability of unilateral/bilateral APAs In principle, both unilateral advance approval and bilateral/multilateral APAs are available in Germany. However, the Federal Ministry of Finance issued administrative regulations stipulating that in cases 180 Baker & McKenzie where a double tax treaty contains a clause on MAPs with the country of the foreign enterprise, the German taxpayer should not be granted a unilateral advance approval, but advance rulings may only be obtained by way of a bilateral APA. Alternative mechanisms of advance certainty may, in practice, be available in a given case. Where no double tax treaty exists, the tax authorities may, on request, provide the taxpayer with a unilateral APA that can have various legal forms, provided that the specific case is appropriate and the taxpayer has a bona fide interest. APAs are also available for the taxation of business restructurings or transfers of functions and on other (corporate) tax questions. According to the Federal Central Tax Office, most of Germany’s APAs are concluded with the US, Japan, UK, France, the Netherlands and South Korea. 7.2 Description of the application process and conditions, timing, and possibility of roll-back, among others The Federal Central Tax Office is the competent authority for conducting the intergovernmental APA procedure and coordinates the procedure with the competent regional tax authorities. The local tax authorities of the federated state or Länder are responsible for granting advance approval of transfer prices and for issuing relevant tax assessment notes. Advance approval is granted by implementing the APA procedure. The competent authority for APAs is the Federal Central Tax Office. An APA request does not prevent a tax audit from being conducted or continued. In fact, there is a standing administrative practice of cooperation between the Federal Central Tax Office and the local tax audit units. 7.3 Pre-filing The APA procedure usually starts with a pre-filing meeting to discuss the procedure and to agree, for example, on the right subject matter Transfer Pricing Handbook – Germany Baker & McKenzie 181 and content of the APA, and on what documents are required in the specific case. Pre-filing on an anonymous basis is also permitted. 7.4 Application and information required The APA request has to be filed with the Federal Central Tax Office, including all necessary documents and information. The scope of the application in terms of both content and period has to be defined in the request. The other country with which an APA is to be reached has to be named. The applicant has to explain the request in detail and to provide all the necessary records. The tax authorities may make additional queries at any time and demand further information and documents. In their guidelines, the Federal Central Tax Office has provided the following (non-exhaustive) list of documents that should be submitted with the APA request: • Description of shareholding ratios • Description of the organizational and operative structure of the group • Description of the operative areas, insofar as is required for the APA • Description of the business relations with associated enterprises (planned contractual arrangements) • Economic performance of the company before and during the APA period • Description and explanation of the functions and risks assumed • List and brief description of the main assets (in particular, intangibles) of significance to the business relations at issue • Description of the market situation, competition, and the business strategy/strategies chosen 182 Baker & McKenzie • Description and assessment of the planned value-added chains, and contributions from the companies involved • List of all outstanding tax issues (also in relation to other tax administrations) connected with the transactions to be covered by the APA In addition, the applicant should also suggest which critical assumptions in its view should apply with regard to the effectiveness of the mutual agreement, for example, with reference to circumstances prevailing for the business or its business partner, or with reference to conditions prevailing generally in business, trade and industry. 7.5 Annual report For each fiscal year to which the APA applies, the taxpayer must submit a report to the Federal Central Tax Office stating whether the intercompany transactions have been compensated in accordance with the APA, and whether the critical assumptions have been observed. 7.6 Term and rollback In practice, APAs are usually granted for a period of three to five years. Since APAs relate to the future, their term generally commences at the beginning of the fiscal year in which the formal request is filed. An earlier commencement may be allowed if, on the date when the APA request is filed with the Federal Central Tax Office, a tax return has not yet been submitted for an earlier fiscal year and the statutory deadline for submitting the tax return has not yet expired. Informally, the Federal Central Tax Office may grant a rollback under certain circumstances, especially if the other country consents. Procedurally, rollback procedures have to be initiated separately and are legally independent. In practice, however, rollback procedures are conducted alongside the APA. According to the regulations, a rollback requires proof from the taxpayer that the circumstances brought about Transfer Pricing Handbook – Germany Baker & McKenzie 183 in the respective preceding years match the circumstances during the years covered by the APA. In practice, tax authorities usually combine the granting of a rollback with a tax field audit. 7.7 Fees In contrast to the MAP, German tax authorities levy fees for APA procedures (see Section 178a of the GTA). The fees will be determined by the Federal Central Tax Office after the filing (i.e., the pre-filing is free). The standard fee for an APA is EUR20,000. If there is already an APA in place that the taxpayer wants to extend, fees will be reduced to EUR15,000. Amendments to prior APA filings are charged at EUR10,000. For taxpayers qualifying as small to medium companies in the meaning of the legislative regulations on transfer pricing documentation, the fees are limited to EUR10,000, EUR7,500 and EUR5,000, respectively. 7.8 Country-specific experiences with APA procedures In recent years, especially after the publication of a consistent administrative framework for APA procedures, APAs have become more and more popular among taxpayers who seek certainty on their transfer pricing position and who appreciate the constructive way in which their cases are handled by the Federal Central Tax Office. As a matter of experience, German tax officials take a very detail-oriented approach toward APAs. Also, when taxpayers raise bona fide APA cases, German tax authorities have consistently shown a consistent drive to find a solution workable for all parties concerned. Transfer Pricing Handbook – Hungary Baker & McKenzie 185 Hungary Gergely Riszter, Partner Gergely Riszter focuses on tax advice for multinational companies and tax structuring of investments into Hungary, including cross- border taxation matters. He represents clients before the courts, the Ministry of Finance and the tax authority in respect of tax litigation matters. His work also extends to advising on tax and related legal issues arising in merger and acquisition transactions. He has also advised various foreign funds in relation to the Hungarian tax implications of fund structuring. [email protected] Tel: +36 1 302 3330 336 Tímea Bodrogi-Szabó, Associate Timea Bodrogi-Szabó specializes in tax law. Her major areas of practice are Hungarian corporate taxation, cross-border taxation, corporate restructuring and VAT. [email protected] Tel: +36 1 302 3330 Kajtár Takács Hegymegi-Barakonyi Baker & McKenzie Ügyvédi Iroda Dorottya utca 6. 1051 Budapest Hungary 186 Baker & McKenzie 1. Statutory Rules and Administrative Regulations 1.1 Introduction The Hungarian transfer pricing regulations basically follow the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (“OECD Transfer Pricing Guidelines”). Article 31 of Act 81 of 1996 on Corporate Income Tax (“CIT Act”) implies that the OECD Transfer Pricing Guidelines could be applied in cases where the CIT Act does not explicitly contain any provision. In Hungary, the CIT Act sets out the corporate income tax rules on transfer pricing and the transfer pricing methods. The rules of transfer pricing documentation are prescribed in Decree 22 of 2009 of the finance minister. 1.2 Transactions in scope The Hungarian transfer pricing regulations require that transfer prices applied in transactions between related parties must be established at arm’s length. According to the wording of the CIT Act and the general practice of the Tax Authority, “controlled transactions” shall mean contracts and agreements on the one hand, and the following corporate transactions on the other: • Contributions in kind provided as registered capital or as capital reserve when establishing a company • Contributions in kind provided as an increase of a company’s registered capital or capital reserve • In-kind distribution of assets provided upon the reduction of a company’s registered capital, or upon the dissolution of the company without legal succession Transfer Pricing Handbook – Hungary Baker & McKenzie 187 • In-kind distribution of dividends provided that the member providing or receiving the above assets has majority influence in the company or acquires majority influence by the transfer of assets 1.3 Obligations The taxpayer is obliged to: (a) report the related party transaction to the Tax Authority; and (b) prepare transfer pricing documentation for all controlled transactions between the taxpayer and a related party. As to the reporting obligation, taxpayers must report to the Tax Authority the name, registered office and tax number of the related party of the taxpayer within 15 days of having executed the first contract between the parties. If related parties have no transactions with each other and they do not conclude agreements, no reporting obligation exists. As to the documentation requirement, see Section 3 below. 1.4 Related party definition Pursuant to the CIT Act, for transfer pricing purposes, the term “related parties” shall mean: • a company and another company in which the first company has direct or indirect majority control; • a company and another company that has direct or indirect majority control in the first company; • a company and another company, both in which a third party has direct or indirect majority control; or • a foreign entity and its Hungarian branch office or a Hungarian entity and its foreign branch office (in both cases, the branch office and the person who maintains any of the above relationships with the company). 188 Baker & McKenzie Pursuant to Section 8:2 of the Hungarian Civil Code, majority control is a type of relationship where a company holds over 50 percent of the voting rights in another company or where a company has a decisive influence over another company. For the purposes of this rule, a company may have direct or indirect decisive influence over another company. 1.5 Statute of limitation for transfer pricing adjustments The Tax Authority generally has five years to audit a certain tax obligation, commencing on the last day of the year in which the obligation should have been declared, reported or paid, unless the taxpayer has committed tax fraud, in which case the statute of limitations for tax assessment is equal to the statute of limitations of the tax fraud. 1.6 Advance Pricing Agreement (APA) Upon the taxpayer’s request, the Tax Authority can declare in a resolution the proper method for determining the fair market price to be used in a future transaction between related parties, the facts and circumstances based on which the applicable method is determined, and, if possible, the fair market price or price range (fair market price). 2. Transfer Pricing Methods 2.1 General acceptance of OECD guidance Hungary basically follows the OECD Transfer Pricing Guidelines. Hungarian legislation is required to be construed in a way that best ensures consistency with the OECD Guidelines. 2.2 Acceptability and hierarchy of methods According to Article 18 of the CIT Act, the following methods can be used to meet the arm’s length standard: (i) Comparable uncontrolled price method Transfer Pricing Handbook – Hungary Baker & McKenzie 189 (ii) Resale price method (iii) Cost plus method (iv) Transactional net margin method (v) Profit split method (vi) Other methods, if the fair market price cannot be established by the above methods Regarding (i)-(v), the CIT Act does not distinguish between these methods. Therefore, the taxpayer may decide which method to apply to determine the fair market price. 2.3 Acceptability of year-end adjustments and retroactive adjustments Year-end and retrospective pricing adjustments may be acceptable, for example, to take into account actual circumstances that have occurred where only budgeted indicators were initially used to set transfer pricing policies. 2.4 Safe harbors and rules of thumb Generally, there are no published safe harbors or rules of thumb in Hungary. There is a safe harbor rule, however, for low value-added intragroup services, as described in 3.2. 3. Transfer Pricing Documentation and Filing Requirements 3.1 Statutory rules and administrative regulations The rules of transfer pricing documentation are set out in Decree 22 of 2009 of the finance minister (the “Decree”). The Decree applies to all companies that, on the last day of the relevant tax year in which the transaction between related parties 190 Baker & McKenzie occurred, do not qualify as a small and medium enterprise under the Act on Small and Medium-Sized Enterprises. A small or medium enterprise is a company that meets each of the following three requirements: (i) the yearly average number of employees is fewer than 250; (ii) the annual net turnover does not exceed EUR50 million or the balance sheet total does not exceed EUR43 million; and (iii) the ownership in the company by the state or municipality does not exceed 25 percent. The thresholds must be examined on a group level. If the group level data exceed any of the numbers under (i)-(iii), the exemption does not apply. The documentation requirements apply to all contracts in effect between the taxpayer and a related party if any of the obligations under the contract have been fulfilled (i.e., performed) by one of the parties. However, no transfer pricing documentation shall be prepared for a transaction, among others, if: • the transfer price was determined by the Tax Authority in an APA; • the affiliated company recharges the fee of a product or service that does not fall under the principal activity and was supplied by a third, unrelated person; • cash or other financial assets are delivered free of charge; and • the net payments under the contract have not exceeded HUF50 million (approximately EUR162,000 as of October 2014) from the conclusion of the contract until the last day of the financial year. Pursuant to the Decree, taxpayers have the discretion to choose whether they wish to comply with transfer pricing documentation obligations by preparing “joint documentation” or “single documentation.” The concept of joint transfer pricing documentation Transfer Pricing Handbook – Hungary Baker & McKenzie 191 basically adopts the European master file concept. Taxpayers must declare, in their corporate income tax returns, the type of transfer pricing documentation they prepare. 3.2 Minimum scope of documentation as required under statute Single transfer pricing documentation, based on the decree, shall contain the following information: • The name, registered seat and tax ID number (if tax ID is not available, the company registry number and the name and registered seat of the registration authority) of the affiliated company taking part in the transaction • Description of the content of the contract, including the subject of the contract, date of the signature (and the modification) and the effect, and the description of the product or service that is the subject of the contract; the method and the conditions of the delivery • Introduction of the relevant market and its characteristics • Functional analysis • Presentation of the method that was used to choose the relevant data • The method of determining the arm’s length price and the reason it was applied • The possible difference between the compared transaction and the unrelated transaction, and adjustments made due to the differences, if the differences are affecting the arm’s length price • The calculated arm’s length price • The date of the preparation and the modification 192 Baker & McKenzie • In case an administrative or judicial procedure is going on or has been held in the subject of the contract, then the details (case number, date, conclusion, etc.) of such a procedure 3.3 Low value-adding intragroup services Simplified documentation may be prepared regarding the low valueadding intragroup services if the arm’s length payments due under the contract do not exceed HUF150 million (approximately EUR486,000 as of October 2014) in the given tax year, and do not exceed 5 percent of the service provider’s annual net revenue or 10 percent of the operating costs and expenditures of the user of the service. Low value-adding intragroup services are low-risk, routine services that do not fall under the principal activity of the whole group or of other company/companies of the group. Such services are, in particular, IT services, management of real estate, and educational and administrative services, among others. If transfer pricing documentation is prepared under the rules of the low value-adding intragroup services, the arm’s length price shall be determined by the cost plus method. Under this provision, the transaction is considered at arm’s length if the margin falls between 3 percent and 10 percent. This provision cannot be applied if the company provided or used low value-adding services under comparable circumstances to or from an unrelated company, and the price of such services demonstrates that the above margin would not be at arm’s length. 3.4 Deadline to submit documentation to tax authorities Transfer pricing documentation must be prepared by the corporate income tax return filing deadline. However, the taxpayer must actually make the transfer pricing documentation available to the Tax Authority only when it so requests. Transfer Pricing Handbook – Hungary Baker & McKenzie 193 3.5 Statutory documentation retention requirement Transfer pricing documentation must be retained for a minimum of five years, commencing on the last day of the year in which the preparation of the transfer pricing documentation was due. 3.6 Language of documentation Pursuant to the Decree and the Taxation Procedure Act, it is possible to prepare transfer pricing documentation “in a language other than Hungarian.” The documentation should be presented to the Tax Authority in Hungarian, English, German or French. In case the documentation is prepared in a language other than these, upon the request of the Tax Authority, the taxpayer must provide the transfer pricing documentation and the underlying documentation in Hungarian as well. 3.7 Frequency of documentation update Transfer pricing documentation must be updated if the facts and circumstances of the intercompany transaction change in a way that would be taken into account among unrelated parties. 3.8 Due date of tax returns Corporate income tax return must be filed by 31 May of the year following the subject year. Taxpayers with a financial year different from the calendar year must file their corporate income tax return on or before the last day of the fifth month following the financial yearend date. 3.9 Comparison with the European Code of Conduct Joint transfer pricing documentation adopts the master file concept of the European Code of Conduct. However, in country-specific documentation, further to the information required by the European concept, the documentation shall also contain the name, registered seat and tax ID number (if tax is ID not available, the company registry number and the name and registered seat of the registration 194 Baker & McKenzie authority) of the affiliated company taking part in the transaction, as well as the date of the preparation and the modification of the documentation. 4. Tax Audit Procedures 4.1 Selection of companies for an audit Audit activities are carried out on the basis of the Guidelines of the Tax Authority issued by its president by 20 February of each year. The Guidelines will consider the general scope of audits defined in the Taxation Procedure Act and will take the economic climate, the regulatory background, the tax policy of the government and popular tax minimization schemes into consideration. The number of taxpayers who will be audited in a given year is based on geographical locations and other demographics. In 2014, for instance, the following taxpayers are most likely to be audited: • Taxpayers with cash register • Commercial chains including other countries • Corporate groups • Research and development activities The tax authority will choose target taxpayers for an audit based on the following: • Tax returns submitted to the Tax Authority • Information collected from public databases and from unrelated parties • Tax payments by taxpayers • Experience in earlier tax audits Transfer Pricing Handbook – Hungary Baker & McKenzie 195 • Information provided by other authorities The Tax Authority aims to audit all taxpayers approximately once every five years. 4.2 Tax audit and appeals procedures The tax audit begins with prior written notification, or by the personal delivery of the notification or the presentation of a general notification by the auditor. The notification might be delivered electronically as well. Personal delivery of the notification is very rare in the case of legal entities. Generally, the audit must be completed within 90 days, beginning on the day the notification is received. However, the audit may be extended by an additional maximum period of 90 days by the auditor’s superior. Under extraordinary circumstances, the extended period shall be further extended by an additional 90 days by the president of the National Tax Authority. In special cases, where one of the biggest taxpayers is audited, the general audit must be completed within 120 days. As far as appeal procedures are concerned, the taxpayer has the following remedy rights at various instances: (i) During the audit Once the auditors think that they have gathered all the information necessary for the tax assessment, or if the period open for the audit has elapsed, the auditors will summarize their findings in the closing minutes of the audit. The taxpayer has the right to make comments on the closing minutes within 15 days after their delivery. In this case, the audit may be continued for an additional 15 days in order to examine the taxpayer’s comments. The audit officially ends when the Tax Authority issues a resolution on the conclusions of the audit. 196 Baker & McKenzie (ii) Administrative level A taxpayer who disagrees with the Tax Authority’s resolution has the right to file an appeal to change the resolution. The appeal must be filed with the Tax Authority of first instance and addressed to the Tax Authority of second instance. The appeal suspends the enforceability of the decision of the Tax Authority of first instance. The Tax Authority of second instance may sustain, modify or annul the decision of the Tax Authority of first instance. If the Tax Authority of second instance concludes that the Tax Authority of first instance failed to sufficiently examine the background of the case, then the Tax Authority of second instance may order the Tax Authority of first instance to review the case, or it may review the case itself. (iii) Litigation level The taxpayer has 30 days upon receipt of the final decision of the Tax Authority of second instance to file a request for judicial review with the competent administrative court. Filing an appeal at the court level does not suspend the enforceability of the decision of the Tax Authority of second instance. However, the administrative court may suspend enforceability upon the taxpayer’s request. The county court has the right to sustain, modify or set aside the decision of the Tax Authority of second instance or to order the Tax Authority to review the case. As a principal rule, the judgment of the administrative court is nonappealable. That is, no ordinary appeal can be filed against the judgment of the county court. However, there are two extraordinary remedies against the judgment of the county court. The taxpayer may file a request for judicial review with the Supreme Court, or the taxpayer may file a request for “novation” with the county court that handed down the contested judgment. Transfer Pricing Handbook – Hungary Baker & McKenzie 197 4.3 Administrative proceedings: duties and rights of the taxpayer in the course of an audit, burden of proof During a tax audit, the taxpayer’s major obligation is to cooperate and assist with the process. The taxpayer’s major rights include that to confirm the tax inspector’s entitlement to audit the taxpayer, to be present at the audit, and to have proper representation during the audit. The burden of proof is generally on the Tax Authority. However, the Tax Authority is also obliged to consider evidence in favor of the taxpayer. There are certain exceptions where the burden of proof is on the taxpayer. 4.4 Information obtained by the tax auditors from unrelated parties The Taxation Procedure Act authorizes the Tax Authority to request information from third parties. Third parties are obliged to provide the Tax Authority with all the requested information they have or that is contained in their accounts and records. Most often, third-party taxpayers will be requested to provide information about their contracting partners. Further, the Tax Authority may request information from the following individuals and official bodies: • Employers and other persons paying out benefits • Insurance companies • Real estate authority • Financial institutions • Customs offices and notaries • Authorities granting permissions • New vehicle distributors, among others 198 Baker & McKenzie 4.5 Recent audit developments and experiences Recent audit experiences show that Hungarian tax audits are becoming more and more focused on transfer pricing issues, and tax inspectors are becoming more and more specialized in detecting transfer pricing issues with the taxpayers. 5. Dispute Resolution 5.1 Mutual agreement procedures Hungary has more than 60 double tax treaties, almost all of which contain a mutual agreement procedure article. This article most often corresponds to Article 25 of the OECD Model Convention with respect to Taxes on Income and on Capital. 5.2 The European Arbitration Convention As far as dispute resolution with other member states of the European Union is concerned, Hungary has ratified the 90/436/EEC Convention on the elimination of double taxation in connection with the adjustment of profits of affiliated enterprises (Arbitration Convention). 5.3 Practice and major public cases Due to the relative novelty of the Hungarian transfer pricing regulations, there is hardly any public case law available in the field of transfer pricing. However, the Tax Authority issues administrative rulings in which it interprets the transfer pricing regulations. For example, according to Administrative Ruling No 48/2007, in the case of framework agreements concluded for an indefinite period of time, simplified transfer pricing documentation cannot be prepared, because the price of the actual contracts entered into on the basis of the framework agreement cannot be determined in advance. Transfer Pricing Handbook – Hungary Baker & McKenzie 199 6. Interest and Penalties If related parties apply a price that is higher or lower than the fair market price in their contracts, then the taxpayer must adjust its corporate income tax base with the spread between the applied price and the fair market price. If the applied transfer price results in a lower corporate tax base than would have been the case under fair market conditions, then the corporate tax base must be increased by the difference between the applied and the fair market price. If the applied transfer price results in a higher corporate tax base than would have been the case under fair market conditions, then the corporate tax base may be reduced under certain circumstances. If the taxpayer fails to fulfill the above adjustment obligation, then the Tax Authority will make the necessary adjustment in the frame of an audit. The consequences of such an audit are the following: (i) Payment of the normal tax rate upon the spread if the Tax Authority finds that the taxpayer’s taxable income is higher than indicated in the tax return, in which case the tax base will be adjusted, and the spread will be subject to normal tax rates. (ii) Late payment interest is due on any unpaid tax. The daily rate of interest is calculated according to the following formula: basic rate of the Hungarian National Bank x 2/365. (iii) The most serious consequence of a tax underpayment is a tax penalty. The value of the tax penalty is based on the deficit of the assessed tax base. The general rate of the penalty is 50 percent of the tax base deficit (in case the tax deficit is related to concealing taxable income or falsifying accounting records, the maximum rate of the penalty is 200 percent of the tax base deficit). (iv) Default penalty: The general maximum amount of default penalty is HUF500,000. 200 Baker & McKenzie (v) In addition, a penalty may be imposed for failure to comply with the transfer pricing documentation obligations, which may amount to HUF2 million per transfer pricing documentation. In case of a second default, the penalty may be up to four times the original penalty. 7. Advance Pricing Agreement Procedures 7.1 Availability of unilateral/bilateral APAs Upon the taxpayer’s request, the Tax Authority declares, in a resolution, the proper method for determining the fair market price to be used in a future transaction between related parties, the facts and circumstances, on which the applicable method is determined, and, if possible, the fair market price or price range. For the resolution to be valid, the declaration of all related parties involved in the transaction, or in the case of bilateral and multilateral procedures, the agreement of the Tax Authority and the competent foreign authorities for conducting the procedures is necessary. The procedure to establish the fair market price may be unilateral, bilateral or multilateral. Where the laws of another country relating to income taxes also apply to the transaction in question, the related party must indicate its intention to use unilateral, bilateral or multilateral procedures to establish the fair market price in the application. 7.2 Process Only taxpayers who are obliged to prepare a transfer pricing documentation are entitled to file a request with the Tax Authority. The Tax Authority may issue its resolution for three to five years. The validity period of the resolution may be extended once for an additional three years, upon the request of the related parties on whose behalf the fair market price is determined. The validity period of the resolution may not be extended if the facts underlying the original Transfer Pricing Handbook – Hungary Baker & McKenzie 201 resolution have changed to such an extent that a new resolution would be required to determine the fair market price. The application to extend the time period during which the resolution is valid must be submitted at least six months before the resolution expires. The applicants shall be represented by a tax consultant, a tax expert or a certified tax expert, or an attorney in front of the Tax Authority during the proceedings. A statement from the applicant must be attached to the application, guaranteeing that the information conveyed in the application is full and correct. The Tax Authority issues an APA in the form of a resolution. With certain exemptions, the resolution is binding upon the Tax Authority, with retroactive effect from the date when the application was submitted, provided that the facts remain the same. 7.3 Fees The APA procedure is subject to the following administrative fees: • For unilateral procedures • HUF500,000 to HUF5 million in the case of comparable uncontrolled price method, resale price method or cost plus method • HUF2 million to HUF7 million in the case of any other methods • HUF3 million to HUF8 million for bilateral procedures • HUF5 million to HUF10 million for multilateral procedures Transfer Pricing Handbook – Ireland Baker & McKenzie 203 Ireland Joseph Duffy, Partner Joe Duffy is a partner in the Tax Group at Matheson. He specializes in international tax matters, with particular focus on transfer pricing and intangible property structuring. He also advises on structuring inward investment projects and corporate reorganizations, as well as mergers and acquisitions. Joe speaks regularly on international tax matters, focusing particularly on transfer pricing and the Irish tax aspects of intangible property ownership and development. [email protected] Tel: +353 (0)1 232 2688 John Ryan, Tax Principal John Ryan is head of the firm’s US offices and practices corporate tax, focusing principally on advising foreign corporations doing business in and through Ireland. He has represented numerous US and other foreign corporations in establishing their Irish operations, and is standing advisor to a number of Irish based multinationals across a range of industry sectors. He has extensive experience in advising on transfer pricing and Irish competent authority proceedings. [email protected] Tel: +1 646 354 6583 Matheson 70 Sir John Rogerson’s Quay, Dublin, 2 Ireland 204 Baker & McKenzie 1. Statutory Rules and Administrative Regulations 1.1 Introduction Ireland introduced general transfer pricing legislation (the “TFP Legislation”) for the first time in 2010. The TFP Legislation requires transactions between associated persons undertaken in the course of trading activities to be entered into at arm’s length. Where an arrangement between associated persons is not made at arm’s length, an adjustment may be made by the Irish Revenue Commissioners (IRC), where the Irish taxpayer has understated income or overstated expenses. The TFP Legislation came into effect and is valid for accounting periods commencing on or after 1 January 2011, in relation to transactions the terms of which were agreed on or after 1 July 2010. 1.2 Scope of the TFP legislation Ireland’s TFP Legislation applies to any arrangement where the following facts and circumstances exist: • There is an arrangement involving the supply and acquisition of goods, services, money or intangible assets. • The arrangement is between associated persons. • The profits, gains or losses arising are within the scope of being charged to tax as trading or professional income, in the case of either the supplier or the acquirer, or both. The TFP Legislation applies to both domestic and international arrangements between associated persons. An exemption exists for small- and medium-sized enterprises (SMEs). 1.3 Key definitions The key definitions to be considered in determining the applicability of Ireland’s TFP Legislation are as follows: Transfer Pricing Handbook – Ireland Baker & McKenzie 205 (a) The TFP Legislation applies to the supply and acquisition of “goods, services, money or intangible assets.” While, broadly speaking, the scope of the TFP Legislation is in line with the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the “OECD Guidelines”), the term “money,” which is used in the legislation, is not mentioned in the OECD Guidelines. (b) Taxpayers are “associated” when one participates (directly or indirectly) in the “management, control or capital” of the other; or when the same person (directly or indirectly) participates in the management, control or capital of each of these two persons. A company is deemed to have control of another person when it can assure that the affairs of the first-mentioned company are conducted in accordance with the wishes of that person. This may be done: (i) by means of holding shares in or possessing voting power in the first-mentioned company, or in relation to that or any other company; or (ii) by virtue of any powers conferred by the articles of association or other documents regulating that or any other company. In relation to a partnership, control means the right to a share of more than 50 percent of the assets, or of more than 50 percent of the income, of the partnership. (c) The TFP Legislation applies only to trading or professional operations (e.g., in the context of a company, those operations taxable at the rate of 12.5 percent). Non-trading operations are not within the ambit of the legislation. Therefore, for example, from a tax perspective, it should be possible for a company to make an interest-free loan, where the making of loans does not constitute a trading activity of the company. 206 Baker & McKenzie 1.4 Consequences of the TFP legislation Ireland’s TFP Legislation entitles the IRC to adjust profits to an arm’s length amount, when an Irish taxpayer is within the scope of the TFP Legislation and has understated profits or overstated expenses. The TFP Legislation cannot be used, however, to decrease profits taxable in Ireland or to increase expenses deductible in Ireland. An “arm’s length amount” is defined as “the amount of the consideration that independent parties would have agreed on in relation to the arrangement, had those independent parties entered into that arrangement.” 1.5 Grandfathering The TFP Legislation does not apply to an arrangement, the terms of which are agreed before 1 July 2010. An arrangement is broadly defined within the legislation as “any agreement or arrangement of any kind (whether or not it is, or is intended to be, legally enforceable).” This is a very broad definition and can encompass verbal arrangements. 1.6 Compliance Irish corporation taxpayers are subject to self-assessment and they must, therefore, decide whether the taxable profits entered on their self-assessment return reflect the application of the arm’s length principle where relevant. 1.7 Time limits for assessment There is no separate statute of limitations applying to transfer pricing audits. The IRC normally has up to four years from the end of the relevant accounting period in which to raise a tax assessment, unless there has been fraud or neglect on the part of the taxpayer, in which case no time limit applies. Transfer Pricing Handbook – Ireland Baker & McKenzie 207 1.8 Attribution of profit Although they have not published a position on the matter, the IRC is likely to follow the OECD Report on the Attribution of Profit to Permanent Establishments, which describes how profits should be attributed to permanent establishments in accordance with the OECD Model Tax Convention’s tax treaty provisions. Advance pricing agreements (APAs) While there are no prescribed rules for APAs set out in the legislation, the IRC will consider the attribution of profit in the context of a bilateral or multilateral APA. In such cases, the IRC would expect to receive a detailed submission, together with an economic study supporting the position that the pricing is at arm’s length. 2. Transfer Pricing Methods 2.1 Understanding the legislation The legislation states that in computing the profits and losses of a taxpayer, the legislation shall be interpreted to “ensure, as far as practicable, consistency” with the OECD Guidelines. The legislation further provides that any additional guidance published by the OECD and designated by the Minister for Finance will be considered part of the OECD Guidelines for the purposes of the legislation. 2.2 Selection of method The Irish rules do not favor or prescribe any particular methodology. Provided the methodology is appropriate in the circumstances and adheres to general OECD principles, it should be acceptable. 2.3 Contemporaneous information There is no specific Irish legislation requiring persons to keep contemporaneous documentation. However, supporting transfer pricing documentation must be available on a timely basis. In addition, UK case law is persuasive in Ireland and in this regard, DSG 208 Baker & McKenzie Retail v. Revenue & Customs Commissioners1 is likely to be followed in Ireland. This case is the authority for the proposition that hindsight cannot be used to determine whether a price was at arm’s length; only information that was available to the parties at the time (including reasonably foreseeable information) can be relied upon. 2.4 Commensurate-with-income rules Irish legislation does not include a commensurate-with-the-income type of rule. 2.5 Pricing adjustments Year-end and retrospective pricing adjustments may be acceptable, for example, to take into account actual circumstances that have occurred where only budgeted indicators were initially used to set transfer pricing policies. Other factors (for which adjustments need to be made), such as indirect taxes, may also be relevant. 2.6 Working capital/inventory Ireland does not generally require calculation of comparability adjustments to ascertain levels of working capital/inventory when comparing equivalent business activities. Adjustments may be required if, for example, distributor companies are being used in benchmarking returns as a proxy for commission-based sales functions. 2.7 Business restructurings The modifications to the OECD Guidelines in respect of business restructurings have been specifically endorsed, and the TFP Legislation must be interpreted to ensure, as far as practicable, consistency with the OECD Guidelines, including the chapter on business restructurings. 1 (2009) UKFTT 31 (TC) 1. Transfer Pricing Handbook – Ireland Baker & McKenzie 209 2.8 Safe harbors There are no safe harbors as such within the TFP Legislation. However, the TFP Legislation does not apply to SMEs, nor does it apply to activities that are not trading or professional in nature. 3. Transfer Pricing Documentation and Filing Requirements 3.1 Recordkeeping The IRC have issued some limited guidance on the documentation requirements under the legislation (the “Revenue Guidance”). The Revenue Guidance states that transfer pricing documentation “is fundamental to validating and explaining the pricing of intragroup transactions.” However, the documentation need not be kept in a standard form and there is no requirement that the company itself must prepare the documentation or that the documentation must be kept in Ireland. The Revenue Guidance goes on to state that documentation prepared by an associated company in another jurisdiction will be sufficient if the documentation can be made available to the IRC. Significantly, the Revenue Guidance acknowledges that “the manner of meeting the requirement for documentation may take into account the cost and administrative burden involved. The cost should be commensurate with the risk involved.” The following items must be clearly identified in the transfer pricing documentation: (a) The associated persons for the purposes of the legislation (b) The nature and terms of transactions within the scope of the legislation 210 Baker & McKenzie (c) The method by which the pricing of transactions was arrived at, including any study of comparables and any functional analysis undertaken (d) How that method has resulted in the arm’s length pricing (e) Any budgets, forecasts or other papers containing information relied on in arriving at arm’s length terms (f) The terms of relevant transactions with both third parties and associates The Revenue Guidance provides that the IRC accept both EU Transfer Pricing Documentation and OECD Guidelines as representing good practice with regard to documenting transfer pricing transactions. It states that it is best practice that the documentation is prepared at the time the terms of the transaction are agreed upon. It goes on to state that for a company to be in a position to make a correct and complete tax return for an accounting period in which there are trading transactions with associates, the documentation should exist by the time the tax return is due to be made. 3.2 Contemporaneous documentation The TFP Legislation does not require that contemporaneous documentation be maintained; rather, it provides that a taxpayer should maintain “such records as may reasonably be required” to justify the relevant transfer pricing methodology. Furthermore, records should be prepared “on a timely basis.” The IRC has indicated that the absence of prescriptive requirements is designed to provide taxpayers with a measure of flexibility with regard to the form of documentation produced. 3.3 Timing of evidence and analysis There is no specific requirement to file transfer pricing documentation with the IRC. The statutory filing date for corporation tax selfassessment returns is normally on the 21st day of the ninth month after Transfer Pricing Handbook – Ireland Baker & McKenzie 211 the end of the accounting period, so an Irish taxpayer should have sufficient evidence and analysis by that date to demonstrate that his or her transactions with related parties are at arm’s length. 3.4 Recordkeeping duration The TFP Legislation does not provide a specific period for retention of records for transfer pricing purposes. The general period for the retention of documentation for tax purposes is six years. 3.5 Reviewing and updating documentation Documentation should be reviewed on an annual basis to determine if historical, functional and economic analyses are still relevant, but there is no requirement to update formal documentation. 3.6 Returning information There is no special corporation tax return form for reporting connected party transactions. However, these must be reflected in the normal annual corporation tax return, on an arm’s length basis. Information regarding transfer pricing is, in the first instance, gathered by the IRC from the tax return, and supplemented by further information disclosed as a result of specific enquiries. 3.7 Language of documentation Transfer pricing documentation may be prepared in either Irish or English. 3.8 Comparison with the European Code of Conduct The TFP Legislation does not prescribe specific transfer pricing documentation to be prepared and retained by the taxpayer. However, the Revenue Guidance confirms that transfer pricing documentation prepared in accordance with the European Code of Conduct on Transfer Pricing Documentation will be sufficient for Irish tax purposes. 212 Baker & McKenzie 4. Tax Audit Procedures 4.1 Transfer pricing compliance reviews In November 2012, the IRC announced that transfer pricing compliance reviews (TPCRs) will form the cornerstone of monitoring compliance with the TFP Legislation. However, as experience of transfer pricing matters has grown within the IRC, a more traditional audit of transfer pricing matters is now more likely. Under the TPCR, taxpayers are selected on a risk assessment basis to conduct a self-review on their transfer pricing for a specified period. Taxpayers have three months to conduct the self-review and to provide a report to the IRC. TPCRs are not formal audits, and adjustments may be agreed upon under the TPCR without the imposition of any penalties. If the IRC is satisfied with the results of the TPCR, a letter confirming that they have no further enquiries will be issued, giving taxpayers comfort that their transfer pricing policy for that period has been accepted by the IRC. Where the IRC is not satisfied with the level of information received, or with the transfer pricing, TPCRs may be escalated to more formal audits (with the related risk of penalties). However, the IRC considers the TPCR to be a substantial compliance check in its own right and not normally a precursor to a transfer pricing audit. While the TPCR process is in its infancy, the approach to date, in respect of the TPCRs, has been cooperative and open. The report to the IRC under the TPCR should provide the following information: 1. The group structure 2. Details of transactions by type and associated companies involved 3. Pricing and transfer pricing methodology for each type of transaction Transfer Pricing Handbook – Ireland Baker & McKenzie 213 4. The functions, assets and risks of parties 5. A list of documentation available/reviewed 6. The basis for establishing how the arm’s length standard is satisfied The information does not have to be provided in a particular format and the IRC has confirmed that where a transfer pricing study or report already exists, that study will suffice, provided it contains the information listed above. 4.2 Revenue audit There is no specific transfer pricing audit procedure; however, normal audit procedures apply. An IRC- authorized officer can require a taxpayer to deliver, or to make available for inspection, books, records and other documents (including transfer pricing documents) or to furnish information relevant to the taxpayer’s tax liability under the legislation. An authorized officer can also apply to the High Court for an order directing the person concerned to comply with the officer’s requirements in respect of books, records and other information. However, the TFP Legislation does provide that enquiries relating to compliance with the transfer pricing rules may only be initiated by an authorized officer specifically appointed by the IRC. This ensures that transfer pricing audits are undertaken only by officers who are equipped with the requisite knowledge and experience to deal with the complex difficulties in applying the arm’s length principle. The IRC has specifically noted that the deployment of their resources will take into account risk factors and therefore, it is unlikely that transactions between persons that involve no overall loss of revenue will be targeted. 4.3 Irish domestic appeals process At the domestic level, a company may appeal against an assessment of the IRC that involves a transfer pricing adjustment. Appeals are made to the Appeal Commissioners. An appeal of the Appeal 214 Baker & McKenzie Commissioners’ decision may be made to the Circuit Court. If dissatisfied with the decision of the Appeal Commissioners or that of the Circuit Court, either party may seek to have a case stated to the High Court on a point of law only. 4.4 Taxpayer’s rights in the course of an audit The rights of taxpayers in the course of and following an audit are set out in detail in the IRC’s Code of Practice for Revenue Audit (the “Code of Conduct”). Broadly, the Code of Conduct details how audits should be conducted and provides that audits should be conducted in an efficient, courteous and professional manner. 4.5 Resources available to tax auditors The IRC has a number of general resources and powers available to them. As noted above, an IRC- authorized officer can require a taxpayer to deliver, or to make available for inspection, books, records and other documents (including transfer pricing documents) or to furnish information relevant to the taxpayer’s tax liability under the legislation. An authorized officer can also apply to the High Court for an order directing the person concerned to comply with the officer’s requirements in respect of books, records and other information. Furthermore, the IRC has the power to gain access to information and documents held by third parties. 4.6 Recent audit developments As the TFP Legislation only applies to accounting periods commencing on or after 1 January 2011, the 31 December 2011 tax returns are generally the first tax returns subject to audit and were due in September 2012. IRC’s initiation of the TPCR process rather than formal audits show the intention of the IRC to engage taxpayers, outside a potentially contentious audit setting, in an effort to understand the transfer pricing applied by these taxpayers. More recently, the IRC has sought to increase resources within its internal transfer pricing function. Going forward transfer pricing audits will not be confined to the TPCR process and a more traditional tax audit Transfer Pricing Handbook – Ireland Baker & McKenzie 215 is more likely, particularly in respect of transactions that are identified as higher risk. 5. Dispute Resolution 5.1 Mutual agreement procedure (MAP) Ireland has a significant number of double tax treaties, almost all of which contain a MAP article. The extent to which the MAP procedure is available is, to a large extent, dependent upon the discretion of the IRC. The granting of corresponding adjustments is a matter for the IRC. The IRC’s general approach is that a transfer pricing adjustment in relation to an international transaction that increases profits in one contracting state should be matched by a corresponding reduction in profits elsewhere. OECD treaties will generally require the competent authorities to endeavor to apply the MAP in such a way that double taxation is eliminated, and this result will be achieved in the majority of cases. There is no formal statutory method to set a case in motion. 5.2 Arbitration The European Arbitration Convention could provide a useful means of solving disputes. However, uncertainty surrounds its application, as Ireland’s double tax treaties do not include mandatory arbitration provisions. 5.3 Litigation While there have been some cases on the issue of “arm’s length” that were brought before the Irish courts prior to the introduction of formal transfer pricing legislation (most notably Bellville Holdings Limited v. Cronin), there has been no case law since the recent introduction of Ireland’s transfer pricing legislation. 216 Baker & McKenzie 6. Interest and Penalties 6.1 Interest Where additional tax becomes due following a transfer pricing adjustment, any shortfall in tax that, accordingly, is paid late, will be subject to interest. 6.2 Penalties The TFP Legislation does not contain any specific penalties. Therefore, normal taxation and penalty provisions will apply. The Code of Conduct contains a list of penalties that apply to various revenue offences. Both fixed and tax-geared penalties (which may amount up to 100 percent of the underpaid tax) may apply. 7. Advance Pricing Agreement Procedures The IRC has stated that it will not conclude unilateral APAs but is prepared to engage with taxpayers and tax authorities on the negotiation and agreement of bilateral or multilateral APAs. There are no prescribed rules for APAs, though the Guidelines for Advance Pricing Agreements with the European Union have been politically endorsed. 8. Other Topical Subjects At present, there is still some uncertainty as to how aggressively the IRC will pursue transfer pricing audits in practice. The initial phase of the TPCR process points toward a more collaborative rather than a contentious approach to transfer pricing in Ireland, with IRC upskilling teams to review transfer pricing matters. However, as experience within the IRC grows, a more contentious approach is likely. Grandfathering from the TFP Legislation exists for arrangements, the terms of which were agreed upon prior to 1 July 2010. While this grandfathering has the potential to apply indefinitely, it is apparent that the IRC will take a very strict interpretation of this grandfathering provision. Transfer Pricing Handbook – Ireland Baker & McKenzie 217 However, of particular interest will be the IRC’s approach to transactions between Irish taxpayers and non-OECD member states, and trends in this regard are likely to become apparent over the coming months and years. When the TFP Legislation was introduced, the IRC argued that it was important, in order to protect the position of the Irish taxpayer in an international context. Now, in the context of a greater number of international transfer pricing disputes, taxpayers are very often looking to the IRC to vigorously defend the transfer pricing position within MAP. For their part, the IRC is committed to doing so where the taxpayer has adopted a reasonable OECD-based transfer pricing position with the adequate supporting documentation. Most recently, in the Road Map for Ireland’s Tax Competitiveness issued by the Department of Finance in October 2014, it was recognized that in the current environment, transfer pricing disputes are likely to grow in number and Ireland must be ready to defend its tax base. Accordingly, Ireland will strengthen the capabilities of its transfer pricing competent authority by assigning new resources to the IRC to meet this priority need. Transfer Pricing Handbook – Italy Baker & McKenzie 219 Italy Mario D’Avossa, Partner Mario D’Avossa is a transfer pricing specialist with experience in international business restructurings, economic valuations and benchmarking analysis of intercompany transactions in support of documentation and planning studies. He advises in many industries, mainly with respect to transfer pricing documentation, international tax planning, advance pricing agreements, supply chain restructuring, licensing agreements, cost sharing transactions and litigation. mario.d’[email protected] Tel: +39 02 76 231 404 Studio Professionale Associato a Baker & McKenzie Piazza Meda, 3 20121 Milano Italy 220 Baker & McKenzie 1. Statutory Rules and Administrative Regulations 1.1 Introduction Until 2010, Italy had no rules on the documentation of inter-company transactions. New legislation introducing documentation requirements for transfer pricing purposes was introduced by Law Decree n. 78/2010, converted into Law n. 122/2010 as well as by the Documentation Regulation of 29 September 2010. Clarifications on the transfer pricing legislation are also contained in Circular Letter 58/E issued by the Italian Tax Authorities on 15 December 2010. The legislation provides that enterprises that conclude transactions with foreign companies belonging to the same group may prepare adequate transfer pricing documentation and flag a specific box in the tax return, indicating the availability of the transfer pricing documentation. Documentation does not need to be filed contemporaneously but, if requested by the tax auditors, should be handed over within 10 days. Documentation is considered “adequate” if it meets the requirements set by Italian regulations, which, however, prescribe a mandatory format that is burdensome and more detailed with respect to the format recommended by the Code of Conduct issued by the European Joint Transfer Pricing Forum. The documentation should be written in Italian, while agreements may be left in English. The preparation of adequate documentation and the flag of the specific box in the tax return will entitle the taxpayer to obtain administrative penalty relief, which otherwise will range from 100 percent to 200 percent of the higher tax applied to the adjusted revenue. Italian transfer pricing legislation refers to the OECD Guidelines, both in the aforementioned Documentation Regulation of 29 September 2010, and in the Circular Letter 58/E, clarifying that the Italian legislation should be read and applied in accordance with the indications contained in the OECD Guidelines. Transfer Pricing Handbook – Italy Baker & McKenzie 221 1.2 Transactions in scope Under Article 110 (7) of Presidential Decree no. 917/86, the Italian Income Tax Code (IITC), only transactions between an enterprise resident in Italy and a foreign enterprise, where both entities belong to the same multinational group, are relevant for transfer pricing purposes. The rules apply to a wide range of related party transactions, including goods and services and financing transactions, as well as the licensing and sale of intellectual property. 1.3 Obligation (documentation and filing) The preparation of transfer pricing documentation is an option available to taxpayers in order to be granted a relief from potential administrative penalties in case transfer pricing adjustments are made in the course of a tax audit. The availability of the documentation is communicated on a yearly basis by ticking a specific box in the annual tax return. However, for fiscal years that closed on or before 31 December 2009, late notifications (through electronic filing) will be valid if made before any audit activity is started. As stated above, transfer pricing documentation has to be submitted upon and within 10 days of the request of the Tax Authorities. 1.4 Related party definition Article 110, Paragraph 7 of the IITC provides a general definition of related parties for transfer pricing purposes, more precisely: “The items of income deriving from transactions with nonresident companies, which, directly or indirectly, control or are controlled by the undertaking, or which are controlled by the same company controlling the undertaking, are assessed on the basis of the fair market value (i.e., the arm’s length value) of the goods sold, the services rendered, and the goods and services received as determined pursuant to paragraph 2” (paragraph 2 refers to Article 9 of the IITC). The concept of control is very wide and it extends to cases of family 222 Baker & McKenzie relationships, common board members, and, in general, capacity to influence the definition of the pricing. In particular, Article 9 (3) of the IITC defines fair market value (arm’s length value) as “the price or consideration normally applied to the goods and services of the same kind or similar, in an arm’s length condition and at the same stage of commercialization, at the time and in the place where the goods and the services have been acquired or provided and, failing that, at the nearest time and place.” In determining the so-called fair market value, reference shall be made, as far as possible, to the price lists or tariffs of the entity supplying the goods and services and, where these are not available, to the price lists of the chambers of commerce and professional tariffs. 1.5 Statute of limitation for transfer pricing adjustment As a general principle, the statutory term of tax assessment limitations, including transfer pricing, is the fourth calendar year following the year in which the tax return was filed. These limits are extended by one year in case of failure to file the annual tax return. The limitation period is doubled if the taxpayer’s violation is also punishable under criminal law, in which case notice of the violation must also be given to the prosecutor. The limitation period is not interrupted by the beginning of a tax audit or by the notification of a request for information or a questionnaire. As a result, the tax office is obliged to issue the taxpayer with the tax assessment before the statute of limitations has expired. 1.6 Relationship to permanent establishment allocation of profits provisions Article 162 of the IITC follows the OECD Report on the Attribution of Profit to Permanent Establishments, which describes how profits should be attributed to permanent establishments (PEs) in accordance with the OECD Model Tax Convention’s tax treaty provisions. Transfer pricing rules apply to an Italian PE of a nonresident enterprise. Documentation requirements depend on whether the Transfer Pricing Handbook – Italy Baker & McKenzie 223 nonresident taxpayer, of which the PE is part, qualifies as a holding, subholding or subsidiary part of a multinational enterprise (MNE). 1.7 Advance pricing agreements (APAs) The Italian Tax Authorities offer unilateral APAs in respect of intercompany arrangements between Italian and non-Italian related parties and within the same enterprise for attributions, for example, between the head office of a company in one country and its branch in another country, or between branches where the head office or branch is subject to Italian tax. Bilateral APAs are de facto applicable upon specific requests to the APA office. 2. Transfer Pricing Methods 2.1 General acceptance of OECD guidelines The transfer pricing methods in the OECD Guidelines are fully accepted by the Italian transfer pricing legislation. In particular, the documentation regulations of 29 September 2010, defining the “traditional transactional methods” and the “transactional profit methods,” directly refer to the OECD Guidelines. 2.2 Selection of method (acceptability, hierarchy of methods and best method rules) The OECD Guidelines, revised in 2010, no longer specify a hierarchy of methods. However, where a transaction-based method (CUP, resale price or cost plus) and a profit method (profit split or transactional net margin method) are both equally valid in the circumstances, the transaction method is preferable. Similarly, where a CUP method and another transfer pricing method are both equally reliable, the CUP method should be used. Italian rules provide that in the section regarding the selection of method, taxpayers must clarify the reasons for excluding a traditional transactional method. 224 Baker & McKenzie Indeed, as indicated in the Circular Letter 58/E, the Italian legislation is fully aligned with the approach in the OECD Guidelines. Therefore, if a transaction-based method and a profit method are both applicable in a reliable manner, taxpayers should adopt the transaction-based method or, otherwise, taxpayers are requested to present adequate reasons for adopting a profit method. Adequate reasons have to be provided by taxpayers as well if the comparability analysis outlines the possibility to apply the CUP method in a reliable way, but the taxpayers select a different transfer pricing method. When requested, these justifications for the selected method have to be reported in Chapter 5 of the Country File (subparagraph “Description of the selected transfer pricing method and of the underlying reasons determining its consistency with the arm’s length principle”). 2.3 Relevant level of knowledge and timing According to the OECD Guidelines, hindsight may not be used to determine whether a price was at arm’s length; only information that was available to the parties at the time (including reasonably foreseeable information) can be relied upon. 2.4 Pricing adjustments Year-end and retrospective pricing adjustments may be acceptable, for example, to take into account actual circumstances that have occurred where only budgeted indicators were initially used to set transfer pricing policies. Other factors (for which adjustments need to be made), such as indirect taxes, may also be relevant. In any case, the possibility to make an intercompany year-end adjustment and the methodology to determine the amount of the yearend adjustment have to be indicated in a written intercompany agreement and in the transfer pricing policy of the group. 2.5 Calculation of comparability adjustments According to the OECD Guidelines, calculation of comparability adjustments (such as working capital/inventory) is allowed if, and Transfer Pricing Handbook – Italy Baker & McKenzie 225 only if, it increases the reliability of the results. Adjustments may be required if, for example, distributor companies are being used in benchmarking returns as a proxy for commission-based sales functions. 2.6 Commensurate-with-income-rules and regulations As previously indicated, Italian transfer pricing regulations are based on the fair market value (i.e., the arm’s length value) concept. Therefore, the commensurate-with-income standard is not fully applied. 2.7 Safe harbors There are no published safe harbor rules. The official guidelines released in 1980 included certain safe harbor rules regarding royalty rates, but they have largely been repealed by the new regulation and guidelines. 3. Transfer Pricing Documentation and Filing Requirements 3.1 Statutory rules and administrative regulations As indicated in Paragraph 1, the preparation of transfer pricing documentation is not mandatory and the availability of the documentation has to be indicated in the tax return of the company flagging a specific box. If requested by the tax authorities, transfer pricing documentation has to be filed within 10 days. 3.2 Minimum scope of documentation as required under statute The Italian transfer pricing legislation requires taxpayers to prepare the masterfile that collects information regarding the multinational group, as well as the countryfile that contains information regarding the enterprise. 226 Baker & McKenzie An MNE will have to prepare either the masterfile or the countryfile, or both, depending on the features of the Italian entity claiming the benefit of the penalty relief. • Italian-resident holding companies of an MNE, with no other parent companies and that control other foreign legal entities, have to prepare both a masterfile and countryfile documentation. • Subholding companies, belonging to an MNE and controlled by other legal entities, and that control other foreign subsidiaries, have to prepare both a masterfile and countryfile documentation, but the masterfile may be limited to information relating to the subsidiaries controlled by the subholding company. Alternatively, the subholding company may rely on the masterfile prepared by its foreign parent company if drafted according to the EU Code of Conduct. • Subsidiaries controlled by other legal entities (wherever resident) and that do not control any foreign companies have to prepare only the countryfile. • PEs of foreign entities have to prepare either the masterfile or countryfile documentation depending on the features of the foreign company to which the PE belongs. If the foreign company qualifies as a holding company under Italian regulations, it is necessary to draft both a masterfile and a countryfile. The Decision of the Commissioner of Italy Revenue Agency dated 29 September 2010, prescribes a template for transfer pricing documentation. Transfer Pricing Handbook – Italy Baker & McKenzie 227 The mandatory template for the masterfile contains the following paragraphs: 1. General description of the multinational group (history, recent developments, business sectors in which it operates and overview of relevant markets of reference) 2. Multinational group structure 2.1. Organizational structure (including an organizational chart, a list of group members, their legal nature, including reference to their shareholding percentages) 2.2. Operational structure (contains a general description of the role that each of the associated enterprises carries out with respect to the multinational group’s activities) 3. Business strategies pursued by the multinational group (with specific reference to its development and consolidations strategies) including potential changes to the overall business strategies if compared to the previous tax year 4. Transaction flows (includes an overview of the general transaction flows as described in the following Chapter 5 must be provided for, including the invoicing flows and the amounts thereof and describing the underlying legal and economic reasons, on the basis of which the activity has been structured as shown in the transaction flows; the transaction flows will have to be described in a flowchart, encompassing also those pertaining transactions not falling under the ordinary management activity.) 5. Intragroup transactions 5.1. Sale of tangible or intangible assets, provision of services, financial services transactions (For each set of transactions, it has to provide: (i) a description of the underlying nature of the intragroup transactions; and (ii) a 228 Baker & McKenzie list of the entities part of the multinational group involved in the transaction.) 5.2. Intragroup services (For each inter-company service transaction, it shall provide, in detail, the features of intragroup services carried out by one or more associated enterprises to the benefit of one or more associated enterprises and the entities involved in the transaction.) 5.3. Cost contribution arrangements (In this chapter, a list regarding the actual cost contribution arrangements shall be provided, with an indication, for each arrangement, of the scope, duration, members of the arrangement, areas of activity and projects covered.) 6. Functions performed, assets used and risks assumed (In this chapter, the taxpayer will have to provide a general description of the functions performed, assets used and risks assumed by each of the enterprises involved in the transactions, and of potential changes occurring in the functions, assets and risks if compared to the prior taxable year, with specific reference to changes triggered by business restructuring transactions.) 7. Intangible assets (In this chapter, a list of the intangible assets owned by each associated enterprise will have to be provided, with a separate identification of any royalty payment, separated per recipient or payer, respectively, and paid as a result of the exploitation of them.) 8. Transfer pricing policy of the multinational group (In this chapter, a description of the multinational group’s transfer pricing policy will have to be provided, and of the underlying rationale that should support its consistency with the arm’s length principle. In order to substantiate this information, it will be necessary to briefly refer to the contractual arrangements underlying the abovementioned transfer pricing policy.) Transfer Pricing Handbook – Italy Baker & McKenzie 229 9. Relationship with the tax administrations of the member states of the European Union (EU) regarding APAs and transfer pricing rulings (In this paragraph, a brief description of the APAs and rulings signed or released by the tax administrations of the countries in which the multinational group operates will have to be submitted, by describing the scope, content and duration of each agreements. The paragraph should be structured per country.) In relation to the countryfile, the mandatory format prescribed by the Italian Tax Authorities contains the following paragraphs: 1. A general description of the company (history, recent evolution and general overview of the relevant markets of reference) 2. Business sectors (a general overview and analysis of the industries in which the group operates) 3. The company’s operating structure (a general overview of the role that each of the enterprise’s business units carries out within the general activity) 4. General business strategies pursued by the company and potential changes compared to the previous tax year’s (information regarding specific strategies on specific sectors or markets) 5. Controlled transactions (sale of tangible or intangible goods, provision of services, financial services transactions). For each type of the inter-company transactions that occurred in the fiscal year, a specific subparagraph has to be prepared according to the following structure: 5.1. Transaction 1 5.1.1. Description of the transactions 5.1.2. Comparability analysis 230 Baker & McKenzie a) Characteristics of property or services b) Analysis of the functions performed, risks assumed and assets c) Contractual terms d) Economic circumstances e) Business strategies 5.1.3. Selection of the transfer pricing method a) Description of the selected transfer pricing method and of the underlying reasons, determining its consistency with the arm’s length principle b) Criteria for the application of the selected transfer pricing method c) Results derived from the application of the selected transfer pricing method 6. Intragroup transactions (Cost Contribution Arrangements, or CCAs, of which the enterprise is part): 6.1. Participants, scope and terms 6.2. Activities’ framework and projects covered 6.3. Method used to determine the expected benefits for each participant, including expected results, partial outcomes and divergences 6.4. Form and amount of each participant’s contribution to the arrangement, including methods and criteria to determine them accordingly Transfer Pricing Handbook – Italy Baker & McKenzie 231 6.5. Formalities, procedures and consequences arising from the entry to and withdrawal from the CCA by associated enterprises participating in it, including the termination thereof 6.6. Contractual arrangements concerning balancing payments or amendments to the CCA, stemming from a change of circumstances 6.7. Changes that occurred during the validity period of the CCA The country file format indicated by the Italian Tax Authorities also prescribes the following mandatory annexes: Annex 1: Flowchart describing the transaction flows, including those falling out of the scope of the ordinary management activities Annex 2: Copy of written contracts on the basis of which the transactions referred to at Chapters 5 and 6 are regulated (may be in English) 3.3 Contemporaneous documentation N/A 3.4 Deadline to submit documentation to tax authorities The documentation requirement is not mandatory, so taxpayers only need to confirm that it is available on a yearly basis by flagging a specific box in the tax return. However, for fiscal years ending on or before 31 December 2009, late notification (through electronic filing) will be considered valid if made before any audit activity is started. • In a tax audit, documentation must be submitted to the Tax Authorities within 10 days following a request. Further information may be requested and must be provided within seven days or within a reasonable longer time period consistent 232 Baker & McKenzie with the timing of the tax audit and with the complexity of the transactions under investigation. • On the other hand, if the taxpayer has communicated the availability of documentation but it turns out to be unavailable during the tax audit, more stringent penalties (proportionate to the seriousness of the taxpayer’s conduct) may be applied. Transfer pricing documentation is not mandatory, so no filing is required by law. However, the taxpayer should make documentation available at the request of the tax office at the beginning of a tax audit or following an inquiry or questionnaire. Transfer pricing documentation must be prepared in the electronic format and the legal representative or a delegate of the company must initial each page of the masterfile/countryfile and sign the bottom of the last page, or authenticate the document/s with an electronic signature. 3.5 Statutory documentation retention requirement The Italian legislation does not prescribe a specific retention requirement concerning transfer pricing documentation. Therefore, transfer pricing documentation retention is usually determined in accordance to the limitation for transfer pricing adjustments as explained in Paragraph 1.5. 3.6 Language of documentation The masterfile and the countryfile must be drafted in Italian; however, if the taxpayer submits the masterfile prepared by the foreign holding/subholding company, it may be drafted in English. 3.7 Frequency of documentation update Documentation should be reviewed on an annual basis to determine if historical, functional and economic analyses are still relevant, but there is no requirement to formally update documentation. Only small- and medium-sized enterprises (SMEs) are entitled not to update the economic analysis performed to document intercompany Transfer Pricing Handbook – Italy Baker & McKenzie 233 transactions (i.e., the selection of comparable companies) with respect to the two taxable periods following the one the documentation relates to, in case the comparability analysis is based on publicly available information sources, and insofar the comparability analysis factors do not incur substantial changes during the two abovementioned taxable periods. 3.8 IC transaction/other disclosure filed with tax return As indicated above, the availability of transfer pricing documentation has to be communicated to the Tax Authorities by flagging a specific box in the tax return. In the tax return, the volumes of the I/C transactions also have to be indicated. 3.9 Due date of tax returns The yearly tax return must be filed within nine months following the company’s year-end. Therefore, companies using the calendar year must file their tax returns by the end of September each year. 3.10 Comparison with the European Code of Conduct Consistent with the EU Code of Conduct, the Italian transfer pricing documentation should comprise two different sets of documents: the masterfile and the countryfile. Italian transfer pricing legislation prescribes a mandatory format for both the masterfile and countryfile that is complex and more detailed than the format recommended by the EU Code of Conduct. 4. Tax Audit Procedures 4.1 Selection of companies for an audit At the beginning of each fiscal year, the Ministry of Finance prepares and circulates operating instructions among its offices in order to provide guidelines for the auditing activity. 234 Baker & McKenzie The selection of companies to be audited is generally made by using special lists based on criteria chosen each year by the Ministry of Finance. The selection criteria take into consideration a number of facts and elements that are considered by the tax authorities to be signs of possible tax evasion or tax avoidance, such as: (i) a request for the reimbursement of tax receivables; (ii) the specific industry of business activity in which the taxpayer is involved; and (iii) the completion of extraordinary transactions listed in anti-abusive tax provisions (e.g., mergers, de-mergers, contributions in kind and transfers of receivables). Moreover, a tax audit may start based on information collected by the tax authorities during their investigations or auditing activity (for instance, by an exchange of information or a cross-selling activity) or through questionnaires addressed directly to the taxpayer and aimed at obtaining certain types of information. In addition to the existing rules, companies with a turnover higher than EUR100 million, generally referred to as “large enterprises,” should be audited on a yearly basis. The purpose is not to make a general and rigorous investigation, which could affect the capability of large enterprises to carry out their regular business activity, but to provide a sort of “tutorship,” which will also improve the level of collaboration between the taxpayers and the tax administration. Enterprises with a fiscal year turnover higher than EUR25.8 million would generally be subject to a tax audit every two years, and enterprises with a fiscal year turnover between EUR5.1 million and EUR25.8 million will have one every four years. Finally, tax offices are required to audit companies that have reported operating losses for more than one fiscal year. 4.2 Tax audit and appeals procedures Tax audits are normally conducted onsite, that is, at the taxpayers’ offices, without any advance notice. A tax audit may also begin with a preliminary questionnaire sent to the taxpayer, along with a list of Transfer Pricing Handbook – Italy Baker & McKenzie 235 information and documents to be submitted to the tax office within a relatively short period of time. There are no provisions obliging the tax authorities to notify in advance that they are initiating the auditing process. A tax audit may be “general” if it is aimed at reviewing and analyzing the taxpayer’s overall position with regard to income and indirect taxes, or “special,” if its objective is to scrutinize only specific types of taxes or transactions. The Taxpayers’ Charter (2000) establishes the time frame for tax audits (which, in the past, could last up to six months) by providing that the presence of the tax auditors at the taxpayer’s premises may not exceed 30 working days, which can be extended by another 30 working days if the inspection proves to be particularly complex and difficult. Although the physical presence of tax auditors at the taxpayer’s office may not lawfully exceed this number of days, the common practice is, however, that tax auditors will collect the necessary documentation during their visit, which they will then review at their offices. This means that the tax audit will only be, in fact, concluded after a number of months, depending on the size and complexity of the taxpayer’s business activity. Minutes on the report of the daily activity should be prepared and signed by both the tax auditors and the taxpayer at the end of each day when the tax auditors are in the taxpayer’s offices. At the end of the tax audit, the tax auditors will draft a final report (the “Report”) summarizing the violations identified during the tax audit and indicating the proposed tax adjustments and the applicable administrative sanctions. The Report is issued to the taxpayers and forwarded to the competent tax office, which will be entitled to review the tax auditors’ proposed tax adjustments and issue the tax adjustment notice. During the tax audit activity, no resolution procedures are available; the taxpayer can only ask for comments and observations on the 236 Baker & McKenzie inspection activity carried out by the tax auditors to be included in the Report. After the Report has been sent to the taxpayer, the taxpayer has the right to draft and submit to the tax office a brief with some observations and comments on the proposed tax adjustments indicated in the Report to prevent the tax office from including tax assessments and challenges in the final adjustment that appear to be manifestly wrong. Intragroup relationships are generally deeply scrutinized. Tax auditors normally request a copy of all intragroup agreements and any additional documentation proving that intragroup transactions are concluded at arm’s length. Tax auditors do not limit the audit to a mere review of the relevant agreements, but will ask to be given evidence of the underlying economics and benefits achieved by the taxpayers. If there is a lack of evidence regarding management fee agreements, the relevant costs will normally be disallowed entirely. Extraordinary transactions carried out for the purpose of restructuring or business reengineering (such as mergers, de-mergers, transfer of ongoing business, contributions in-kind in exchange for shares and share-for-share exchanges) that have an impact on Italian companies are subject to close scrutiny by the tax auditors for possible exit charge assessment or under the Italian anti-abuse regulations. Under these provisions, the tax authorities are entitled to disallow (but only for tax purposes) transactions that have been put in place without any business reasons and for the sole purpose of obtaining tax savings. Other areas of investigation during tax audits include transactions concluded with low-tax jurisdictions or PEs in the case of the commissionaire/agent structures. The taxpayer may fully accept the conclusions reached by the tax auditors in the Tax Report by giving notice to the relevant tax office within 30 days from the date the Report has been officially served. The acceptance of the Report, with a consequent waiver of any Transfer Pricing Handbook – Italy Baker & McKenzie 237 litigation, entitles the taxpayer to benefit from a reduction of the applicable penalties to one-sixth of the minimum statutory amount. For instance, since in the majority of cases, the penalties are equal to 100 percent of the higher tax assessed, acceptance of the challenges raised in the Report will result in the taxpayer having to pay the higher amount of taxes assessed, plus penalties equal to 16.7 percent. The aim of the provision is to discourage taxpayers from starting tax litigation by reducing the payable penalties. This option is not available to taxpayers who have drafted transfer pricing documentation and properly notified the tax authorities to claim penalty protection in the case of transfer pricing adjustments. The Tax Assessment notice follows the Tax Report and contains final tax remarks against the taxpayer to determine the tax liability and the type and amount of penalties. The Tax Assessment notice cannot be served on the taxpayer before the 60-day term provided by law for written comments has expired. The actual length of time that normally applies from the day on which the Report is served and the day on which the tax office issues (and notifies) the Tax Assessment notice may vary greatly on a case-bycase basis, being in some cases more than one year after the notification of the Report. This is because the competent tax office often issues the tax adjustment notice just before the expiration of the statute of limitation provided by the law. Generally speaking, when a Tax Assessment notice is served, the assessed higher taxes (plus related interest and penalties, if any) will become final and due after 60 days. Before the expiration of the 60- day term, the taxpayer may: (i) pay the requested amount; (ii) file an appeal with the competent tax court; or (iii) file a settlement proposal with the competent tax office. 238 Baker & McKenzie The taxpayer is entitled to settle the dispute upon the receipt of the Tax Assessment by accepting the challenges that were raised by the tax office and by paying the assessed amounts before the 15th day preceding the date fixed for the meeting with the tax office. In such a case, penalties will be further reduced by half and therefore be due for one-sixth of the minimum. In addition to the above, Italian tax legislation allows tax authorities and the taxpayer in a tax court case to settle the dispute by means of a negotiated settlement. In case of a settlement, the taxpayer is obliged to pay the amount of taxes agreed upon with the tax authorities as well as the interest accrued on the relevant amount, plus 40 percent of the tax penalties due on the agreed amount. The payment can be made either in one single instalment at the time of the settlement or in no more than eight quarterly instalments (12, if the total amount due is higher than EUR51,645.69), subject to interest. The settlement terminates the tax case, but has no impact whatsoever on the criminal law consequences, if any, of the accusations that were raised against the taxpayer. The Tax Assessment notice, which is served on the taxpayer by the competent tax office, must be appealed before the First Level Tax Court (the Provincial Tax Court), in the province where the competent tax office is, within 60 days after its notification. The tax office, as the opposing party, has to file a counter-appeal within 60 days from the notification of the appeal brief made by the taxpayer. The tax court will then schedule a public hearing for the discussion of the case, and supplementary documents and briefs can be filed within 20 and 10 days, respectively, prior to the date scheduled for the public hearing. Any decision of the First Level Tax Court may be appealed before the Second Level Tax Court (the Regional Tax Court). The Supreme Court in Rome handles any appeal against a Second Level Tax Court’s decision. Transfer Pricing Handbook – Italy Baker & McKenzie 239 4.3 Administrative proceedings (duties and rights of the taxpayer in the course of an audit, burden of proof) As mentioned, the taxpayer has the right or the opportunity to provide the tax office with comments and clarifications on the tax remarks raised by tax inspectors during the tax audit or in the Report. The burden of proving unlawful behavior on the part of the taxpayer falls on the tax authorities. However, the burden of proof is reversed and may be transferred to the taxpayer when, in the course of the tax audit, the taxpayer is not in a position to provide sufficient documentation justifying its behavior. The most obvious case is management fees. If the taxpayer is not able to provide evidence that the costs paid to a group company acting as a service provider correspond to services actually provided, and that those services brought actual benefits to the recipient, the tax auditors will disallow the cost amount entirely, so that the taxpayer will be obliged to prove the legitimacy of the cost deduction before the tax court. 4.4 Resources available to the tax auditors (secret comparables, databases) The Italian tax authorities do not use secret comparables or similar resources to challenge transfer pricing policies. However, more and more frequently, these are used to challenge the comparables provided in order to disregard some of them, include new ones or present a new set of comparables. For this, the authorities rely on official available databases, including the financial statements of all Italian companies. 4.5 Recent audit developments and experiences Italian tax authorities’ remarks concerning the selection of comparables and benchmark analyses are increasingly denoting a more “technical” approach of the Italian tax authorities to transfer pricing documentation. Concerning the process of selecting the final set of comparables, Italian tax authorities usually do not use pan-European comparables (as only Italian comparables are accepted) and the use of multiple 240 Baker & McKenzie databases because they could operate according to very different logistics. If Italian tax authorities disregard the selection of comparables presented by the company, Italian tax authorities usually conduct a totally new benchmark analysis. When Italian tax authorities carry out benchmark analysis, the following search criteria are usually used: • Absence of operating losses – Italian tax authorities usually accept the inclusion, in the final set of comparables, of just companies that have not incurred operating losses during the fiscal years being assessed. • Minimum turnover – Italian tax authorities usually apply a “filter” related to the level of revenues. • Employees/turnover ratio – This ratio is sometimes applied by the Italian tax authorities to assess the level of comparability of companies. 5. Dispute Resolution 5.1 Mutual agreement procedure (MAP) and the arbitration convention Italy has a significant number of double tax treaties and all of these contain the MAP clause under Article 25 of the OECD Model treaty. However, no procedural rules have been implemented in domestic legislation and only a few MAPs have been carried out. Their findings are confidential and thus, not public knowledge. The Italian tax authorities may make corresponding adjustments to the Italian taxpayer’s income as a consequence of a reallocation of income by a foreign taxing authority, only to the extent that mutual agreement between the two competent authorities has been reached. To the best of our knowledge, however, MAP has not actually been applied yet. The level of enforcement of MAP provided by double taxation treaties has been rather low, and almost nonexistent. No official explanations Transfer Pricing Handbook – Italy Baker & McKenzie 241 exist for this, and the subject has been largely ignored by tax commentators. The likely reason is that MAP is a facultative procedure that does not bind the tax authorities to reach an agreement and is aimed at avoiding double taxation and is thus not appealing to taxpayers. 5.2 Arbitration; possibility and practice under European Arbitration Convention, treaty developments Italy has ratified the EU Arbitration Convention, dealing with correlative adjustments arising as a result of transfer pricing adjustments with respect to EU companies. It functions in much the same way as MAP, but the Convention provides a specific arbitration procedure in case the two competent authorities fail to reach a mutual agreement. In August 2003, the EU Arbitration Commission concluded its first case since adopting the Arbitration Convention by resolving a dispute between Italy and France over the taxation of the affiliate companies of a multinational group. The arbitration procedure is likely to be a more advantageous process for taxpayers than MAP, within an EU context, since the parties are bound to reach a conclusion that avoids double taxation. 5.3 Litigation: practice, typical areas of litigation, any major public cases Regional Tax Court of Lombardy, no. 4287/34/14, 5 August 2014 In determining the arm’s length value of the royalties for the use of trademarks and patents, the Tax administration may apply the transfer pricing rules by referring to the principles contained in Ministerial Circular no. 32/9/2267 of 22 September 1980. In this document, in fact, the Tax administration has identified “arm’s lengthˮ ranges of values to be considered adequate under certain conditions (the “safe harborsˮ). 242 Baker & McKenzie This judgment confirms that the considerations of the 1980 Ministerial Circular, in terms of royalties, may continue to have an important role in order to verify and determine the arm’s length nature of the intercompany transactions, although dated, especially if they do not result supported by a specific policy. Provincial Tax Court of Milan, no. 7996/40/14 In making transfer pricing adjustments based on the comparable uncontrolled price method, the Revenue Agency must make reference to comparable samples (relative to the same period of time), and it can not arbitrarily deviate from the results of the transfer pricing analysis carried out by an independent consulting firm. In particular, this judgment underlines that loss-making comparables can not be automatically excluded but the exclusion is to be evaluated through a case-by-case analysis. 6. Interest and Penalties 6.1 Interest on overdue tax On overdue taxes, the following interests are applied: • From the day after the payment term to 30 September 2009, the applied interest rate is 2.75 percent. • From 1 October 2009 to 31 December 2009, the applied interest rate is 4 percent. • From 1 January 2010, the applied interest is 3.5 percent. 6.2 Penalties: nature, amount, if deemed as serious for purposes of arbitration In the event of transfer pricing adjustments, the penalties that can be avoided while preparing adequate transfer pricing documentation are the following: Transfer Pricing Handbook – Italy Baker & McKenzie 243 • Administrative penalty – May range from 100 percent to 200 percent of the higher tax applied on the adjusted revenues (taxpayers may obtain tax penalty protection if adequate transfer pricing documentation is prepared and the notice to the Tax Authorities is filed) • Criminal penalties (only if defined thresholds are exceeded) – Imprisonment from one year up to three years 7. Advance Pricing Agreement Procedures 7.1 Availability of unilateral/bilateral APAs A unilateral APA may be requested by any enterprise engaged in international business, resident in the Italian territory, or nonresident but with a PE in Italy. A nonresident company trading in Italy through a PE is eligible for the APA procedure simply because of the existence of its PE in Italy. On the other hand, an Italian resident company would have to prove that it controls, directly or indirectly, a nonresident company; that it is controlled, directly or indirectly, by a nonresident company; or that it and the non-resident company are both controlled by the same company. The ruling has a preventive nature because it aims to determine the fair market value for transfer pricing purposes. Despite that, the process may be viewed as an opportunity to ratify the conduct followed by the company up to that time. If the approach of the company, as notified to the authorities, would still have been put in place within the tax year, the company may want to extend the effectiveness of that ruling. 7.2 Description of the application process and conditions, timing, possibility of roll-back The procedure is as follows: • The taxpayer submits a formal application to the appropriate office of the Revenue Agency. 244 Baker & McKenzie • Within a 30-day period, the tax authorities assess the taxpayer’s eligibility for the APA procedure. • If the taxpayer is eligible for the APA procedure, he or she is invited to attend a meeting (within 30 days) in order to verify the information submitted, receive a potential request for additional information, and plan the timing of the procedure as a whole. • The procedure may require several different stages, but it must be completed in 180 days. The tax authorities may gain access to the premises where the company’s activities are conducted, in order to acquire further information. In addition, the Italian tax authorities may, by international cooperation procedures, solicit the support of foreign authorities (in this case, the duration of the procedure may be extended). As a result of the changes introduced by Decree Law No. 145, 23 December 2013 (the “Decreto destinazione Italiaˮ), the provisions included in the APA will be operative from the financial year in which it enters into force and for the next four years, and not two, as previously stated in Article 8, Paragraph 2, Decree Law No. 269/2003. In case there is a change in the conditions underlying the APA, both the taxpayer and the tax authorities may apply for a modification of its terms; a new agreement must be reached within 180 days from the request of the taxpayer/tax authorities. Ideally, the business should request a renewal of an APA not later than three months before the expiry of its current term; the renewal application should expressly consider any changes or anticipated changes in facts and circumstances since the existing APA was reached, whether any amendments are necessary and if these demonstrate that the proposed methodology is, and still is, appropriate. Transfer Pricing Handbook – Italy Baker & McKenzie 245 7.3 Fees There are no APA filing fees. 7.4 Country-specific experiences with APA procedures The APA procedure requires a long period (about two years) to be completed up to the signing of the final agreement with the Tax Authorities. During the APA procedure, meetings with Italian Tax Authorities are very frequent, and the Tax Authorities also access the premises frequently in order to check the information provided by the taxpayer. To define the transfer pricing policy of the intercompany transaction for which the APA has been requested, the Italian Tax Authorities usually apply the Transactional Net Margin Method or TNMM (which is done by comparing the profit/net margin earned by a related company with the profit/net margin achieved by independent parties in comparable transactions; the comparison is focused on the profit/net margin related to an appropriate basis of sales, total costs or assets), focusing on the median and not on the entire interquartile range identified through the benchmark analysis. 8. Other Topical Subjects/Trends New trends can be detected in audits performed by the Italian Tax Authorities. In particular, recent tendencies are the following: – PE risk for dependent agents The risk is particularly high for structures that qualify as agents, commissioners and sales support service providers. In such cases, the Tax Authorities generally perform profit allocations based on simplified TNMM approaches. – Focus of specific industries 246 Baker & McKenzie Italian Tax Authorities are used to focusing on specific industries (i.e., pharmaceutical and bio-medical industries) and propose that the same benchmark and economic analyses be used in different audits performed on taxpayers operating in the same industry. – Aggressive audit approach In recent audits, the Italian Tax Authorities have sometimes adopted an aggressive approach when accessing IT infrastructure and systems and collecting the emails of the taxpayer under audit. In particular, this approach is more probable to be adopted during the inspections performed by the Tax police. 8.1 Significant developments that occurred in 2014 Patent box regime Law no. 190/2014 (so-called Stability Law for 2015) introduces an optional tax regime for income derived from the right to use or from the direct use of intellectual property, patents, know-how and trademarks, even if exclusively commercial, as modified by the Law Decree no. 3 of January 2015 (so-called Investment compact). This new tax regime is applicable from the fiscal year 2015. For the first two fiscal years, 2015 and 2016, the extent of the incentive is reduced, as the portion of exempted income will be equal, respectively, to 30 percent for 2015, and 40 percent for 2016. From fiscal year 2017, the tax exemption will be equal to 50 percent of the income deriving from the (direct or indirect) use of patent, intellectual property, know-how, as well as any kind of trademark. The tax concession is subject to the performance, by the beneficiary company, of internally created research and development activities on the intangible assets or through agreements with universities and similar institutions. The Law Decree no. 3/2015 extends the relevance of the research activity to that one performed through contracts with third party companies not belonging to the same group of the company owning the intangible asset. Transfer Pricing Handbook – Italy Baker & McKenzie 247 The exempted income is the result of the ratio between the research expenses and the total cost of production. The numerator can be increased to include the expenses incurred for the purchase and research on the assets from related parties, but within the limit of 30 percent of the numerator. A taxpayer can benefit from the patent box regime only following an international standard ruling procedure. The tax exemption of the income deriving from the direct use of intangible assets, without any consideration, requires the identification of the economic contribution of such assets to the total income earned by the company. To determine this amount, the activation of an international standard ruling procedure (i.e., APA) is requested. Therefore, from 2015, the transfer pricing rules will also be applied to companies with exclusively national activities with regard to licensing transactions or sale of intangible assets. On the other hand, following the modifications introduced by the Law Decree no. 3/2015, the ruling procedure is optional if the income derives from intercompany transactions of sale or license of IP, both with resident and non-resident counterparties. In this case, the international ruling procedure presents its typical characteristics, being aimed at determining the arm’s length value of the intercompany transactions, with the only particularity that it will be applied also to transactions between Italian resident companies. Transfer Pricing Handbook – Luxembourg Baker & McKenzie 249 Luxembourg Andre Pesch, Principal Andre Pesch heads Baker & McKenzie’s Luxembourg Tax Practice. He has extensive experience in advising on Luxembourg tax issues related to tax-efficient investment holding, financing and IP structures. His clientele encompasses many multinationals, financial institutions (banks, insurance companies) and asset managers (alternative and retail). He often intervenes in the tax analysis of capital market transactions and the development of structured products. [email protected] Tel: +352 26 18 44 218 Amar Hamouche, Tax Director Amar Hamouche is a member of Baker & McKenzie’s Tax Practice Group in Luxembourg. Prior to joining Baker & McKenzie in 2011, he worked as a senior tax manager at a ‘Big Four’ accountancy firm’s Tax Advisory Services. He regularly advises companies on a wide range of local and international tax matters. [email protected] Tel: +352 26 18 44 234 250 Baker & McKenzie Ludovic Deflandre, Senior Tax Specialist Ludovic Deflandre is a member of the Tax Practice Group in the Firm’s Luxembourg office. Prior to joining the Firm, he was a tax advisor in the VAT department of Ernst & Young Luxembourg. [email protected] Tel: +352 26 18 44 228 Baker & McKenzie Luxembourg 10 - 12, Boulevard Roosevelt L-2450 Luxembourg Luxembourg Transfer Pricing Handbook – Luxembourg Baker & McKenzie 251 1. Statutory Rules and Administrative Regulations Luxembourg does not have specific transfer pricing legislation. There are two articles in the Luxembourg income tax law (LITL) that refer to the arm’s length principle – Article 56 LITL relating to the transfer of business profits, and Article 164 (3) LITL relating to hidden profit distribution. Despite the fact that Luxembourg does not have any specific transfer pricing legislation, the Luxembourg tax authorities have recently issued two circulars, Circular n° 164/2 and Circular n° 164/2bis (the “Circulars”), in relation to the tax treatment of intercompany financing transactions. The Circulars aim to provide clear rules on the scope of the application of the arm’s length principle to international groups engaged in intercompany financing transactions, and they generally refer to the OECD principles. In addition, following the announcement made by Prime Minister Xavier Bettel on the salient elements of the state budget for the year 2015, a draft bill N° 6722 on the implementation of the first part of measures for the future package “Zukunftspack” was submitted to the Luxembourg Chamber of Representatives on 15 October 2014. The bill notably contains measures in order to strengthen the national legislation applicable to transfer pricing. According to the provisions of the draft bill, Article 56 LITL will be replaced. The aim is to grant a formal legal basis to the arm’s length principle and hence clarify the legal provisions applicable on transfer pricing. In particular, the new article will make a clear reference to the arm’s length principle and will regulate the tax treatment applicable to associated entities carrying out commercial and financial transactions. Accordingly, a new provision under the current paragraph 171 AO should be introduced. This new provision will clarify that existing 252 Baker & McKenzie information, and documentation obligations will also be applicable for transfer pricing purposes. 2. Transfer Pricing Methods Apart from the references to the arm’s length principle in the LITL, there is no further guidance on transfer pricing. Therefore, where transfer pricing issues are concerned, Luxembourg refers to the OECD Transfer Pricing Guidelines (the “OECD Guidelines”) to determine whether the arm’s length principle has been respected in a particular case. The OECD Guidelines have, however, not been officially enacted in the LITL, which means that the parties might prove adherence to the arm’s length principle in their transactions by means of other generally accepted transfer pricing guidelines, such as the Resale Price and the Cost Plus method. No hierarchy is currently in force among the different methods. 3. Transfer Pricing Documentation and Filing Requirements The LITL does not provide for specific transfer pricing documentation requirements. However, it is recommended that intercompany transactions can be justified by the production of any relevant documentation. As the LITL does not provide for specific transfer pricing documentation requirements, there is no specific provision regarding filing requirements. Nevertheless, in the scope of a tax audit, the Luxembourg tax authorities might request the companies to provide the documentation within a certain timeframe. In addition, according to the above draft bill, existing information and documentation obligations will also be applicable for transfer pricing purposes. Transfer Pricing Handbook – Luxembourg Baker & McKenzie 253 Where the Circulars apply in a specific case of intercompany financing transactions, the companies have to provide the Luxembourg tax authorities with a transfer pricing study respecting the OECD Guidelines and containing a complete description of the transfer pricing method used and detailed analysis justifying this method. 4. Tax Audit Procedures There is no specific transfer pricing division with the Luxembourg tax authorities dealing with transfer pricing issues. Transfer pricing issues will be dealt with by the tax office to which the company is registered. The Luxembourg tax authorities have to prove that market conditions have not been followed during the determination of the prices between the parties. Within the scope of the tax audit, the Luxembourg tax authorities might adjust the tax returns filed by the company by challenging the transfer pricing. Should it be the case, the burden of proof will be reversed and it will then be up to the taxpayer to prove that these adjustments are not appropriate. There is no specific time limitation on transfer pricing adjustments. The general statute of limitation of five years starting from 1 January of the year following the relevant tax year is then applicable. The fiveyear period might be extended up to 10 years in certain circumstances, such as in case of fraud. 5. Dispute Resolution The Luxembourg tax authorities are usually flexible with the taxpayer and open for mutual agreement procedures. In practice, the Luxembourg tax authorities might accept compensating adjustments under certain conditions on a case-by-case basis. 254 Baker & McKenzie 6. Interest and Penalties The potential adjustments that could be made by the Luxembourg tax authorities in the case a tax audit might result in penalties of 0.6 percent per month on the tax assessed. However, in practice, the risk of litigation and penalties is quite remote. The tax authorities will re-assess and/or adjust the taxable result of the company so that it is in line with the arm’s length principle, but no specific penalties are likely to be imposed for this. 7. Advance Pricing Agreement Procedures Except for companies engaged in intercompany financing transactions, there is no formal advance pricing agreement procedure with the Luxembourg tax authorities. This said, the tax authorities might give their view on transfer prices used by the companies on their request and on an individual basis. In practice, agreements are obtained from the tax authorities where the parties agree upfront on the level of the spread to be realized in respect of their transactions, particularly in the scope of financing operations or intellectual property structuring. The APA procedure will actually become more and more important in the scope of intercompany financing transactions as the Circulars explicitly require that a transfer pricing study is attached to the advance tax clearance letter in which the companies will agree beforehand on the tax treatment of their contemplated transactions. Without a valid transfer pricing study, the advance tax clearance letter cannot be presented to the Luxembourg tax authorities. Transfer Pricing Handbook – The Netherlands Baker & McKenzie 255 The Netherlands Margreet Nijhof, Partner Margreet Nijhof focuses on international tax planning for multinationals, with an emphasis on corporate reorganizations and restructurings, and a strong focus on transfer pricing. Margreet joined the international tax group at Baker & McKenzie’s San Francisco/Palo Alto office in 1997. In July 2008, she joined the international tax group of Baker & McKenzie Amsterdam where she currently co-leads the Transfer Pricing Group. [email protected] Tel: +31 20 551 7543 Hub Stolker, Associate Hub Stolker works as a tax adviser in the International Tax team of Baker & McKenzie Amsterdam. Hub advises on transfer pricing, business restructuring and avoidance of double taxation, and corporate tax matters more generally. He has published articles in BNA Magazine and has lectured at the Maastricht University. Hub joined the Firm in 2009. [email protected] Tel: +31 20 551 7847 Baker & McKenzie Amsterdam N.V. Claude Debussylaan 54 1082 MD Amsterdam P.O. Box 2720 1000 CS Amsterdam The Netherlands 256 Baker & McKenzie 1. Statutory Rules and Administrative Regulations 1.1 Existence of the arm’s length principle As of 1 January 2002, transfer pricing rules became effective in the Netherlands. Article 8b of the Dutch Corporate Income Tax Act (CITA) contains transfer pricing rules codifying the arm’s length principle. Before 1 January 2002, the arm’s length principle was also adhered to through the general concept of profits. With the introduction of Article 8b of CITA, the Netherlands formally embraced the arm’s length principle as defined in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the “OECD Guidelines”) and included formal administration requirements. The wording of Article 8b closely follows the wording of Article 9 of the OECD Model Tax Convention. Article 8b of the CITA allows the Dutch Tax Administration (DTA) to adjust transfer prices when the transactions are not at arm’s length. The arm’s length principle set out in Article 8b applies to all Dutch resident taxpayers, including permanent establishments (PEs). 1.2 Transactions in scope (e.g., including financing, IP returns) Article 8b casts a wide net; no particular intercompany transactions are excluded from its application. 1.3 Obligations (documentation, filing) Upon filing the tax return, the taxpayer does need not to provide transfer pricing documentation to the DTA. Instead, taxpayers are expected to be able to support their intercompany transaction(s) at the time the transaction(s) take place. Moreover, transfer pricing documentation has to be provided upon the request of the DTA. There are no specific procedural rules governing the delivery of transfer pricing-related information by taxpayers. Based on general audit experience, if the tax authorities request information, the taxpayer must generally respond within four weeks. In the case of complex transactions, this period may (upon consultation with the Transfer Pricing Handbook – The Netherlands Baker & McKenzie 257 DTA) be extended to three months. That said, in some cases, the tax inspector has only allowed the taxpayer two weeks to provide the information requested. Although the Dutch transfer pricing obligations are rather pragmatic at this stage, it is also expected that the landscape will be more formal within the next couple of years. This development has mainly been driven by the OECD’s Base Erosion and Profit Shifting project, and in particular by the country-by-country documentation obligations. Upon publication of this handbook, the Netherlands hasn’t provided any specific regulations or guidance at this stage, but generally speaking the Netherlands is one of the early adaptors of new international tax standards and OECD initiatives. 1.4 Associated enterprises definition Article 8b applies to transactions between “associated enterprises.” Dutch tax law does not provide a specific definition of associated enterprises. However, Article 8b CITA provides that the arm’s length principle is applicable to transactions between: • an enterprise that directly or indirectly participates in the management, control or capital of any other enterprise (or vice versa); or • an individual who participates directly or indirectly in the management, control or capital of two or more enterprises that are dealing with each other. The State Secretary of Finance has clarified in Dutch parliamentary debates on Article 8b CITA that enterprises are associated if a party is able to control or influence pricing between two or more enterprises. Whether this requirement is satisfied should be analyzed on a case-bycase basis. It is also possible to contact the tax inspector in advance and request a (preliminary) ruling on whether or not the enterprises are associated. A Dutch taxpayer can also obtain other rulings as described below. 258 Baker & McKenzie 1.5 Statute of limitation for transfer pricing adjustments Under the general rules, a final corporate income tax assessment should be issued by the DTA within three years, starting from the end of the fiscal year. If the DTA grants an extension for filing the tax return, the assessment period is extended for the same period as the extension period granted. The tax authorities can issue an additional tax assessment within five years, starting from the end of the fiscal year. Moreover, in case of foreign-sourced income, the period for issuing an additional tax assessment may upon certain conditions be extended to 12 years. An additional tax assessment is only possible in limited circumstances, including: • if the DTA has “new facts” that it could and should not have been familiar with at the moment the original tax assessment was issued; • if the taxpayer acted in bad faith; or • if (1) by mistake, no tax assessment has been filed; or (2) if by mistake, the taxable amount is set too low and a reasonable taxpayer is aware of this mistake. The latter requirement is at least satisfied if the taxable amount is 30 percent lower than the correct taxable amount. Such additional assessments may only be issued (1) two years after the moment that the initial tax assessment has been issued; or (2) two years after the moment that it was determined that no tax assessment will be issued. 1.6 Attribution of profits to PEs At the beginning of 2011, the Dutch State Secretary of Finance issued a decree clarifying the position of the DTA on the allocation of profits to PEs. Transfer Pricing Handbook – The Netherlands Baker & McKenzie 259 From the decree, it can be derived that the arm’s length principle similarly applies to taxable income of nonresident taxpayers. This is in agreement with the existing practice where income allocation to PEs of nonresident taxpayers is determined based on Article 7 of the OECD model tax convention. The jurisdiction in which the permanent establishment is situated may tax the income to the extent the income can be allocated to the PE. The earnings and cost will be divided between the main company and the PE, depending on the functions performed. The main company and the PE need to be treated as if they are independent enterprises. This is the “separate entity” approach. 2. Transfer Pricing Methods 2.1 General acceptance of OECD guidance The Netherlands is a member of the OECD and generally follows the framework of the OECD Guidelines. Official positions and clarifications are contained in various transfer pricing decrees. The Dutch Ministry of Finance published a transfer pricing decree (no. IFZ2013/184M) (“Decree 2013/184”) on 26 November 2013. Decree 2013/184 provides further (domestic) guidance on the application of the arm’s length principle, as well as in cases where the OECD Guidelines do not indicate a clear position or where there is room for different interpretation. Decree 2013/184, which became effective as of 27 November 2013, replaces two prior transfer pricing decrees released in 2001 (no. IFZ2001/295M) and 2004 (no. IFZ2004/680M). Decree 2013/184 identifies three possible areas of profit shifting and proposes countermeasures through an interpretation of the arm’s length principle. The three areas include: (i) transactions involving intangibles; (ii) centralized procurement activities; and (iii) captive insurance companies. In addition to these three specific areas, Decree 2013/184 specifically focuses on financial transactions. In section 2.7, we elaborate on the Dutch position regarding these transfer pricing topics. 260 Baker & McKenzie 2.2 Acceptability and hierarchy of methods, best method rules In line with the 2010 updates of Chapters 1 to 3 of the OECD Guidelines, the Netherlands does not impose a rigid hierarchy of methods. Decree 2013/184 confirms this approach. Nevertheless, should a comparability analysis show that more than one method may be applied in an equally reliable manner, traditional methods (i.e., the Comparable Uncontrolled Price [CUP] Method, the Resale Price Method [RPM] and the Cost Plus Method [CPM]) are preferable to transactional methods (i.e., the Transactional Net Margin Method [TNMM] and the Profit Split Method [PSM]). Among the traditional methods, the CUP has priority over the other two. The choice of the method has to be substantiated by a comparability analysis. However, the taxpayer is not required to provide in-depth evidence of having tested the rejected methods under the “best method” analysis. 2.3 Acceptability of year-end adjustments and retroactive adjustments Adjustments carried out by the taxpayer after the end of the accounting year but in any case before a final tax assessment by the DTA (self-initiated adjustments) may be possible, as long as the adjustment relates to facts that existed before the accounting year ended. When making such an adjustment, it should be considered that the application of the transfer pricing method used will often lead to a range of results within which the transfer price to be applied may be found. However, when there is a shift within the range because the initially established transfer price is adjusted up or downward, the taxpayer will need to substantiate the changed facts on the basis of which an adjustment of the transfer price is justified. If no changed circumstances can be indicated as a result of which an adjustment of the transfer price can be justified, the DTA assumes – according to Decree 2013/184 – that the change of the transfer price will generally be tax motivated. In those situations, the DTA will not agree with the changed transfer price. Furthermore, a requirement for accepting a Transfer Pricing Handbook – The Netherlands Baker & McKenzie 261 shift within the range is that the price adjustment is in fact written down in an agreement between the parties and is actually charged. 2.4 Calculation of comparability adjustments In the Netherlands, there are no prescribed methodologies to calculate comparability adjustments. However, the comparability adjustments as described in the Annexes to the OECD Guidelines should be considered since the Netherlands adheres to these provisions. Generally, adjustments that are economically sound and mathematically reliable may be submitted and will be supported. 2.5 Commensurate-with-income rules and regulations In Decree 2013/184, it is stated that there are circumstances where nonrelated parties would agree upon a price adjustment clause, indicating that the price depends on the future revenue of the relevant assets, rather than on a fixed price. A price adjustment clause should be included, mutatis mutandis, in the intercompany agreement of the transfer of intangible assets when valuation at the time of the transaction is not possible. 2.6 Safe havens and rules of thumb The Netherlands adheres to the OECD Guidelines and its corollary, the arm’s length principle. No safe harbors, rules of thumb or similar administrative simplification procedures have been published, except for intra group services. For intragroup services, the starting point is the use of an arm’s length fee with an appropriate profit margin. However, it is also reflected in Decree 2013/148 that on the basis of a cost/benefit analysis, it may be concluded that services such as bookkeeping, legal affairs, fiscal affairs and human resources may be considered support services that do not necessarily require a mark-up if: (i) these activities do not add more than marginal value to the primary business processes of the group; and (ii) the respective services are also not provided more than incidentally to nonrelated parties. Also, for other than the 262 Baker & McKenzie abovementioned support services, the DTA may – upon certain conditions – approve, on request of the taxpayer in advance, that instead of determining a mark-up, only the relevant cost will be charged. 2.7 Additional guidance from Decree 2013/148 Additional guidance from Decree 2013/148 reflects the Dutch progressive stance toward the current projects undertaken by the OECD, such as the project on the transfer pricing aspects of intangibles and the Action Plan on Base Erosion and Profit Shifting (also referred to as BEPS) as well as the European Commission’s initiative to fight tax fraud and tax evasion and the debate on “fair share” in international taxation. As mentioned, the guidance includes the following areas: (i) transactions involving intangibles; (ii) centralized procurement activities; (iii) captive insurance; and (iv) financial transactions. (a) (In)Tangible assets The section on (in)tangible assets in Decree 2013/148 borrows certain elements of the Revised OECD Discussion Draft that was released earlier that year.1 Decree 2013/148 provides guidance on what the DTA considers arm’s length behavior and states that: • Third parties would normally only enter into a transfer of intangible assets if both parties expect an increase in (combined) profitability resulting from the transaction. • Therefore the buyer needs to have the functionality in order to add value and control risks. 1 The Revised Discussion Draft on Transfer Pricing Aspects of Intangibles (the “Revised OECD Discussion Draft”) as published by the OECD on 30 July 2013. Available online at http://www.oecd.org/ctp/transferpricing/revised-discussion-draft-intangibles.pdf. In the meantime, the OECD issued on 16 September 2014 an updated report on the same topic. Transfer Pricing Handbook – The Netherlands Baker & McKenzie 263 • The transfer of a (in)tangible asset is commercially irrational if there is no expectation of an increase in the combined profits. The decree also discusses a situation where the buyer of intangible assets is located in a low-tax jurisdiction. In the absence of the relevant functions at the level of the buyer, there should be no expectation of increased (combined) profits. Therefore, the buyer will not be able to benefit from the low(er) tax regime. (b) Central purchasing companies The guidance provided for in Decree 2013/148 is, to a large extent, in line with the Revised OECD Discussion Draft on Chapter 1, where the issue of centralizing purchasing functions is addressed. The Revised OECD Discussion Draft stipulates that benefits arising from group synergies connected to deliberate concerted group actions, such as centralizing the purchasing function, should generally be allocated among group members in proportion to their contribution to the creation of the synergy. This means that benefits arising from increased purchasing power should, after appropriately remunerating the central purchasing company, be allocated among the members of the group contributing to the increased purchasing power. Decree 2013/148 further states that additional benefits resulting from discounts obtained due to increased purchasing power should be allocated among the relevant affiliates. The centralized procurement company is only entitled to more than a routine return to the extent that the (additional) discount results from the specific knowledge and skills of the centralized purchasing company. Allocation of profits to procurement companies beyond a routine return will require a clear demonstration that the procurement activities constitute a core function. (c) Captive (re)insurance companies The third area of potential profit shifting behavior addressed by Decree 2013/148 includes captive (re)insurance companies. In short, it is stated that in cases where the captive does not perform certain key 264 Baker & McKenzie (re)insurance-related activities such as product development, marketing and sales, insurance accreditation, asset and liability management, and the development of an independent reinsurance policy, the captive should only be entitled to a routine remuneration. (d) Financial transactions The other two main topics covered are financial guarantees and intercompany loans. With regard to documentation, additional documentation burden applies in the case of financial transactions. To illustrate, pursuant to Decree 2013/148, a nonrelated borrower will, in general, not conclude a loan transaction with a company that has a creditworthiness below investment grade (< BBB- (S&P rating)). For these transactions, additional documentation is required. More specifically, the company should make it plausible that the loan has been agreed upon under arm’s length conditions. 3. Transfer Pricing Documentation and Filing Requirements 3.1 Documentation requirements Article 8b CITA provides that, for transactions with related parties, taxpayers are required to maintain documentation demonstrating how the intercompany price has been established and that the terms and conditions of the intercompany agreements were established at arm’s length (in essence, this requires that a transfer pricing report be prepared). However, the information that should be included in transfer pricing documentation is not specified in Article 8b, in the parliamentary debates, nor in any of the transfer pricing decrees. Nevertheless, the Ministry of Finance has indicated that the documentation should contain: • a functional analysis, in which the five comparability factors as mentioned in the OECD Guidelines are taken into account, namely: (i) the characteristics of the goods and/or services; (ii) Transfer Pricing Handbook – The Netherlands Baker & McKenzie 265 the allocation of the functions, risks assumed and assets used; (iii) contractual terms; (iv) economic circumstances; and (v) business strategies; • a description of the transfer pricing method applied; and • the result of the application of the transfer pricing method. There is no explicit obligation for the taxpayer to include an economic study or a comparability study as such, although it is common practice to include one. If there is insufficient information on how the transfer prices were established, the burden of proof may shift to the taxpayer. This implies that in such cases, the DTA may adjust the taxpayer’s profit to what the DTA deems to be at arm’s length (within reasonable limitations). It will then be up to the taxpayer to provide evidence that the assumption of the tax authorities is incorrect. In 2006, the EU Joint Transfer Pricing Forum adopted the Code of Conduct on Transfer Pricing Documentation. The DTA accepts transfer pricing documentation that is consistent with the Code of Conduct. Also, Decree 2013/148 acknowledges that taxpayers may comply with their documentation requirement by applying the “European Code of Conduct on EU Transfer Pricing Documentation” as accepted by the Council of the European Union. There is no obligation to update the comparability analysis of a transfer pricing report on a yearly basis. However, in order to ensure that the transfer pricing documentation is up to date, it is advisable to confirm that the transfer pricing documentation still reflects reality and to update the transfer pricing documentation, if necessary, once a year. As mentioned under Section 2.7, a related party loan transaction with a company that has creditworthiness below investment grade is scrutinized by the DTA. For these transactions, additional 266 Baker & McKenzie documentation is required. More specifically, the taxpayer should make it plausible that the loan has been agreed upon under arm’s length conditions. 3.2 Filing requirements No transfer pricing documentation has to be submitted with the filing of the tax return. Although the return does not include any references to the contemporaneous existence of transfer pricing documentation, the return does require an indication of the existence of specific related-party transactions. 3.3 Penalties Although Dutch law does not provide for a specific transfer pricing penalty regime, penalties may be imposed if the taxpayer: (a) does not keep accounts or does not keep the accounts according to the transfer pricing documentation requirements; (b) does not keep books or other information that he or she is required to; or (c) does not cooperate with an audit. General tax penalties may range from 10 percent to 100 percent of the amount of the assessment. If the taxpayer has a transfer pricing policy and documentation in place, penalties in case of an adjustment will typically be mitigated. In fact, the State Secretary for Finance has indicated that fines will be imposed only if the use of non-arm’s length prices is the consequence of serious misconduct (grove schuld) or conditional intent (voorwaardelijke opzet). 4. Tax Audit Procedures Dutch taxpayers must file a corporate income tax return annually. As noted above, no specific transfer pricing documentation should be attached to the return, but the tax return form contains transfer pricingrelated elements. Subsequently, the tax inspector will issue (one or more) preliminary corporate income tax assessments, followed within three years by a final corporate income tax assessment. This period may be extended if an extension has been granted for filing the tax return. Transfer Pricing Handbook – The Netherlands Baker & McKenzie 267 4.1 Selection of companies for an audit The degree of DTA scrutiny depends on several facts and circumstances. For example, specific statements in the tax return may lead to an audit or request for additional information. A company may also be selected for an audit randomly. The DTA does not publish a periodic list of audit issues. With respect to transfer pricing-related issues, the DTA may exchange information from different disciplines. For example, they may use Customs and/or VAT valuations to verify the arm’s length character of an intercompany transaction. In addition, tax authorities from various countries may exchange information through formal and informal procedures, or even start a multinational audit. In the Netherlands, we are seeing more and more multinational audits (e.g., a combined audit of multiple European countries on several tax and transfer pricing-related issues). Transfer pricing-related issues have increasingly gained the attention of the DTA. In general, the Dutch tax inspectors have a mature enough level of knowledge to handle transfer pricing issues. If a case involves more complex transfer pricing-related matters, the competent tax inspector will handle the issue or audit, together with colleagues from the Transfer Pricing Coordination Group. 4.2 Administrative proceedings: duties and rights of the taxpayer in the course of an audit, burden of proof, etc. (a) Duties and rights Dutch resident companies (including PEs of foreign companies in the Netherlands) are obliged to maintain and keep administrative records for seven years. Administrative records include books, documents and other data holders. These records should be kept in such a manner that they clearly show the rights and obligations of the taxpayer at any given moment and any other information relevant for taxation. 268 Baker & McKenzie Upon request, a Dutch resident company should provide information to the tax authorities. The following information is relevant under Dutch tax law: • Every Dutch resident company has the obligation to provide the tax inspector – upon request – with information, books and documents that may be relevant in connection with the taxation of that company. • A person or company can also be obliged to provide information regarding other companies/persons. In practice, this means that: (i) a Dutch parent company may be obliged to provide information about books and documents of a foreign subsidiary in which it has a controlling interest; or (ii) a Dutch subsidiary may also be obliged to provide information about its foreign parent or other affiliates. However, per 1 July 2011, the “information decision” or “information request” (informatiebeschikking) was introduced. As a consequence of this information decision, a taxpayer can formally appeal against the legitimacy of an information request upon its issuance, whereas prior to 1 July 2011, the taxpayer could only appeal against such an information request once a tax assessment was imposed. Due to the formal appeal, the tax inspector should contemporaneously substantiate in its information decision what is expected from the taxpayer and why the requested information is relevant from the perspective of the DTA. If the decision of the DTA on the formal appeal against the information decision is unfavorable, the taxpayer can appeal in the courts against the decision of the DTA. At the time of a tax audit, the taxpayer must provide the tax auditor not only with the administrative records but also with other data and information, such as minutes of the meetings, client files and receipts. In light of the above, it should be noted that the tax auditor is not authorized to physically search against the taxpayer’s will for documents stored in filing cabinets and computers. The taxpayer Transfer Pricing Handbook – The Netherlands Baker & McKenzie 269 would be well advised not to give the tax auditor permission to go “look for documents” by himself or herself since correspondence with and advice from civil law notaries (notarissen) and attorneys-at-law (advocaten) are covered by the attorney-client privilege and do not have to be disclosed. Communications with tax consultants do not have legal privilege. However, case law has established that correspondence with or advice from tax consultants does not, in certain circumstances, have to be disclosed, based on the principle of “fair play.” Accordingly, it is sensible to keep these documents separate from documents related to tax and financial administration. Finally, the auditor of the DTA also has the right to make copies, printouts and extracts of any information provided. It is advisable for the company to make its own copies in order to keep track of all information the auditor of the DTA has gathered. (b) Burden of proof Dutch tax law provides that, for transactions with related parties, taxpayers are required to maintain documentation demonstrating how the intercompany price has been established and that the terms and conditions of the intercompany arrangements are established at arm’s length. If there is no sufficient information on how the transfer prices were established, there may be a reversal of the burden of proof. This implies that in such a case, the tax authorities may adjust the taxpayer’s profit to what they deem to be at arm’s length (within reasonable limitations). It will then be up to the taxpayer to provide evidence that the assumption of the tax authorities is incorrect. In the case of an audit, failure to provide (relevant) data and information such as accounts receivable/payable and administration fees, to offer books and documents for inspection, to keep proper administrative records and comply with the documentation obligation can lead to a reversal of the burden of proof. 270 Baker & McKenzie 4.3 Tax audit and appeals procedures (a) Tax audit As standard practice, an auditor of the tax authorities will contact the company in advance to announce his or her visit. Particularly in the case of transfer pricing issues, a company visit is made generally to collect information and gain insight into operational management and the accounting system of the company (in other words, the audit verifies whether the functions, assets and risks documented are in accordance with actual practice). Accordingly, this type of tax audit is not aimed at checking the correctness of a particular tax return. By contrast, the book audit is aimed at checking the degree of truthfulness of the tax returns submitted and the accounting system. The tax audit may lead to a transfer pricing dispute. Such a dispute may be settled during an audit, thus avoiding litigation. If the dispute is not settled, the tax inspector will normally adjust the intercompany pricing. (b) Appeal procedures If the company disagrees with the inspector’s adjustment, the company may file a formal objection with the DTA. If the formal objection does not resolve the transfer pricing issue, an appeal may be filed with the District Court (Rechtbank). An appeal against a wholly or partially unfavorable decision of the District Court may be filed with the Court of Appeal (Gerechtshof) and, ultimately, with the Dutch Supreme Court (Hoge Raad). 4.4 Resources available to the tax auditors (e.g., secret comparables, databases) Generally speaking, Dutch tax inspectors have a good basic knowledge of transfer pricing-related issues. More complex issues are handled in conjunction with the Transfer Pricing Coordination group, which has access to various transfer pricing databases. Transfer Pricing Handbook – The Netherlands Baker & McKenzie 271 Generally speaking, no use is being made of “secret comparables” for substantiating transfer pricing adjustments, except in cases where there is a situation involving a shift of the burden of proof. 4.5 Recent audit developments and experiences (e.g., focus on specific transfer pricing areas) The DTA has not published a list of specific areas subject to heightened audit scrutiny. That said, based on our experience and (limited) case law development, several areas of interest can be distinguished: • The arm’s length nature of loan transactions and guarantees • The arm’s length nature of transactions with low-tax jurisdictions • Business restructuring transactions • Transactions with captives (group (re-)insurance companies) • Transfer pricing planning with regard to carried-forward losses • Transactions without sufficient economic substance 5. Dispute Resolution The lack of (recent) case law is in part due to the easy accessibility of the Advance Pricing Agreement (APA) program. Moreover, transfer pricing disputes are often settled before reaching litigation. Another recent development that may mitigate transfer pricing disputes in court is the Horizontal Monitoring (Horizontaal Toezicht) program instituted by the DTA. Under this program, the taxpayer sits down on a contemporaneous basis with the DTA to come to an upfront agreement with the DTA on tax positions that will be taken in the return. Obviously, the Horizontal Monitoring program will not prevent the taxpayer from engaging in transfer pricing disputes. Furthermore, it should be considered that information shared under the Horizontal 272 Baker & McKenzie Monitoring program may be exchanged with other jurisdictions (specifically in the event of an automatic exchange of information and in Europe under the 2011/16 EU Directive and the local implementation thereof). If a company faces or is likely to face double taxation arising from transfer pricing or cross-border taxation conflicts, the company may apply for the elimination of double taxation by way of the mutual agreement procedure (MAP) under a bilateral tax treaty. Within the European Union (EU), companies resident in an EU member state may also apply for the EU Arbitration Convention, provided that both states involved are signatories to it. 5.1 Mutual agreement procedures under a bilateral tax treaty A person/company resident in the Netherlands for tax treaty purposes and who is subject to economic or legal double taxation is allowed to invoke competent authority proceedings under an applicable bilateral tax treaty. Generally, all bilateral double tax treaties concluded by the Netherlands contain a provision similar to Article 25 of the OECD Model Convention. As of 1992, the Netherlands, as a general policy, has been in favor of including an arbitration clause in the competent authority article when concluding a bilateral tax treaty (for example, in the 1992 treaty with the United States). 5.2 Arbitration under the European Arbitration Convention Under the EU Arbitration Convention, double taxation within the EU may be eliminated, separate and apart from applicable double tax treaties. This convention explicitly caters to the handling of transfer pricing issues between associated enterprises resident within an EU member state. The Arbitration Convention has a significant advantage over regular double tax treaties in that it applies to situations including PEs of EU companies in other EU states as well. The Arbitration Convention Transfer Pricing Handbook – The Netherlands Baker & McKenzie 273 guarantees the removal of double taxation within a certain time period. However, the scope of the EU Arbitration Convention is narrower than the scope of the MAP. Whereas the EU Arbitration Convention relates solely to transfer pricing disputes, the MAP is applicable to all double taxation cases that are not in accordance with the provisions of that specific tax treaty. Under the EU Arbitration Convention, member states are given two years to resolve double taxation through the MAP. The Dutch regard the two-year period as beginning on the latest on either of the following dates: (i) The date when the tax assessment incorporating the adjustments is irrevocably determined (ii) The date when the competent authority receives the request If EU member states have not reached an agreement to eliminate double taxation after the commencement of this two-year period, the case must be referred to an arbitration committee. This committee has to present its advice within six months. After the arbitration committee has given its advice, the competent authorities of the member states are obliged to resolve double taxation within six months; otherwise, the advice of the arbitration committee becomes final. 5.3 Dutch standard policy for the mutual agreement procedure/EU Arbitration Convention In 2008, the Dutch Ministry of Finance introduced a new decree (the “MAP Decree”)2 containing the Dutch policy on the MAP process under bilateral treaties and as applicable under the EU Arbitration Convention. The main objectives set out in the decree are improved transparency, reducing (taxpayer) costs and finding a resolution within a target (short) timeframe. Notably, the decree also advocates a 2 The transfer pricing decree of 29 September 2008, no. IFZ2008/ 248M, Government Gazette no. 188. 274 Baker & McKenzie flexible approach to eliminate double taxation in cases not provided for in the EU Arbitration Convention and in cases regarding PEs (i.e., triangular cases). The request for competent authority assistance must be submitted within three years after the first notification from which double taxation may result. However, bilateral tax treaties may contain other terms. The Dutch position is that the request of a taxpayer will be deemed to have been submitted on time if the request is received within three years (but this period could differ in specific tax treaties) after the date of the issue of the tax assessment in which the adjustment is reflected, or the moment when the grounds for the adjustment are explained, if this is made at a later stage. As the competent authority procedure involves more than one jurisdiction, the taxpayer must ascertain the position of the other jurisdiction with respect to the commencement of the three-year term within which a request must be filed to get access to the competent authority phase. If another jurisdiction has a different time limit, the three-year term may begin earlier than would be the case from the Dutch position, thus barring access to competent authority proceedings if the taxpayer files its request too late. If a competent authority request is filed on time, the Netherlands, in principle, allows for a corresponding adjustment or a withdrawal of their adjustment even if the limitation period has expired in the Netherlands. Other jurisdictions may take a different view, however, depending on their domestic laws and the applicable competent authority treaty provision (whether or not this includes an override position if the domestic limitation period has expired). The taxpayer should therefore review, in the other jurisdiction(s), whether the limitation period can be suspended (e.g., by filing an additional tax return). This will, of course, depend on the domestic law of the other jurisdiction(s). The Netherlands encourages early access to the MAP process, which may take place before an actual adjustment is proposed or an Transfer Pricing Handbook – The Netherlands Baker & McKenzie 275 assessment containing an adjustment is issued according to the MAP Decree. Also, Decree 2013/148 addresses the early-access-to-theMAP process. More specifically, Decree 2013/148 clarifies that if a taxpayer expects to be confronted with double taxation regarding the transfer prices as a result of the activities of tax authorities in a country with which the Netherlands has the possibility to exchange information, the DTA is willing to seek opportunities to prevent the possible double tax levy as early as possible by exchanging information or carrying out a joint audit. This is even at an earlier stage than was originally anticipated under the MAP Decree. The target period for resolving double taxation issues is two years. The Netherlands does not charge fees for competent authority procedures. At the request of the taxpayer, a deferral of tax collection will be granted until the date when both the domestic and international procedures have been completed. A penalty will be reduced if the amount of the adjustment is waived as a consequence of the competent authority proceedings. If double taxation is caused by an adjustment originating in the Netherlands, an extension can be granted at the request of the taxpayer in respect of payment of any taxes due. Interest payments can be made part of the MAP process. The Netherlands has entered, for example, into an agreement regarding interest payments with France. The MAP process begins with the filing of a formal request when a reasonable assumption exists that taxation will not result in conformity with the applicable treaty to which the Netherlands is a party (this must be within a three-year period after the first notification that double taxation may arise). No special form is required to file a competent authority request in the Netherlands. However, the website of the Netherlands’ Ministry of Finance contains a sample request that can be downloaded and printed for use. The filing of a MAP request is deemed to constitute an approval of the exchange of relevant information. No separate acknowledgement will be provided by the DTA. 276 Baker & McKenzie The Dutch authorities keep the taxpayer informed by sending a notice of receipt of the filing plus a possible request for additional information within five working days after the receipt of the MAP filing. Within two months after filing, additional information will be requested, if required. The Dutch authorities will inform the treaty partner and provide them with a copy of the request and a confirmation that the request was submitted on time. In the case of the EU Arbitration Convention, confirmation will be provided when the two-year term commences. Within one month after the receipt of the filing for the MAP, the competent tax inspector will also receive a copy of the request. 5.4 Litigation Apart from resolving a transfer pricing issue by means of a competent authority procedure, the company may also take action under domestic laws. As a first step, the company may file a formal objection with the DTA against the transfer pricing adjustment that resulted in an assessment/additional assessment. If the formal objection does not resolve the transfer pricing issue, an appeal may be filed with the competent court. The appeal must be filed with the district court. If the district court decision is wholly or partially unfavorable, an appeal against the decision of the district court may be filed with the Court of Appeal and, ultimately, with the Dutch Supreme Court. 6. Advance Pricing Agreement Procedures 6.1 Legal framework The APA program is available in the Netherlands and is governed by the APA Decree,3 which provides procedural guidelines on obtaining an APA in the Netherlands. Aside from an APA program, there is also an Advance Tax Ruling (ATR) program available4 that covers certain 3 Decree DGB 2014/3098. 4 Decree DGB 2014/3099. Transfer Pricing Handbook – The Netherlands Baker & McKenzie 277 transactions such as the participation exemption, hybrid financing and hybrid legal forms of associations, as well as the creation of PEs in the Netherlands. 6.2 Availability of unilateral, bilateral and multilateral APAs The Dutch APA/ATR practice started years ago, but the processes were formalized only in April 2001 and have been amended and updated since then. There is usually a preference for bilateral APAs, but the DTA may also conclude unilateral APAs. Multilateral APAs are popular with the DTA but not with taxpayers because they generally take much longer to conclude. “Synthetic APAs” (i.e., identical unilateral APAs concluded in several countries) are also observed in the Netherlands. 6.3 Term of APAs, roll-back and extensions A time period of four to five years is considered reasonable. Exceptions are possible with long-term contracts, for example. With bilateral APAs, the term will also be dependent on foreign legal requirements. After the expiration of the term, the taxpayer may request that a new APA be entered into, based on the same conditions. Although an APA generally applies to future transactions, the APA may, in certain cases, nevertheless be applicable to the transactions that have already taken place if the relevant facts and circumstances in the “back years” are comparable to the years that are the basis for the APA request. The DTA will, generally speaking, only deal with a request to back-date a unilateral APA if retroactive application will not lead to a reduction in taxable income for those years. 6.4 Time frame to conclude an APA In general, it takes eight to 12 weeks (from filing the request) for the DTA to finalize a unilateral APA, whereas the average time for a bilateral APA is about 18-20 weeks (from filing the request and setting up the APA team). 278 Baker & McKenzie 6.5 Fee There is no fee payable to the DTA for submission and negotiation of an APA. 6.6 APA requests Usually, the taxpayer will have to submit the following: • Information regarding the transactions, products, cases or agreements to which the request relates • Information regarding the enterprises and PEs involved with these transactions or agreements • The other states to which the request relates • Information on the worldwide organizational structure (including details of the beneficial owners of the shares of the company requesting the SPA), the history, financial information, items produced and functions performed including the assets used (tangible and intangible) for the performance of these functions and the risks incurred by the related enterprises • A description of the proposed transfer pricing method, including a comparability analysis (including comparable figures of unrelated parties and possibly applied adjustments) • The assumptions that support the proposed method and a discussion of the effect of changes in those assumptions or other events, such as unexpected results that can influence the term of the proposal • The years to which the proposal applies • A general description of the market conditions (for example industrial trends and competition) Transfer Pricing Handbook – The Netherlands Baker & McKenzie 279 Usually, it is possible to discuss the case in the pre-filing meeting on a “no-names” basis. Submissions must be filed on a named basis. 6.7 Audits and monitoring of APAs During a regular tax audit, the inspector will verify whether the taxpayer has applied its transfer prices consistently with the APA, whether the critical assumptions included in the determination agreement are (still) complied with and if not, whether the determination agreement needs to be adjusted or has become invalid. 6.8 Disclosures and statistics The DTA publishes statistics on APAs and ATRs in its 13th halfyearly report. The information in the 13th half-yearly report is limited to the number of submissions made, accepted and rejected cases, as well as pending and withdrawn applications. The table below provides an overview of APA filings in 2013. Status 1 January 2013 Received Approved Rejected Withdrawn/ Not under discussion Inventory on 31 December 2013 APA 240 323 228 5 67 263 ATR 254 505 441 20 91 207 Total 494 828 669 25 158 470 In general, the DTA does not automatically exchange the APA with the tax authorities on the other side of the transaction. One exception applies to APAs obtained after 1 January 2014 for financial service companies (see below). This exception applies where the financial service company only meets the minimum substance requirements and no other operational activities take place in the Netherlands by affiliates within the Netherlands. 280 Baker & McKenzie 7. Other Topical Subjects/Trends 7.1 Financial service entities A financial service entity is defined by the DTA as an entity of which the activities mainly consist of (intragroup) financing and licensing transactions. Financial service entities are often used, amongst others, to benefit from the Dutch tax treaty network regarding withholding tax on interest and royalties. The main area of focus, besides transfer pricing, has recently been on meeting substance requirements. For financial services companies, minimum substance requirements have been around for at least 10 years now, based on Dutch tax practice and various decrees offering guidance specifically for entities that wish to enter into an advance pricing agreement with the Dutch tax authorities. Recent changes have now turned these substance requirements into law. This is inspired not only by international developments around mutual assistance in the field of taxation, but also in the context of the OECD’s Base Erosion and Profit Shifting initiative. The recent developments regarding the substance requirements are beyond the scope of this transfer pricing handbook. 7.2 DTA position on application of transfer pricing principles to PEs At the beginning of 2011, the Dutch State Secretary of Finance issued a decree clarifying the position of the DTA on the allocation of profits to PEs. The position taken by the DTA on the attribution of profits to PEs is generally in line with the conclusions and the approach established by the OECD in its 2010 Report on the attribution of profits to PEs (the “PE Report”), i.e., the Authorized OECD Approach (AOA). The DTA will not correct an arm’s length profit attribution to a PE if it is based on the principles provided in the PE Report and if these have been consistently applied as such by the taxpayer in the other country involved. Transfer Pricing Handbook – Norway Baker & McKenzie 281 Norway Anders V. Heieren Anders Heieren has extensive experience in assisting international clients with transfer pricing matters in addition to cross-border restructuring and M&A-related work. He has a background with the Norwegian Ministry of Finance, was for several years partner and head of the international tax practice in PwC Norway, and was VP for Tax of a listed company. In 2011, he joined the law firm Arntzen de Besche, which for decades has been recognized as a market leader in a.o. petroleum and energy law in Norway. AdeB’s tax team offers a broad range of transfer pricing services and works with several multinationals on both documentation, presentation/negotiation with the tax authorities (inclunding MAP/APA) as well as dispute resolution. [email protected] Tel: +47 23 89 40 00 Arntzen de Besche Advokatfirma AS Bygdøy allé 2, P.O. Box 2734 Solli 0204 Oslo Norway 282 Baker & McKenzie In 2012, total transfer pricing adjustments in Norway amounted to NOK6.8 billion (approximately USD1 billion or EUR0.8 billion). In 2012, the adjustments totaled NOK7.2 billion (approximately USD1.2 billion or EUR0.9 billion). Twelve agreements under the mutual agreement procedure (MAP) provided for by the tax treaties were concluded in 2013. At the close of 2013, there were four ongoing APA cases, out of which three have been concluded as of October 2014. One new APA request has been lodged. Transfer pricing issues have been, and will continue to be a key area for Norwegian tax authorities. This applies in particular to the oil taxation authorities, as exploration and production activities on the Norwegian Continental Shelf (NCS) are subject to a 78 percent marginal tax rate, and most of the companies on the NCS are part of international groups. The oil taxation authorities have therefore been in the forefront in the transfer pricing area. Several of the larger transfer pricing court cases involve petroleum activity on the NCS. In 2013, the key focus for the Oil Taxation Office has been petroleum pricing and intragroup services. Outside the oil tax cases, the tax authorities have stated that the assessments for 2014 will particularly be concentrated on intragroup financing and services, TNMM and database searches, business restructurings, IP and bareboat lease structures. In line with the increased focus on transfer pricing issues, we have seen that Norwegian tax authorities have staffed up with technical and economic experts. This year, the tax authorities announced their intention to increase their manpower in the transfer pricing area by approximately 15 percent by the end of 2014. In 2014, it was further announced that the tax authorities will assume the role of competent authority and will be responsible for all MAP and APA cases in transfer pricing matters as of 1 January 2015. This responsibility previously rested with the Ministry of Finance. Transfer Pricing Handbook – Norway Baker & McKenzie 283 1. Statutory Rules and Administrative Regulations 1.1 Introduction Norway has mostly followed the OECD guidelines for transfer pricing since these were first introduced in 1979. In 1981, the guidelines were codified as general reference to the arm’s length principle. Further, a set of new transfer pricing regulations, which took effect in 2008, was introduced in the Tax Act Section 13-1 and in the Tax Assessment Act Section 4-12. The Tax Act now states explicitly that attention should be paid to the OECD guidelines when considering whether income has been reduced in the case of transactions between related parties when an applicable tax treaty refers to the arm’s length principle. It is assumed that the reference to the OECD guidelines also pertains to the OECD guidance on business restructurings. At the same time, completely new documentation requirements, closely linked to the OECD recommendations, were introduced in the Tax Assessment Act. The regulations apply in cases where there is a “community of interest” between two parties. This will typically be for transactions between companies that are directly or indirectly fully owned within the same group, but also cover situations where there is less than 100 percent ownership, provided there is common control, substantial influence or other basis for a community of interest that could impact the terms for such dealings. Section 13-1 follows a two-step approach. First, the tax office must substantiate that there is reason to assume taxable Norwegian income has been reduced. Second, the correct price must be determined. The courts can always test the first criterion for a transfer pricing adjustment, while there are certain limitations to how far a court will go in testing the price assessed by the tax office (see paragraph 5.5 below). Where there is a community of interest between the parties to a transaction, and as a result, Norwegian taxable income has been 284 Baker & McKenzie reduced, tax authorities may adjust the pricing for basically all types of transactions and agreements. The tax authorities carry the burden of proof to substantiate that it is more likely than not that the income has been reduced because of wrongful pricing. The tax authorities may normally not adjust terms of the dealings other than the price. However, typically in the area of thin capitalization, a reclassification may be carried out in the sense that debt might be reclassified as equity, or vice versa. Where income has been reduced and the other party to the transaction is a resident outside the EEA,1 the burden of proof is with the taxpayer to demonstrate that the income reduction is not due to the community of interest between the parties. However, the practical implication of this rule is somewhat unclear as the tax authorities, in any event, have to prove that the income has been reduced. For the sale of crude oil and propane, taxable income is determined using a price list presented by the Norm Price Board every quarter. The daily price for each field/product is set based on averages of observed transactions. The Norm Price Board has representatives from the government and from oil companies. The norm price may also be set for natural gas, but has so far only been used for crude oil and propane. The norm price system for petroleum is not explained any further within the framework of this handbook. 1.2 Scope of the rules The Norwegian transfer pricing rules apply to transactions where one of the parties is a Norwegian tax resident and the other one is not, as well as to transactions where both parties are residents in Norway. In practice, they are normally not invoked for purely domestic transactions, unless the transaction implies a value transfer that could be viewed as irregular dividend from a fully or partly owned company, or concerns transactions involving the 78 percent special tax regime on the NCS and the ordinary (27 percent) corporate tax 1 EU plus Norway, Iceland and Liechtenstein. Transfer Pricing Handbook – Norway Baker & McKenzie 285 regime. An example of the latter is the ExxonMobil case from 2010 (appeal court). In that case, the group established a new subsidiary to charter and to operate a vessel for the parent company’s crude production. The subsidiary was funded with equity, and this equity was used to fund a loan to the ship owner. As a result, interest costs were deducted in the 78 percent special tax regime, and interest income was taxed at the level of the subsidiary in the ordinary corporate tax regime. Using the substance-over-form principle, the court, however, concluded that the transaction could not be accepted for tax purposes, and the interest income was taxed at the hands of the parent company (78 percent). Dealings with companies that reside in a tax haven are normally dealt with under the same principles as dealings with companies in other countries. However, the OECD guidelines are not directly applicable. Hence, where the Norwegian tax base has been eroded due to wrongful pricing, it might be more difficult in such cases to challenge the concrete pricing as assessed by the tax office. The allocation of profits to a permanent establishment follows the same principles as laid down in the OECD guidelines and is therefore heavily influenced by the same arm’s length standard as applied under the transfer pricing rules. This entails that the profit of the permanent establishment shall be allocated between the head office and the permanent establishment as if the latter had been a separate legal entity dealing with both the head office and related companies on terms consistent with the transfer pricing guidelines. 1.3 Form and depth of documentation There are detailed regulations outlining the content requirements for transfer pricing documentation. These adhere very closely to the OECD guidelines on documentation. Among the requirements that may be mentioned is a description of the business environment in which the company operates, the legal structure, business areas and business units, important competition factors, financial relations, types and size of internal transactions, functional analysis, centralized 286 Baker & McKenzie service performance, intellectual property, choice of pricing methods, comparable prices, and the internal agreements. The regulations explicitly state that documentation based on the EU Code of Conduct on transfer pricing documentation between associated enterprises is accepted. The documentation must be presented in Norwegian, English, Swedish or Danish. 1.4 Advance pricing agreement (APA) Norwegian tax authorities do not issue APAs. On a case-by-case basis, it is possible to discuss the transfer pricing principles with the tax office, but they will not issue a formally binding pricing acceptance, either in the form of an agreement or a ruling. In practice, where the principles are disclosed and discussed prior to implementation, unless the tax office has indicated that other methods might be superior, the tax office will normally respect the applied principles. The Ministry of Finance has announced that they are considering introducing APA regulations. In the case of sales of gas between related parties, a special APA procedure exists within the oil tax authorities (so far, this has not been used much in practice). Recently, Norway has opened itself up for mutual APA negotiations with other countries. Only a handful of pilot cases have so far been dealt with under such MAP/APA approach. 1.5 Interest limitation rule With effect from 1 January 2014, new rules have been introduced, limiting tax deductions in the corporate tax base for interest expenses to related parties. Under the new rules, deductions for intragroup interest expenses are disallowed if total net interest expenses exceed 30 percent of an adjusted taxable income. The adjusted taxable income is taxable income increased by net interest costs and tax Transfer Pricing Handbook – Norway Baker & McKenzie 287 depreciations, similar to earnings before interest, taxes, depreciation and amortization (EBITDA). The taxpayer cannot carry forward loss against the income caused by the disallowed interest expense, but disallowed interest expense may be carried forward for up to 10 years. The interest deduction cap applies to domestic as well as cross-border loans. Income accrued from interest payments is taxable income for the lender, regardless of the cap on deduction for the borrower. The debt/equity ratio is irrelevant, as is the aggregate interest expense or equity ratio on the group level. Only net intragroup interest expenses are disallowed. However, interests paid to unrelated lenders are included when calculating the interest deduction limit. The cap does not apply to external bank financing, although a few exemptions are made to prevent “back-toback” loans through external banks. The limitation rule does not apply if the net interest expenses do not exceed NOK5 million. For the purpose of the interest limitation rules, a related company is defined as a lender directly or indirectly controlling 50 percent or more of a borrower, or a borrower directly or indirectly controlling 50 percent or more of a lender. The interest limitation rule applies to both limited and unlimited companies, controlled foreign corporations (CFC), and foreign entities with limited tax liability to Norway. Financial institutions are, however, exempt and taxpayers subject to special tax for exploration and production activities on the NCS are also currently exempt from the interest limitation rule. 2. Transfer Pricing Methods 2.1 OECD guidance Norwegian tax authorities have traditionally normally used the cost plus method as well as other traditional methods, but have, over the 288 Baker & McKenzie years, developed a more varied approach based on the characteristics of the concrete transaction. The OECD Guidelines (published in July 2010) provide that the transfer pricing method selected should be the most appropriate method in the circumstances of the case. However, where a transaction-based method (comparable uncontrolled price [CUP], resale price or cost plus) and a profit method (profit split or transactional net margin method [TNMM]) are both equally valid in the circumstances, the transaction-based method is preferable. Where a CUP method and another transaction-based method are both equally reliable, the CUP method should be used. Consideration of which method to apply from a Norwegian perspective should therefore always begin with a consideration of whether any comparable uncontrolled price is available. Cost plus is often used for services where no comparable uncontrolled price is available. Indirect cost allocation methods for overhead costs are accepted. The comparable uncontrolled price should not only be for comparable goods and/or services, but should also be from the relevant period of time. This is particularly important for assets that typically have a fluctuating market value. TNMM has been accepted, for example, when determining the profit level of a distributor/sales company buying and reselling goods from an affiliated wholesale producer (refer to the VingCard Elsafe case). Residual profit split methods are frequently used to determine charter payments for oil rigs and offshore vessels. For certain financing arrangements such as, inter alia, cash pooling arrangements and intragroup loans and guarantees, the tax authorities have also applied the “modified” profit split method (“yield approach” or “expected benefit approach”), where the point of departure is to allocate the profit obtained by the group as a whole between the parties (see below regarding the ConocoPhillips case). Transfer Pricing Handbook – Norway Baker & McKenzie 289 2.2 Pricing adjustment Year-end and retrospective pricing adjustments may be acceptable, for example, to take into account actual circumstances that have occurred, where only budgeted indicators were initially used to set transfer pricing policies. Other factors (for which adjustments need to be made) may also be relevant, such as indirect taxes. 2.3 Working capital/inventory Norway does not generally require calculation of comparability adjustments to ascertain levels of working capital/inventory when comparing equivalent business activities. Adjustments may be required if, for example, distributor companies are being used in benchmarking returns as a proxy for commission-based sales functions. 2.4 Business restructurings The OECD guidelines for business restructurings are critical in determining the Norwegian transfer pricing approach and the impact of changes on functions, risks and assets of taxpayers. It should be expected that Norwegian tax authorities and courts will follow these guidelines in their analyses of business restructuring impact, and as mentioned above, it is assumed that the reference to the OECD guidelines in Tax Act Section 13-1 also includes the OECD guidance on business restructurings. 2.5 Safe harbors There are no safe harbor rules. Previously, there was an explicit rule for oil companies disallowing financial costs such as interest if the equity was less than 20 percent of the total balance. This was abolished with effect from 2007. An article published by tax administration employees indicates that for practical terms, it might be reasonably safe to rely on a level of debt financing at a subsidiary level that is within the overall debt-equity ratio at group level. Based on the Scribona case (see paragraph 5 below), the starting point is whether or not the company in question could have obtained such a 290 Baker & McKenzie loan from an independent bank (without a parent company guarantee). The approach in a different court case was to consider the normal debt ratio based on public data available for listed companies, although this was only one of several relevant factors. 3. Transfer Pricing Documentation and Filing Requirements 3.1 Recordkeeping A special form has to be filed with the annual tax return listing all intragroup transactions by type and size (RF-1123). This form is a relatively simple, three-page listing of the various types of possible intragroup transactions, where the taxpayer indicates by ticking boxes whether or not the company has undertaken any such transactions. This form provides a starting point for the tax office to consider whether or not to look into transfer pricing matters for the company in question. Upon request from the tax office, the company must submit complete written documentation in a transfer pricing report. This must be filed within 45 days after such request has been made. Companies with fewer than 250 employees, and a turnover of less than NOK400 million or a total balance sheet value of less than NOK350 million, are exempted from the full documentation requirement. This exemption does not, however, apply in relation to dealings with companies located in countries without a tax treaty with Norway, and it does not apply to taxpayers that are subject to special tax under the Petroleum Tax Act. The documentation requirement applies where one company owns or controls at least 50 percent of the other party, and between companies with at least 50 percent direct or indirect common ownership or control. It should be noted that a breach of the regulations concerning transfer pricing documentation may result in penalty tax (ref. item 6.2 below). Transfer Pricing Handbook – Norway Baker & McKenzie 291 3.2 Timing of evidence and analysis The statutory filing date for corporation tax returns is 31 May in the year following the income year. The company should have sufficient evidence and analysis at that date to confirm that its transactions with related parties are at arm’s length. 3.3 Statute of limitation The tax authorities may not adjust the prices when this leads to an increased tax burden for the taxpayer if such adjustments are made more than two years after the lapse of the income year to which the adjustment relates. However, this is dependent upon the taxpayer having provided complete and correct information when filing the tax return. If this is not the case, the time limit for the tax authorities to raise transfer pricing adjustments is 10 years after the income year. It has been shown in practice that the tax authorities have often found that insufficient information had been given in cases of transfer pricing adjustment, but this might change as taxpayers provide the new and more detailed reporting requirements related to transfer pricing. Errors in applying the transfer pricing principles that result in significant underreporting of income may, in itself, be treated as filing of wrong or incomplete information (refer to the maximum 40 percent deviation rule in the 2012 Statoil case under paragraph 5.5 below). 3.4 Duration of recordkeeping Records must be preserved for 10 years. 3.5 Reviewing and updating documentation Documentation should be reviewed on an annual basis to determine if historical, functional and economic analyses are still relevant. The documentation must be “prepared” for each income year (upon request), but in practice, there will often be time to do an update of the previous year’s report within the 45-day time limit if no major changes have taken place. 292 Baker & McKenzie 4. Tax Audit Procedures 4.1 Tax office questions Based on the information provided in the mentioned form RF-1123, the tax office will determine whether or not to raise questions related to transfer pricing. Large cross-border transaction amounts and/or transactions with affiliated companies in low-tax jurisdictions are more likely to attract follow-up questions. The tax authorities may choose to focus on specific industries in a given year. If the tax office knows that a company has implemented transfer pricing documentation, either from having seen a previous year’s report or from other sources, it is less likely that a full report will be requested. The largest tax offices and in particular, the Oil Tax Office and Central Tax Office for large enterprises, have dedicated personnel who specialize in transfer pricing. Similarly, the five regional tax offices and the tax directorate have dedicated groups of personnel dealing with transfer pricing. No guidelines have been published for the tax authorities’ focus or work in relation to transfer pricing matters. As an alternative to written questions, the tax office may initiate an audit of selected themes. The taxpayer will be notified of such an audit. When an audit has been performed, the tax office will issue an audit report summarizing its findings and conclusions. This will be sent to the taxpayer for comments before the tax office decides on issues raised in the report. 4.2 Information powers The tax office may generally ask the taxpayer to provide any documentation that may be relevant for the purpose of verifying a taxpayer’s tax position. This includes information about companies that are not liable to tax in Norway to the extent that they are included Transfer Pricing Handbook – Norway Baker & McKenzie 293 in dealings with Norwegian taxable companies. In more extreme cases where serious tax fraud is suspected, “dawn raids” have been arranged with computers and files sealed off for further investigation, but this would not happen as part of a more regular transfer pricing enquiry. Taxpayers subject to tax under the Petroleum Tax Act have extensive reporting obligations toward the oil taxation authorities. Thus, since 2012, such taxpayers shall report all key conditions in the gas sales agreements (internal and external) to the oil taxation authorities on a quarterly basis. Through these reporting obligations, the oil taxation authorities will build up a large database for gas sales, and major concerns have been made with respect to the oil taxation authorities’ use of this, that is, to compare internal gas sales with external gas sales without the taxpayer being able to access the same information (secret comparables). In the Total case from 2012 concerning internal gas sales (lower court), the oil taxation authorities had compared the pricing applied in the internal arrangements with information on external sales that was not available for the taxpayer. The taxpayer claimed that this use of secret comparables implied a procedural error for the tax authorities’ decision (breach of the adversarial principle). However, the court held that if the taxpayer was given access to the information used as comparables by the tax authorities, this would imply a breach of the tax authorities’ professional secrecy. Thus, according to the court, lack of access to the comparables did not constitute a procedural error. The case has been admitted to the Supreme Court, which will rule on this issue in 2015. 4.3 Transfer pricing information The type of information available to the tax authorities includes the company’s transfer pricing documentation, everything that the company has prepared for its corporate tax return for transfer pricing purposes, any further evidence of arm’s length pricing, the company’s transfer pricing manual, and budgets for each function and management accounts, among others. In assessing the company’s position, the tax office may also include in their business case 294 Baker & McKenzie sensitive information or confidential information that the company itself has not provided. 5. Dispute Resolution 5.1 Appeal Provided the tax office concludes, after examination of documentation submitted and arguments put forward, that there is reason to believe that the income of a company has been reduced due to dealings with related parties, it will issue a reassessment for the relevant income year(s). Within three weeks, the taxpayer may appeal this decision to the same tax office, and subsequently, to the Appeal Board. A taxpayer who disagrees with the Appeal Board’s decision may, within six months, bring the case before the courts (three instances). 5.2 Settlement strategy In practice, many potential transfer pricing disputes can be resolved in discussions with the tax office, provided this takes place at an early stage and with full disclosure of all relevant facts. Once a reassessment has been issued, this may be more complicated and the tax authorities have no particular strategy for settling such cases. 5.3 Mutual agreement procedure (MAP) Norway has concluded a significant number of double tax treaties that contain a MAP article. The extent to which the MAP is available is largely a discretionary assessment by the competent authority. The tax directorate will often be authorized as the competent authority by delegation from the Ministry of Finance. The treaty will generally require the competent authorities endeavoring to apply a MAP in such a way that double taxation is eliminated. Only a few cases have so far been dealt with on a MAP basis and there is no obligation for the parties to such proceedings to reach a result that prevents double taxation. The taxpayer must initiate a MAP within the time limit mentioned in the tax treaty clauses for such procedures. Transfer Pricing Handbook – Norway Baker & McKenzie 295 Where another state has adjusted prices resulting in double taxation, a Norwegian taxpayer may alternatively use this as an argument to reopen the Norwegian assessment and ask for a corresponding adjustment by an appeal. A corresponding adjustment will normally be accepted if the adjustment made in the other state is found to be in accordance with the OECD principles for transfer pricing as practiced in Norway. 5.4 The European Arbitration Convention Norway has not signed the European Arbitration Convention. The Ministry of Finance has indicated that they will consider introducing arbitration provisions in new tax treaties. So far, this has been done in the tax treaties with the UK and the Netherlands. 5.5 Transfer pricing litigation There are Norwegian court cases dealing with different aspects of transfer pricing. Tax litigation regarding transfer pricing would, in earlier years, typically relate to adjustments of insurance premiums paid by oil companies to their captive insurance companies offshore. Examples here are the Schlumberger case in 1995 (Supreme Court), the Agip case in 2001 (Supreme Court) and the Amoco case in 2002 (Supreme Court). In the Agip case, the Supreme Court accepted that the tax authorities had determined the arm’s length premium rate using a combination of pricing methods, as well as its own discretionary judgment. Other cases dealt with adjustments/apportionment of salary versus dividend from personally owned companies, due to tax rate differences between the two types of income. In a case in 1999, the Supreme Court found that Baker Hughes had paid too much for the leasing of equipment from a related company. From 2000 onward, there have been court cases dealing with the level of license fees and royalties paid by Norwegian companies to their foreign affiliates. In a case regarding Intrum Justitia in 2008, the deductible license fee was reduced as the court found that the taxpayer 296 Baker & McKenzie paid more than an independent company would have been willing to pay. A case regarding 3M in 2002 had an opposite outcome, as the court found that an independent party would probably have been willing to pay a license fee of a size comparable to what 3M paid to the parent company. Moreover, a 2004 case dealt with Mercuri International Norge AS, which was found to have paid royalties in excess of the value of the services received. Another notable case of charges for intragroup services is that of Enterprise Oil Norge AS from 2010 (in the appeal court). In this case, the appeal court rejected Enterprise Oil Norge AS’s claim for deductions related to charges for services provided by the parent company, inter alia, because the taxpayer had not, in a sufficient manner, documented the services that had been performed and thus was not able to document the benefits obtained related to the services. Margins on charges for intragroup services is a focus area in particular for the oil taxation authorities, and a key issue here is whether the applied margin reflects the level of risk undertaken by the (foreign) service provider. Meanwhile, in the 2007 Cytec case, the court ruled on tax questions related to cross-border restructuring. A Norwegian business was changed from being a producer for its own risk and account to a contract producer, receiving cost plus 8 percent. Based on the facts and circumstances, the majority of the court found that the technology and know-how that Cytec had previously acquired, in effect, had been transferred out of Norway. The court concluded that in reality, what took place was a transfer of business from the Norwegian party to the affiliated party abroad. Only the assets needed to be a contract producer were left in Norway, with the affiliated party taking over the income potential previously belonging to the Norwegian business. No consideration was paid and an adjustment was made, resulting in a substantial increase in taxable income. In 2004, the courts ruled in the Scribona case that interest deductions could be reduced, as the Norwegian subsidiary was found to be thinly capitalized because it was probable that an independent bank would Transfer Pricing Handbook – Norway Baker & McKenzie 297 not have granted such a loan. The tax office had, in that case, based the assessment on a deemed equity ratio of 15 percent, which was found acceptable by the court. Other notable cases on the financing of subsidiaries are Telecomputing (Supreme Court 2010) and Bayerngas Norge AS (lower court 2012). Further to the Telecomputing case, lack of borrowing capacity for the borrower will not in itself imply that provided funds shall be characterized as equity; the question is whether the funds predominately have the characteristics of a loan arrangement or an equity arrangement. The Bayerngas Norge AS case concerned the interest margin on loans from a foreign group company to a Norwegian subsidiary. In determining the arm’s length margin, the court’s point of departure was the standalone credit rating of the Norwegian subsidiary, notched up for group affiliation (implicit support). A third case concerning group financing arrangements is the ConocoPhillips cash pool case from 2010 (appeal court). In this case, two Norwegian ConocoPhillips companies (“COP”) were parties to a cash pool arrangement. COP had several accounts in different currencies, and the sum of these accounts constituted COP’s net position in the cash pool. The sum of all net positions of all companies participating in the cash pool constitutes a so-called top-account, which was placed in the Bank of America. COP was constantly in a net deposit position. Even if COP was able to demonstrate that in case of an alternative standalone relationship with a third-party bank COP would have received a lower interest income on its deposits than actually achieved in the cash pool scheme, the appeal court ruled that in an arm’s length setup, an independent party in COP’s position would have received a larger part of the overall benefit of the cash pool arrangement, and, thus, a higher interest rate was applied and taxable income for COP increased correspondingly. The appeal court’s decision has been criticized, especially because COP unsuccessfully argued that cash pool arrangements are never entered into by independent parties. In addition the company could demonstrate that in case of an alternative standalone relationship with a third-party bank, COP would actually have received a lower interest income on its deposits than it achieved in the cash pool scheme. 298 Baker & McKenzie However, the theoretically expected benefit approach has also been advocated by the tax authorities in other cases (in particular by the oil taxation authorities) and the case has not been admitted to the Supreme Court. Another cash pool arrangement was the subject of a 2014 district court case (Exxonmobil). The taxpayer was member of a cash pool arrangement headed by a Dutch group company. The Norwegian entity had, for the tax years in question, a consistent net deposit. The interest rate was based on an “overnight rate.” The tax authorities argued that a six-month deposit rate was more appropriate and the court accepted this argument. Both in the Scientific Drilling case in 2010 and the 3M case in 2002, the court found that indirect cost allocation methods are acceptable. The 2010 case was related to a Norwegian permanent establishment. The tax authorities argued that the taxpayer had not documented that the overhead administration and engineering costs were relevant for the Norwegian permanent establishment. The taxpayer had described this in more general terms, without presenting accurate calculations for administrative services and costs that were allocated to the permanent establishment. The court concluded in favor of the taxpayer, referring to the OECD guidelines that accept allocations based on turnover when a more precise allocation method would be unreasonably burdensome, considering the nature of the services rendered. It should be noted, however, that in a district court decision from 2014 (Total), the court, rather than reviewing the allocation key for indirect charges, analyzed each item of the services that formed part of the indirect allocation scheme and assessed whether or not the taxpayer had sufficiently documented actual use and benefit of the service in question. In 2012, there were two notable Supreme Court cases on transfer pricing. In the Norland case, the court concluded that it may only overturn the price as assessed by the tax office if it finds that the tax administration based its decision on incorrect facts or valuation principles, or the result is manifestly unreasonable. As the court was Transfer Pricing Handbook – Norway Baker & McKenzie 299 convinced that the income was underreported, the actual price setting by the tax office could, hence, not be tested in this case. Even though the case concerned a purely domestic transaction (a taxpayer sold shares to his or her wholly owned domestic company), it is also relevant for cross-border transactions. However, in those transactions, the OECD transfer pricing guidelines apply, and the court should test whether the tax authorities have correctly applied the guidelines. The practical impact of the decision is therefore uncertain. Acknowledging that transfer pricing is not an exact science, the Supreme Court held in the Statoil case (with reference to previous case law) that price adjustments constituting less than a 40 percent deviation from the price as applied by the company could not, in itself, imply that the company had filed wrong or incomplete information. Hence, in cases where the correctly adjusted income is less than 40 percent higher than the declared income, and the taxpayer otherwise has filed correct and complete information, there is a two-year time bar within which the tax office must raise their case, and no penalty tax is applicable. 6. Interest and Penalties 6.1 Interest Where additional corporation tax becomes due following a transfer pricing adjustment, any corporation tax paid late will carry interest. 6.2 Penalties Penalties may be applied where the taxpayer has presented wrong or incomplete facts to the tax office. The basic rate of penalty is 30 percent. In cases of transfer pricing adjustment, it has quite often been the case that the tax office finds that wrong or incomplete information was filed with the tax return. Penalties will then often be applied, at least where the adjustment made is substantial compared to the income declared in the tax return. In cases of willful misconduct or gross negligence, the penalty rate can be increased to 45 percent or a maximum of 60 percent. The burden of proof of negligence is with the 300 Baker & McKenzie tax office. The penalty is based on the potential lost tax revenue. However, where the taxpayer is in a tax loss position after adjustment, losses from other sources are disregarded when calculating the amount of penalty. Where only a timing benefit is achieved, the penalty is based on the net present value of the deferral. Transfer Pricing Handbook – Poland Baker & McKenzie 301 Poland Tomasz Chentosz, Counsel Tomasz Chentosz joined Baker & McKenzie Warsaw in March 2005 as a member of the office’s tax group. He has a decade of experience working for international tax consultancy firms and has written several articles regarding taxation issues in the real estate sector. [email protected] Tel: +48 22 445 3408 Baker & McKenzie Krzyzowski i Wspólnicy Spólka Komandytowa Rondo ONZ 1 Warsaw 00-124 Poland 302 Baker & McKenzie 1. Statutory Rules and Administrative Regulations 1.1 Introduction Polish transfer pricing legislation generally follows the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the “OECD Guidelines”) and applies where a “provision” is made between two persons by means of a transaction or a series of transactions where those persons are under common control or management. If the provision has not been made at arm’s length and, consequently, a potential tax advantage has been conferred, then the transaction must be recomputed for tax purposes as if it had occurred on arm’s length terms. 1.2 Transactions in scope Polish transfer pricing rules apply to transactions where both parties are Polish tax residents (domestic entities), as well as to transactions where one party is a Polish resident and the other is not (foreign entity). The rules apply to a wide range of related party transactions, including goods and services and financing transactions, as well as the licensing and sale of intellectual property, excluding, however, transactions where both parties are domestic subjects operating within the same tax capital group. The transfer pricing documentation obligations also apply to transactions with entities based in tax haven countries, regardless of whether the parties to the transactions are related entities. 1.3 Obligations A taxpayer that in a given tax year carried out transactions with related entities is obliged to inform the tax authorities about this in the annual tax return. Transactions or a series of transactions with related parties should be specifically documented when they exceed a given annual value. The value differs according to the subject of transaction. Similar conditions apply to tax haven transactions. This documentation should be filed with the tax authorities (within seven days) upon their request. Transfer Pricing Handbook – Poland Baker & McKenzie 303 1.4 Related party definition Transfer pricing legislation applies to the parties of a transaction that are under common control or management. Control exists for transfer pricing purposes where either one person controls the other or the same person controls both parties to the transaction. Control can be direct or indirect (e.g., through the attribution of rights of connected parties), and controlling persons can be partnerships or individuals as well as companies. A 5 percent share in capital is sufficient to create the capital relation. When both parties to the transactions are Polish resident entities, the meaning of “control” also includes: • links of a family nature, (i.e., marriage, consanguinity or affinity up to the second degree); • links resulting from employment relationships; or • property relations between Polish residents or between persons performing managerial, inspection or supervisory duties with Polish residents. 1.5 Statute of limitation for transfer pricing adjustments Tax settlements are open for TP audits five years from the end of the calendar year when the tax payment for the tax year was due. 1.6 Relationship to the permanent establishment allocation of profits provisions Under Polish regulations, transfer pricing rules apply to permanent establishments. 1.7 Advance pricing agreements (APAs) Domestic entities can apply to the Minister of Finance for an APA in respect of arrangements between Polish and foreign related parties. 304 Baker & McKenzie These arrangements can take a unilateral, bilateral or multilateral form. 2. Transfer Pricing Methods 2.1 General acceptance of OECD guidance Polish transfer pricing legislation generally follows the OECD Guidelines. 2.2 Acceptability and hierarchy of methods and best method rules The OECD Guidelines (published in July 2010) provide that the transfer pricing method selected should be the most appropriate method in the circumstances of the case. Polish legislation is generally compliant with these guidelines. 2.3 Relevant level of knowledge and timing Hindsight cannot be used to determine whether a price was at arm’s length; only information that was available to the parties at the time (including reasonably foreseeable information) can be relied upon. 2.4 Acceptability of year-end adjustments and retroactive adjustments Year-end pricing adjustments and retroactive adjustments may be acceptable, for example, to take into account actual circumstances that have occurred where only budgeted indicators were initially used to set transfer pricing policies. Other factors (for which adjustments need to be made), such as indirect taxes, may also be relevant. Adjustments need to be transaction-based, and deductibility of general TP adjustments (e.g., based on profit margin) may be questioned. 2.5 Calculation of comparability adjustments Poland generally requires the calculation of comparability adjustments related to, among others, levels of working capital/inventory when comparing equivalent business activities. Transfer Pricing Handbook – Poland Baker & McKenzie 305 2.6 Business restructurings Generally speaking, Polish tax authorities follow the current OECD guidelines on business restructurings. In 2014, the Polish MF issued detailed comments related to tax analysis of the business restructurings that are strongly based on the recent developments of the OECD. 3. Transfer Pricing Documentation and Filing Requirements 3.1 Statutory rules and administrative regulations Polish transfer pricing regulations set a requirement for additional documentation, apart from general accounting records, if transactions between related parties or tax haven transactions exceed an annual amount (actually paid) equivalent in Polish zloty to: • EUR50,000 in general cases; • EUR100,000 if the value of the transaction does not exceed 20 percent of the initial capital; • EUR30,000 in the case of performance of services, sale of intangible assets, or making them available; and • EUR20,000 in case of any tax haven transactions. 3.2 Minimum scope of documentation as required under statute According to Polish TP law, transfer pricing documentation should contain at least: • an identification of the functions performed by the parties to the transaction (including the assets used and the risk undertaken by the parties); • specification of all anticipated costs of the transaction as well as the payment details (form and payment date); 306 Baker & McKenzie • method and manner of calculating the profits and specification of the price of the object of transaction; • determination of the economic strategy in case the strategy adopted by the party to the transaction has influenced the value of the transaction; • indication of other factors if the parties to the transaction took these factors into account while determining the value of the object of the transaction; and • indication of the benefits that are expected by the parties to the transactions in the case of contracts relating to intangible service. 3.3 Deadline to submit documentation to tax authorities Transfer pricing documentation has to be filed upon the request of the tax authorities only and within seven days of such request. 3.4 Statutory documentation retention requirement According to general rules, records must be preserved until, the latest of: • five years from the end of the year, in which tax payment for the period concerned was due; and • the date on which tax authorities are no longer able to open an enquiry. 3.5 Language of documentation Transfer pricing documentation should be prepared in Polish. 3.6 Frequency of documentation update Documentation should be reviewed on an annual basis to determine if historical, functional and economic analyses are still relevant. Transfer Pricing Handbook – Poland Baker & McKenzie 307 Moreover, the financial data provided in the documentation should be updated. 3.7 IC transaction/other disclosures filed with the tax return In the annual tax return, the taxpayer has to indicate whether transactions with related entities were concluded in the year concerned. There is no special corporation tax return form for reporting connected party transactions. However, these must be reflected in the normal annual corporation tax return, on an arm’s length basis. Information regarding transfer pricing will, in the first instance, be gathered by tax authorities from the tax return, and supplemented by further information disclosed as a result of specific enquiries. 3.8 Due date of tax returns The statutory filing date for corporation tax self-assessment returns is normally three months from the end of the tax year, so a Polish taxpayer should have sufficient evidence and analysis at that date to confirm that its transactions with related parties are at arm’s length. 4. Tax Audit Procedures 4.1 Selection of companies for an audit TP audit is, in practice, performed in Poland as part of each income CIT audit. TP audit may also be initiated as a result of audit carried out in the related entity. Based on our experience, intercompany services fees are one of the issues that attract the most attention from Polish tax authorities during CIT audits. Polish tax authorities pay a lot of attention to the documentation of the results of the intercompany services purchased by Polish entities. 308 Baker & McKenzie 4.2 Tax audit and appeals procedures / administrative proceedings Polish tax authorities begin a transfer pricing enquiry by requesting TP documentation and other information related to the intercompany transactions. The obligatory Polish TP documentation does not include economic analysis. Consequently, the burden of proof that the transaction is not at market value rests on the tax authorities’ side. If the tax authorities conclude that the examined transaction was not concluded at market value, they issue a tax decision declaring the correct amount of assessed tax. It is crucial to provide tax authorities with formal TP documentation, since neglecting this obligation may result in a 50 percent sanction tax rate on the income, assessed by the tax authorities. The taxpayer is entitled to submit an appeal to the Tax Chamber (the tax authority of the second instance) and a complaint to the district administrative court. 4.3 Resources available to tax auditors The type of information available to tax authorities might include the company’s transfer pricing documentation; everything that the company has prepared for its corporation tax’s self-assessment for transfer pricing purposes; any further evidence of arm’s length pricing (there is, however, no obligation on the company to prepare/collect such evidence); the company’s transfer pricing manual; and budgets for each function and management account. 4.4 Recent audit developments and experiences Key areas of transfer pricing focus for Polish tax authorities include: • cross-border intercompany services; and • business restructurings resulting in the transfer of business functions from Poland. Transfer Pricing Handbook – Poland Baker & McKenzie 309 4.5 Transfer pricing group There is a body of tax and other specialists within the Polish tax authorities that is dedicated to working with APA procedures. The transfer pricing audits, being part of the general Corporate Income Tax audits, are performed by officers who usually do not have sufficient TP expertise. 4.6 Polish tax authorities’ information powers Tax authorities are allowed, under their general information powers, to issue notices requiring a person to provide information or documents. 5. Dispute Resolution 5.1 Mutual agreement procedure Poland has a high number of double tax treaties, almost all of which contain a MAP article. The granting of corresponding adjustments is a matter for the Polish Ministry of Finance (acting as the Polish competent authority). The treaty will generally require competent authorities to endeavor to apply MAP in such a way that double taxation is eliminated, and this result will be achieved in the majority of cases. 5.2 Possibility of arbitration The Polish transfer pricing law implements the European Arbitration Convention. The granting of corresponding adjustments is a matter for the Polish Ministry of Finance (acting as the Polish competent authority). 5.3 Polish litigation practice and typical areas of litigation At a domestic level, a company may appeal against an assessment by a tax office that involves a transfer pricing adjustment. The appeal may be made to the Director of the Tax Chamber and has to be submitted within a specified time limit. The next stage involves filing a complaint, on a point of law only, to the Voivodeship Administrative 310 Baker & McKenzie Court. A formal appeal from the Voivodeship Administrative Court decision may, in turn, be made to the Supreme Administrative Court. The appeals have to be filed with the authority that issued the assessment that is subject to appeal (and not the supervisory authority). 6. Interest and Penalties 6.1 Interest on overdue tax Where additional corporation tax becomes due following a transfer pricing adjustment, any corporation tax paid late will carry interest. 6.2 Penalties Penalties – in the form of a fine or imprisonment – may be imposed where a tax return is submitted, which is not in accordance with the arm’s length principle and which contains a deliberate, or a deliberate and concealed inaccuracy (and not a careless inaccuracy), resulting in a loss of Polish tax, or an increased claim to a loss or a repayment (tax fraud). The onus is on the tax authorities to show that there has been deliberate inaccuracy before any penalty can be charged. Whenever an entity fails to file transfer pricing documentation upon the written request of the tax authorities, the amount of adjustment is subject to a 50 percent tax rate. Based on the potential lost tax, a deliberate inaccuracy might be classified as a demeanor or felony, though the penalty limits in both cases are similar. Penalties may be avoided by disclosing an inaccuracy to the tax authorities in the form of active repentance, provided however that there is no ongoing enquiry or proceeding regarding the settlement period in question. Where a taxpayer can show it has taken reasonable care, there will be no penalty even if an adjustment is subsequently made. Transfer Pricing Handbook – Poland Baker & McKenzie 311 7. Advance Pricing Agreement Procedures 7.1 Availability of unilateral/bilateral APAs The Polish transfer pricing law provides for the possibility of concluding unilateral/bilateral APAs. 7.2 Description of the application process An APA can be requested by any Polish resident, including a partnership, with transactions to which Polish transfer pricing legislation applies; any non-resident trading in Poland through a permanent establishment; or any Polish resident trading through a permanent establishment outside Poland. APAs can cover future transactions, as well as those initiated before filing the application. Excluded from this procedure are transactions covered by tax proceedings, tax control or proceedings before an administrative court. The procedure is as follows: • The potential applicant may apply for an explanation of any doubts about making the arrangement in that individual case. • A formal application is made. • The Minister of Finance may ask for additional documentation and explanations, in case of any uncertainties. • If the suggested method is unacceptable, the Minister of Finance can offer an alternative method while citing its reasons for such choice. In this case, the application might be changed accordingly within 30 days. • An agreed position is (it is hoped) reached (with the consent of foreign tax authorities, if required). 312 Baker & McKenzie • The Minister of Finance issues an APA in the form of a decision, which is then delivered to related parties and to relevant foreign tax authorities (in case of bilateral and multilateral arrangements). • The procedure should be completed within six months in the case of unilateral, a year in the case of bilateral, and 18 months in the case of multilateral arrangements. According to Polish regulation, the formal application for an APA has to include: • information about the proposed method, along with a description of its application, such as an explanation of principles for calculation and financial forecasts, and an analysis of the comparison data; • circumstances affecting the transaction price, such as the type, object and value of the transaction; allocation of assets, as well as their functions and risks; description of transaction-related costs; economic strategy; and organizational and capital structure of the parties; • relevant documents and list of the related parties along with their consent to submit these documents; and • suggested validity period of the arrangement. An APA will be operative for a specified period from the date of entry into force as set out in the agreement. The validity period cannot exceed five years. 7.3 Fee APAs offered by the Minister of Finance are chargeable with a fee based on the value of the transaction and the type of arrangement. The general level of the fee, if paid within seven days from filing an Transfer Pricing Handbook – Poland Baker & McKenzie 313 application, is 1 percent of the value of transaction and has to stay on a level: • between PLN5,000 and PLN50,000 – unilateral arrangements between domestic subjects; • between PLN20,000 and PLN100,000 – unilateral arrangements involving foreign subjects; and • between PLN50,000 and PLN200,000 – any bilateral or multilateral arrangements. Transfer Pricing Handbook – Portugal Baker & McKenzie 315 Portugal Miguel Teixeira de Abreu, Counsel Miguel Teixeira de Abreu is the founding partner of Abreu Advogados. Miguel coheads the firm’s Tax Practice Area, heading its Transfer Pricing Working Group and is an active member of the Corporate M&A Working Group. In the tax area, Miguel has acted for international corporate clients in matters connected with transfer pricing, tax restructuring and tax engineering in setting up acquisition structures, including leveraged acquisitions such as MBOs, MBIs and LBOs. Miguel was a member of the Portuguese Government Committee for the Reform of Portuguese International Tax Laws and, since 2008, has been a professor of International Taxation at the International LLM Program of the Portuguese Catholic University in Lisbon. [email protected] Tel: +351 21 7231831 Abreu Advogados Av. das Forças Armadas, 125 - 12.º 1600-079 Lisbon Portugal 316 Baker & McKenzie 1. Statutory Rules and Administrative Regulations 1.1 Introduction Portuguese transfer pricing legislation is covered by Article 63º of the Corporate Income Tax Code (CIRC) and applies whenever transactions are carried out between two related entities, and the terms under which such transactions are carried out differ from the terms that would have been agreed upon between two independent entities. In applying transfer pricing legislation, Portugal follows the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations published in July 2010 (the “OECD Guidelines”). 1.2 Meaning of “related entities” “Related entities” is a very broad concept. In general, it includes any two entities where one has the power to directly or indirectly exercise a substantial influence over the decisions of the other. In particular, it includes: (a) a company and any shareholder directly or indirectly holding 20 percent or more of its capital or voting rights; (b) two companies, whenever a common shareholder directly or indirectly owns 20 percent or more of their capital or voting rights; (c) a company and any member of its corporate bodies, including such member’s spouse, ascendants or descendants; (d) two companies, whenever the majority of their respective corporate bodies consist of the same persons, including the spouse, ascendants or descendants of any such person; (e) two entities linked by a subordination agreement or an equivalent contract; (f) any companies under common control, as defined by Article 486.º of the Portuguese Companies Code; (g) two entities, whenever the management decisions of one are conditioned by the other, as a result of facts or circumstances other than those connected with their commercial or professional relationship; or (h) a resident entity, or the Portuguese permanent establishment of a non-resident entity, and any entity located in a jurisdiction “blacklisted” under Portaria 292/2011. Transfer Pricing Handbook – Portugal Baker & McKenzie 317 1.3 Scope of the rules Portuguese transfer pricing rules apply to transactions where one or more of the parties is a Portuguese taxpayer. The rules apply to a wide range of related party transactions, including goods and services, and financing transactions, as well as the licensing and sale of intellectual property. 1.4 Application to financing arrangements The rules apply specifically to finance operations. The concept of “related entities” applies similarly in the context of financing operations. 1.5 Compliance Self-assessment applies to a Portuguese taxpayer who must decide whether the taxable profits they enter on their self-assessment return reflect an application of the arm’s length principle. In particular, a Portuguese taxpayer must state in its tax returns the existence of transactions carried out with related entities, specifically indicating: (a) the designation of such entities; and (b) the amount and nature of the transactions carried out with such entities, and further confirming that it has, in a timely manner, prepared all the documentation necessary to explain transfer prices that were carried out in such transactions. 1.6 Time limits for assessment The Portuguese tax authorities normally have up to four years from the end of the relevant accounting period in which to dispute a corporation tax assessment. This period has been lengthened to 12 years if the transactions are somehow connected with a jurisdiction that is blacklisted under Portaria 292/2011. 1.7 Attribution of profit Portuguese transfer pricing rules also apply to the operations carried out between a non-resident entity and its Portuguese permanent 318 Baker & McKenzie establishment, or between such permanent establishment and any other permanent establishments of the non-resident entity outside Portugal, or between a resident entity and its permanent establishments outside Portugal or between such permanent establishments. Portuguese internal laws do not contain any provisions regarding the attribution of profits to permanent establishments, but Portugal follows the OECD Report on the Attribution of Profit to Permanent Establishments. 1.8 Advance pricing agreements (APAs) Portugal offers APAs in respect of arrangements between related entities. The main elements of this new regime are the following: (a) APAs may be unilateral, bilateral or multilateral; (b) the regime follows the OECD Guidelines; (c) the APA process starts with a request filed by the taxpayer with the Portuguese General Director of Taxes; and (d) a fee must be paid by the taxpayer wishing to negotiate an APA with the Portuguese Tax Authorities. In general terms, an APA proceeding has four phases: 1° Preliminary Phase; 2° Presentation of APA Proposal; 3° Evaluation of the Proposal; and 4° Signature of the APA. 2. Transfer Pricing Methods 2.1 Construing the legislation The Portuguese legislation follows the OECD Guidelines in determining the appropriate transfer pricing method. However, one must note that Portugal has enacted legislation (Portaria 1446-C/2001) specifying the criteria for such determination and thus, reference should always be made to such Portaria and not directly to the OECD Guidelines. 2.2 Selection of method The OECD Guidelines provide that the transfer pricing method selected should be the most appropriate method in the circumstances of the case. However, where a transaction-based method (comparable uncontrolled price [CUP], resale price or cost plus) and a profit Transfer Pricing Handbook – Portugal Baker & McKenzie 319 method (profit split or transactional net margin method) are both equally valid in the circumstances, the transaction method must be adopted. Among the transaction methods, the Portuguese tax authorities are known to apply the CUP method above any other and have shown resistance to accepting the application of other methods. Therefore, consideration of which method to apply from a Portuguese perspective should always begin with a consideration of whether any CUPs, either internal or external, are available. 2.3 Contemporaneous information There is no guidance under Portuguese transfer pricing regulations as to the use of hindsight in determining whether a price is at arm’s length. 2.4 Transfer pricing adjustments When comparing a related party transaction, adjustments may be required in order to determine the degree of comparability. Such adjustments relate to the characteristics of the compared transactions, such as volume, functions, contractual terms and conditions, location and employee related costs. Such adjustments are particularly required when using the CUP method. Year-end and retrospective pricing adjustments may also be acceptable, but we always recommend that they be subject to contract. 2.5 Business restructurings The OECD guidance on business restructurings may become critical in determining the Portuguese transfer pricing approach and the impact of changes in functions, risks and assets of Portuguese taxpayers. The Portuguese tax administration is becoming increasingly sensitive to the value at which assets (including, in particular, IPrelated assets) are transferred upon a business restructuring or reorganization. 320 Baker & McKenzie 2.6 Safe harbors There are no published safe harbors or rules of thumb, although some rules have been published in the past regarding acceptable transfer prices on related party loans and license agreements. Thin capitalization ratios have been deleted, in exchange for a more general rule on the limitation of the tax deductibility of interest charges. 3. Transfer Pricing Documentation and Filing Requirements 3.1 Recordkeeping Article 63º of the CIRC, together with Article 14 of Portaria 1446- C/2001, introduced specific recordkeeping obligations for Portuguese taxpayers carrying out transactions with related entities. A Portuguese taxpayer must organize and retain contemporaneous transfer pricing documentation (unless his or her previous financial year’s turnover does not exceed EUR3 million) as part of the general tax assessment documentation, stating and justifying the adopted transfer pricing policy. In particular, such documentation must include: (a) details of commercial or financial relationships within the scope of the transfer pricing legislation; (b) a description of the taxpayer’s activity and the activity of its related parties with which it transacts, specifying the adopted transfer prices by nature and amount of the transactions under these relationships for the last three years, or for the period that they occurred, if less; (c) a detailed description of the goods, intangibles or services comprising the controlled transactions and a description of the terms and conditions established whenever this information is not mentioned in the agreements; (d) information about functions performed either by the taxpayer and the related parties involved in the relevant transactions, taking into account assets used and risk assumed; (e) technical studies of the core part of the business, inter alia, investment, financing research and development, market, restructuring and reorganization of activities, as well as forecasts and budgets regarding both the global activity and the business by division or product; (f) any guidelines regarding the transfer pricing policy’s application, such as chosen method, procedure for gathering the Transfer Pricing Handbook – Portugal Baker & McKenzie 321 external and internal comparables’ data, the strategy for analysis of the comparables, cost policies, and adopted profit margins; (g) the terms of relevant commercial arrangements with both third-party and affiliated customers; (h) explanation and justification of the selection and application of the transfer pricing method/s for each relevant transaction; (i) information regarding the source and reliability of comparable data; (j) details on the assessment of the degree of comparability between controlled and uncontrolled transactions, including functional and financial analysis of third-party comparables, and the adjustments, if any, to eliminate existing differences; (k) information on business strategies likely to influence transfer prices or the attribution of profits among related parties; and (l) any other relevant information, data or documentation justifying the application of the chosen method for determining the terms and conditions normally agreed upon between independent entities (inter alia, how the chosen method results in arm’s length prices, or if it does not, how any adjustments made to the tax return have been computed). 3.2 Timing of evidence and analysis The statutory filing date for corporation tax self-assessment returns is normally 31 May of the following year. Thus, a Portuguese taxpayer should have sufficient evidence and analysis at that date to confirm that its transactions with related parties are at arm’s length. Transfer pricing- related annexes may be filed electronically until 15 July. 3.3 Recordkeeping duration Records must be kept for a period of 12 years. 3.4 Reviewing and updating documentation Documentation should be reviewed on an annual basis to determine if historical, functional and economic analyses are still relevant, but there is no requirement to update formal documentation. 322 Baker & McKenzie 3.5 Form and depth of documentation Portaria 1446-C/2001 includes a rule of proportionality, meaning that the transfer pricing documentation should generally not only be adequate and sufficient, but also proportionate to the complexity and materiality of the transaction. 3.6 Returning information There is no special corporation tax return form for reporting connected party transactions. However, the annexes to the self-assessment tax returns (due on or before 15 July) must include a reference to the existence or non-existence of transactions carried out with related entities. This generally allows the Portuguese tax authorities to gather information regarding transfer pricing directly from the tax returns. 4. Tax Audit Procedures 4.1 Risk assessment Unless a taxpayer is deemed a large taxpayer, there is no guidance whatsoever by the Portuguese tax authorities that may allow a Portuguese taxpayer to determine the level of risk involved in the transactions it carries out with related entities. For large taxpayers, Article 68.º-B of the General Tax Law widened the scope of the attributions granted to the unidade de grandes contribuintes or UGC (a unit within the tax administration dedicated to large businesses) with the purpose to reduce the costs involved in tax litigation. The UGC may now hold a dialogue with the larger taxpayers and, upon their request, provide the tax administration’s view of certain transactions, especially those involving non-resident entities, or those that may be caught under tax avoidance provisions of Portuguese laws. This allows larger taxpayers to, for example, get an anticipated view of the tax administration’s opinion on certain related party transactions. Transfer Pricing Handbook – Portugal Baker & McKenzie 323 4.2 Indicators of high levels of risk Similarly, the Portuguese tax authorities have never issued any guidance in respect of specific transactions where they may raise a transfer pricing issue. 4.3 Commencement of enquiry A transfer pricing enquiry is triggered in the course of a regular corporation income tax assessment. If the designated inspectors perceive that a problem of transfer pricing exists, they may request the involvement of inspectors who specialize in transfer pricing laws and regulations. 4.4 The Portuguese transfer pricing group There is a body of tax and other specialists within the Portuguese tax inspections division (Direcção de Serviços de Inspecção Tribnutária or DSIT), who are part of the transfer pricing team and who are dedicated to investigating transfer pricing issues. 4.5 Progress of enquiry and administrative proceedings After an enquiry is made, the case will proceed through the different stages of the administrative proceeding, including, in general terms: (a) the issuance of a provisory assessment report; (b) the possibility for the taxpayer to comment on the report; (c) the issuance of a final report; (d) the sending of an assessment to the taxpayer; and (e) the possibility for the taxpayer to file an administrative claim against such assessment. 4.6 The Portuguese transfer pricing group’s current focus From our recent experience, the Portuguese transfer pricing group is focusing its attention on the following operations: • Intragroup lending operations involving foreign subsidiaries • Royalties paid to nonresident group companies and other payments related to intellectual property rights 324 Baker & McKenzie • Transfer pricing files and the quality of comparables • Transfer pricing in cash-pooling operations • Use of non-traditional (transactional) transfer pricing methods 4.7 Portuguese tax authorities’ information powers The Portuguese tax authorities may, in the context of a tax inspection, issue information notices to require a person to provide information or documents. The information or documents must be reasonably required by tax authorities for the purpose of checking a taxpayer’s tax position. In practice, the tax authorities will usually make an informal request for the information they require before issuing an information notice. The Portuguese tax authorities may enter business premises and inspect any documents on the premises, provided prior notice is sent to the taxpayer. 4.8 Transfer pricing information The type of information available to the Portuguese tax authorities might include the company’s transfer pricing documentation; everything that the company has prepared for its corporation tax selfassessment for transfer pricing purposes; and any further evidence of arm’s length pricing, as well as the company’s transfer pricing file (see “Recordkeeping” under 3.1). 5. Dispute Resolution 5.1 Relationships with large businesses See references to large taxpayers under 4.1 above. 5.2 Litigation and settlement strategy Under Portuguese law, tax credits cannot be settled by agreement between the taxpayer and the tax administration. In 2011, the Portuguese government allowed the submission of tax litigation for arbitration (Law 11/2011). The impact of this law has been Transfer Pricing Handbook – Portugal Baker & McKenzie 325 considerable, and many cases have now been submitted for arbitration. Decisions are generally final and binding on both parties (the taxpayers and the tax authorities) and are reached quite quickly (generally, six to 12 months). Certain transfer pricing disputes have been submitted for arbitration, especially where the issues under discussion are of a strict legal nature (i.e., needing interpretation of the law) and no evidence needs to be provided. Arbitration in tax matters works as an alternative and thus, taxpayers may also litigate a transfer pricing case in the administrative and tax courts, which are courts of a wider competence and do not specialize in transfer pricing cases. This said, whenever the issues under discussion are of a particular complexity, the parties may suggest that the (judicial or arbitration) court hear individuals/specialists. This may be particularly interesting in transfer pricing cases. Although the taxpayer may revert directly to the (judicial or arbitration) court, immediately after receiving a tax assessment, the general approach is to go through the administrative proceedings and make a claim in court only after such proceedings have been completed (or are deemed completed). 5.3 Portuguese domestic appeal process Currently, and in general terms, there is only one level of appeal regarding a decision issued by the administrative and tax courts. That appeal is filed with the Central Administrative Court or, when it is confined to matters of law, with the Supreme Administrative Court. Note that, in general, there is no appeal regarding a decision issued by the Tax Arbitration Court. 5.4 Mutual agreement procedure (MAP) Portugal has signed 63 double tax treaties (eight have yet to enter into force and effect), all of which contain a MAP article and a corresponding adjustment procedure. The extent to which the MAP procedure is available is largely dependent on the discretion of Portuguese tax authorities. The treaty will generally require competent authorities to endeavor applying the MAP in such a way that double taxation is eliminated. However, the Portuguese tax authorities do not 326 Baker & McKenzie have much experience yet on such cases and effective elimination, in some circumstances, may not be achieved. There is no formal statutory method to set a case in motion. 5.5 Interaction of MAP and domestic transfer pricing enquiry Any request to initiate MAP should not delay the progress and settlement of a domestic transfer pricing enquiry, nor should it delay the making of claims. Subsequent claims may arise as a result of the conclusion of the domestic enquiry, such as group relief, and there may also be impact from secondary adjustments in other jurisdictions. The trigger for a MAP claim would normally be the finalization of the tax inspection containing a transfer pricing adjustment, i.e., the issue of an assessment. 5.6 The European Arbitration Convention The Arbitration Convention is a potentially useful mechanism but some uncertainty still surrounds it. It has the advantage of forcing a solution and it has been more widely used by Portuguese taxpayers. 5.7 Recent transfer pricing litigation in Portugal Most of the court cases regarding transfer pricing in Portugal have to do with very basic issues, such as sale of trademarks between related entities with the nonresident purchaser on selling that trademark for a huge gain. Recent decisions include the following: • Transfer pricing on cash-pooling transactions – Decision in favor of the taxpayer on the basis that the method adopted was appropriate • Intragroup services – Decision in favor of the taxpayer on the basis that the approach by the tax authorities was not the adequate one • Royalties - Decision in favor of the taxpayer on the basis that the method adopted was appropriate Transfer Pricing Handbook – Portugal Baker & McKenzie 327 • Equity contribution in favor of a non-resident subsidiary – Decision in favor of the taxpayer on the basis that transfer pricing cannot be applied to equity contributions. As the Tax Arbitration Court becomes a real alternative in the field of tax litigation, we believe many more transfer pricing cases will be submitted for arbitration. 5.8 Current areas of potential transfer pricing litigation in Portugal As mentioned above, the areas of greater concern should be in respect of royalty transactions and intragroup financing involving Portuguese companies and their non-resident related entities. Another area of concern would be the recharacterization of transactions (e.g., using a non-resident vehicle to convert interest income into dividend income or dividend income into a capital gain), thereby allowing a company to arbitrate between different Portuguese laws. Although, under Portuguese law the recharacterization of transactions must follow different tax provisions (anti-avoidance rules as opposed to transfer pricing rules), it has been common for Portuguese tax authorities to try to use transfer pricing rules for that purpose - since the requirements for evidence are far stricter under the anti-avoidance rules. Another area of concern is aspects of business restructurings (e.g., commissionaire structures or toll-manufacturing agreements). Also, it has been common for Portuguese tax authorities to challenge transfer pricing issues by reverting to the general deductibility provision of Article 23 of the CIRC. Such provision states that all costs and expenses are tax deductible if fundamental for the generation of taxable income. A 2014 amendment to this provision has made it more difficult for the tax authorities to pursue such course of action. 6. Interest and Penalties 6.1 Interest Where additional corporation tax becomes due following a transfer pricing adjustment, any corporation tax paid late will carry interest. Once a tax assessment is issued, and in order to suspend the 328 Baker & McKenzie enforcement proceedings, the taxpayer will have 30 days to either pay or request the issue of a bank guarantee. If the taxpayer opts to pay and later succeeds in appealing against such assessment, it will have the right to receive interest on the amounts so paid. 6.2 Penalties Portaria 1446-C/2001 refers to the fact that specific legislation was to be enacted in respect of penalties applicable to the breach of obligations contained in its provisions. Such specific legislation has not been enacted yet. However, if, pending an inspection the tax authorities notify the taxpayer that he or she has to produce transfer pricing documentation, and the taxpayer fails to do so within the stated deadline, Article 117 of the Regime Geral Das Infracções tributarias or RGIT (the “Portuguese Tax Offence Code”), may apply, and a fine be levied against the taxpayer. Such a fine may range between EUR500 and EUR10,000. This said, a transfer pricing adjustment may also trigger different penalties depending on the type of adjustments made and of the underlying transactions that lead to them (e.g., where a transaction is overpaid, the Portuguese tax authorities may deem that an offense, such as willful decrease of the taxable income, has occurred). 7. Advance Pricing Agreement Procedures 7.1 Who can apply for an APA? An APA may be requested by any Portuguese taxpayer. 7.2 The Portuguese tax authorities’ approach The Portuguese tax authorities offer APAs, for which they charge a fee. The fee may depend on the turnover of the requesting taxpayer. An APA may be unilateral (i.e., signed between the taxpayers involved and the Portuguese tax administration) or bilateral/ multilateral (involving other tax administrations). Where they are bilateral/multilateral and where there is a double taxation agreement between Portugal and the other relevant jurisdiction that includes a MAP article, the Portuguese taxpayer must, when filing the APA Transfer Pricing Handbook – Portugal Baker & McKenzie 329 request, also always request that Portuguese tax authorities approach the other tax administration(s) and seek their participation. 7.3 Typical APA transactions So far, there have been very few APAs signed with the Portuguese tax administration. It is fair to say that, most likely, APAs will involve a case where the transfer pricing issues are complex rather than straightforward or where a multinational group of companies is seeking to have its global transfer pricing policy validated across several jurisdictions. 7.4 Procedure In general terms, the procedure is as follows: • The taxpayer files a request with the Portuguese General Director of Taxes. The basic contents of such a request are proposed under Annex I of the legal diploma that regulates APAs (Portaria 620-A/2008). o Prior to such a request, the taxpayer must go through a preliminary proceeding with the DSIT. Such preliminary proceeding is aimed at discussing the transfer pricing policy the taxpayer wishes to adopt and whether or not an APA is the right solution to the taxpayer’s concerns. • If the request is for a bilateral/multilateral APA, the taxpayer should contact the other group companies and request that they simultaneously file an APA request with their respective tax administrations. o A negotiation proceeding is then triggered between the Portuguese tax administration and the competent authorities of the other jurisdictions, under the MAP of the applicable double taxation treaty. 330 Baker & McKenzie • The Portuguese tax administration aims to complete APAs within six months from the receipt of application in the case of unilateral APAs, or 12 months in the case of bilateral/multilateral APAs. From a practical point of view, these periods should be viewed as indicative. 7.5 Information required During the course of its evaluation, the Portuguese tax authorities may access all the information deemed necessary, including access to: (a) any databases used by the company to support its transfer pricing policy; (b) any technical studies and comparables used; and (c) any documents presented by other related entities to other tax administrations. 7.6 Monitoring an APA The Portuguese tax authorities maintain the right to monitor the compliance of a Portuguese company with the terms of an agreed APA. In particular, the facts and assumptions that were taken into account when negotiating an APA must be monitored on a regular basis, so that the Portuguese tax authorities may see if the adopted method remains valid; if not, the Portuguese tax authorities may initiate a proceeding for the revision of the terms of the APA. 7.7 Term of an APA An APA will be operative for a specified period from the date of entry into force as set out in the APA. However, the term of an APA cannot exceed three years. 7.8 Renewal of an APA An APA may be renewed at the request of the taxpayer, provided such a request is filed at least six months before the end of its term. The proceedings for the renewal are similar to the proceedings for the negotiation of an APA. Transfer Pricing Handbook – Portugal Baker & McKenzie 331 8. Interest Deductibility Rules and Autonomous Taxation 8.1 Interest deductibility rules Tax deduction of interest charges is limited to the higher of: (a) EUR1 million; or (b) 30 percent earnings before interest, taxes, depreciation and amortization (EBITDA). However, the 30 percent EBITDA threshold is to be implemented gradually as follows: 60 percent in 2014; 50 percent in 2015; 40 percent in 2016; and 30 percent in 2017 and onwards. 8.2 Autonomous taxation Any payments made by a Portuguese entity to an entity that is a resident in a low-tax jurisdiction are subject to an autonomous rate of taxation, varying between 35 percent and 55 percent. In addition, they are disregarded as a tax-deductible cost if paid to an entity that is a resident of a blacklisted jurisdiction (Portaria 292/2011). This will not apply if the taxpayer is capable of proving that such payments relate to transactions effectively carried out and do not have an abnormal nature and are not of an exaggerated amount. A low-tax jurisdiction is one that is either part of the blacklist of jurisdictions (Portaria 292/2011) or where the entity receiving payments is subject to an effective level of corporation tax that falls below 60 percent of the tax the entity would pay if a resident in Portugal. In our view, if a proper transfer pricing file exists and the payments are shown to be at arm’s length, then such payments cannot be deemed to be of an exaggerated amount. Transfer Pricing Handbook – Russia Baker & McKenzie 333 Russia Maria Kostenko, Partner Maria Kostenko is a partner in the Baker & McKenzie Moscow office. She specializes in transfer pricing, tax controversies, tax due diligence and tax advice for M& A deals for both domestic and multinational companies investing in Russia. [email protected] Tel: +7 495 787 2725 Arseny Seidov, Partner Arseny Seidov is a partner in the Baker & McKenzie’s Moscow office, practicing tax law. He has been instrumental in developing optimal tax platforms for various industries, and is consistently recommended by Chambers Global, Chambers Europe and International Tax Review. Arseny co-chairs the tax subgroup of the US-Russia Bilateral Presidential Commission’s Innovation Working Group, leading the work on drafting laws to remove obstacles and create incentives for businesses for the promotion of R&D and innovation in Russia. He actively participates in key tax conferences and networking events of the American Chamber of Commerce and the Association of European Businesses. Arseny has authored more than 35 professional publications and is a visiting professor of tax law at the 334 Baker & McKenzie Moscow State Institute of International Relations (MGIMO University). [email protected] Tel: +7 495 787 2737 Roman Bilyk, Associate Roman Bilyk is an associate in the Moscow office of Baker & McKenzie, specializing in tax law. He has extensive experience in advising multinational and local Russian clients on a broad range of Russian and international tax issues, with a particular focus on transfer pricing, tax advice for M&A deals and corporate restructuring, and domestic and international tax structuring and tax planning [email protected] Tel: +7 495 787 67 48 Baker & McKenzie - CIS, Limited White Gardens, 10th Floor 9 Lesnaya Street Moscow 125047 Russia Transfer Pricing Handbook – Russia Baker & McKenzie 335 1. Statutory Rules and Administrative Regulations 1.1 Introduction On 1 January 2012, the new transfer pricing rules entered into force, which substantially changed the manner transfer pricing applies in Russia. Compared to the previous rules, the new rules are, for the most part, in line with the OECD Transfer Pricing Guidelines and they introduce functional analysis requirements, a broad list of information sources, five transfer pricing methods, documentation requirements and special penalties. The new rules replace the previously applied 20 percent safe harbor with an interquartile market price/profitability range. 1.2 Transfer pricing adjustment Transfer pricing adjustments may be made with respect to any income (profits, revenues) that could have been received in a transaction between related parties but was not received due to certain commercial and/or financial conditions that are different from those that would exist in comparable transactions between independent parties. Transfer pricing adjustments may also be made with respect to the following taxes: profits tax, individual income tax, mineral extraction tax (if paid on an ad valorem basis), and VAT (to the extent one of the parties of the controlled transaction is not regarded as a VAT payer or is exempt from VAT). 1.3 Related parties The parties are considered related parties for tax purposes if their relationship can influence the conditions and/or results of transactions between themselves and/or affect the economic results of their activities or the activities of the parties that they represent. In particular, parties would be deemed related for tax purposes under the following circumstances: 336 Baker & McKenzie • An organization (physical person) having more than 25 percent direct or indirect participation in the other organization’s capital • Organizations having the same shareholders with more than 25 percent direct or indirect participation in the capital of each organization • An organization (physical person) having control over the appointment of at least 50 percent of the executive body or the board of directors of the other organization • Organizations sharing the body (physical person) that controls the appointment of at least 50 percent of the executive body or the board of directors of each organization • Organizations having the same physical persons representing more than 50 percent of the executive body or the board of directors of each organization • Organization (physical person) performing the functions of executive body of another organization • Organizations with the same body (physical person) performing the functions of their respective executive bodies • Organizations and/or physical persons with more than 50 percent participation of each upper-tier entity in the capital of a lower-tier entity • Physical persons with administrative subordination between each other • Physical person and his or her close relatives (spouse, parents, children, brothers and sisters, etc.) Transfer Pricing Handbook – Russia Baker & McKenzie 337 The courts have the right to deem the parties related under other criteria if their relationship affects the results of transactions between the parties or their economic activities. 1.4 Scope of the rules Russian transfer pricing rules apply to controlled transactions that, by default, include any transactions between related parties. Regardless of whether the parties to a transaction are related, cross-border transactions with oil and oil products, ferrous and non-ferrous metals, mineral fertilizers, precious metals and stones, as well as cross-border transactions with foreign entities registered in certain low-tax jurisdictions according to the list established by the Russian Ministry of Finance, they are subject to transfer pricing control if they exceed RUB60 million (approximately USD1.1 million) in aggregate with a given foreign entity in a given calendar year. Domestic transactions between related parties not exceeding, in aggregate in a given calendar year, RUB2 billion (approximately USD36 million) for 2013 and RUB1 billion (approximately USD18 million) starting in 2014, are not subject to transfer pricing control. In case the above limits are exceeded, such transactions may still be out of the scope of transfer pricing control, provided both parties are stateregistered in the same Russian region, do not have any separate subdivisions in other Russian regions or outside Russia, and do not pay profits tax in other Russian regions, and neither of the parties have tax losses, including loss carry-forwards from prior years. In addition, the following domestic transactions between related parties are also subject to transfer pricing control if they exceed RUB60 million (approximately USD1.1 million) in aggregate in a given calendar year: • Transactions with commodities subject to the mineral extraction tax payable on an ad valorem basis, where one party is the payer of this tax 338 Baker & McKenzie • Transactions where one of the parties is a resident of Skolkovo Innovation Center, which is exempt from Russian profits tax, or a resident of a special economic zone enjoying special profits tax allowances (applicable starting in 2014 according to the transition rules) • Transactions where one of the parties is a participant in a regional investment project exempt from the federal part of the corporate profits tax (usually payable at a 2 percent rate) or subject to a reduced regional part of the corporate profits tax Domestic transactions between related parties where one party is the taxpayer under the special tax regimes (unified agricultural tax regime or unified tax on imputed income for certain activities regime) are subject to transfer pricing control if they exceed RUB100 million (approximately USD1.8 million) in aggregate in a given calendar year (applicable starting in 2014 according to the transition rules). A transaction may be deemed controlled for transfer pricing purposes by a court if there are reasonable grounds to believe that such a transaction is part of a series of smaller transactions performed with the purpose to remove each of the transactions out of transfer pricing control. Russian taxpayers that form a consolidated taxpayer group under the tax consolidation regime established under the Russian Tax Code will not be subject to transfer pricing control. A consolidated taxpayer group regime is available if the Russian parent company directly or indirectly holds at least 90 percent of the shares in each Russian subsidiary, subject to consolidation, and all consolidated companies jointly meet the following thresholds: (1) the total combined accrued amount of federal taxes for the previous year exceeds RUB10 billion (approximately USD182 million); (2) total combined turnover for the previous year exceeds RUB100 billion (approximately USD1.8 billion), and total combined assets as of 31 December of the previous year exceed RUB300 billion (approximately USD5.5 billion). Transfer Pricing Handbook – Russia Baker & McKenzie 339 Transfer pricing rules do not apply to loans (including trade and commercial credits), sureties and bank guarantees granted under agreements concluded prior to 1 January 2012. This exemption does not apply to agreements amended after this date. 1.5 Regulated prices If the price is subject to state regulations by establishing a particular price or price formula, such a price is regarded as a market price for transfer pricing purposes. If the price is regulated by way of establishing minimum and maximum price levels, markups or discounts, or placing other limits on profitability levels, the taxpayer has to determine a market price or profitability range that is within the regulated price range and test its prices against such market price ranges. This effectively means that the price established within a regulated price range cannot be automatically considered market price for transfer pricing purposes. 1.6 Information sources The list of acceptable information sources on comparables is fairly detailed and includes exchange quotes, statistical data of the Russian customs authorities, official price information published by relevant Russian state authorities, foreign countries, international organizations, and other published and/or public sources of information, specialized price information agencies, information on taxpayer’s own transactions, and other sources of information not specifically mentioned. Profitability data for Russian comparable companies is determined based on Russian statutory accounting statements. Profitability data for foreign comparables, on the other hand, is determined based on accounting statements prepared in accordance with the standards established by relevant jurisdictions and must be adjusted to ensure comparability with information contained in the Russian statutory accounting statements. 340 Baker & McKenzie In the case of a Russian-tested party, foreign companies’ data can be used to determine market profitability ranges only if it is impossible to determine such ranges based on the financial statements of Russian companies engaged in comparable transactions. The taxpayer’s own transactions with independent parties may also be used as comparables. 1.7 Attribution of profits The Russian Tax Code does not establish clear rules for the allocation of profits to a permanent establishment for Russian tax purposes. A new rule in Article 307.9 of the Russian Tax Code in connection with the adoption of the new Russian transfer pricing rules provides that profits of a permanent establishment are determined with account taken of the functions, risks and assets of such permanent establishments in Russia. Though most double tax treaties concluded by Russia follow the OECD model provision on the attribution of profits, there is still no further guidance in Russian domestic law on how this provision should be implemented in actual practice. 1.8 Advance pricing agreements (APAs) Taxpayers that have the status of a “largest taxpayer” under the Russian Tax Code are entitled to conclude unilateral or multilateral APAs with the Federal Tax Service. Russian transfer pricing rules also envisage a possibility of concluding APAs that cover cross-border transactions with a party resident in a state that has a double tax treaty with Russia under the competent authority procedures, with the participation of the relevant foreign tax authority (please see Paragraph 7 below). 2. Transfer Pricing Methods 2.1 Available methods The new rules provide for five transfer pricing methods (comparable uncontrolled price (CUP), resale price, cost plus, comparable profits Transfer Pricing Handbook – Russia Baker & McKenzie 341 and profit split), which are generally in line with the OECD Transfer Pricing Guidelines. 2.2 Selection of method CUP is the primary method to be applied. If CUP cannot be applied, other methods may be used, provided the chosen method allows one to check, in the most appropriate way, if the price in a controlled transaction complies with the market prices. The resale price method is stated as a preferred method in situations goods are purchased from a related party and further resold to independent parties without processing (or with minor sorting, repacking and certain other operations established in the law). The comparable profits method can be applied only if the resale price or cost plus methods cannot be applied, including in the case of the absence or insufficiency of relevant information. The profit split method remains the method of last resort. A combination of two or more transfer pricing methods in order to determine an arms’ length price or profitability level is allowed. Oneoff transactions, which are outside the scope of ordinary activities of a taxpayer, may be valued for tax purposes on the basis of an independent appraisal. 2.3 Selection of comparables The CUP method can be used if there is at least one comparable transaction with identical or similar goods in a given market and there is enough information on such a transaction (provided that the seller in the comparable transaction is not a market-dominating entity under the applicable Russian anti-monopoly rules). To apply other methods, the rules require at least four comparables, provided, however, that the actual number of comparables used may be less, depending on their availability. 342 Baker & McKenzie The following are specific criteria for the selection of comparable companies: (1) no negative net assets as of 31 December of the last year in the period for which the profitability is calculated; (2) no losses from sales for more than one year in the period for which the profitability is calculated; (3) none of the corporate shareholders owns more than 25 percent of the share capital; and (4) there are no subsidiaries in which the company owns more than 25 percent of the share capital (except in cases where consolidated financial reporting is available). If the number of comparables satisfying all criteria established in the law is less than four, the ownership criteria may be relaxed from more than 25 percent to more than 50 percent. 2.4 Timing of information on comparables The information used for comparable analysis could be either the information available at the time of the transaction (but not later than 31 December of the calendar year during which the transaction was performed), or the financial data on comparable companies for the last three calendar years preceding the year when the controlled transaction was performed, or the year when the prices in the controlled transaction were established. The Russian transfer pricing rules do not contain a commensuratewith-an-income-type rule with respect to transfer of intangible assets. 2.5 Voluntary transfer pricing adjustments Taxpayers are allowed to perform year-end retrospective upward transfer pricing adjustments without the application of tax penalties and/or late payment interest if such adjustments are reported and the resulting additional tax amounts are paid no later than the deadline for filing annual profits tax declaration (28 March following the reporting calendar year). No downward retrospective adjustments are allowed (except in the case of corresponding adjustments performed as a result of the transfer pricing audit of the counterparty - please see Paragraph 5.3 below). Transfer Pricing Handbook – Russia Baker & McKenzie 343 2.6 Working capital/inventory adjustments The working capital and inventory level adjustments are not strictly required under the Russian transfer pricing rules. These adjustments may, however, be used to ensure comparability. 2.7 Safe harbors There are no established safe harbors or rules of thumb. 3. Transfer Pricing Documentation and Filing Requirements 3.1 Documentation requirements Taxpayers with controlled transactions are required to maintain transfer pricing documentation. Documentation may be requested by Russian tax authorities only upon the initiation of a special transfer pricing tax audit and not earlier than 1 June of the year following the reporting calendar year. If requested, this documentation must be submitted to the Russian tax authorities within 30 business days upon their request. The following transactions are not subject to the documentation requirement: • Transactions under prices imposed by the anti-monopoly authorities or under state-regulated prices • Transactions with independent parties • Transactions with securities and financial instruments traded on organized securities market • Transactions covered by advance pricing agreements If the documentation is submitted in a timely manner, there is an exemption from tax penalties in case the special transfer pricing tax audit results in a tax assessment. 344 Baker & McKenzie 3.2 Form and depth of documentation The general requirement about the contents of the documentation states that the complexity and thoroughness of documentation must correspond to the complexity of the transaction and its pricing model. However, the rules do not establish clear criteria for determining whether the documentation is sufficient. According to the Russian Tax Code, the documentation must contain information on the activities of the taxpayer that are related to the controlled transaction, including: the list of counterparties to the controlled transaction; description/s of the controlled transaction (including the description of pricing methodology (if any), payment terms and other relevant information); information on the functions of the parties to the controlled transactions (if the taxpayer performs functional analysis); and assets used as well as risks assumed by the taxpayer in respect of the controlled transaction. If the taxpayer uses transfer pricing methods established under the Russian Tax Code, the following information must be included in the documentation: • Justification of the choice of the method and its application • Reference to the information sources used • Determination of the market price (profitability) range, including a description of the approach on the selection of comparable transactions • Amount of income/expenses/profitability related to the controlled transaction • Information on economic value received by a party to the controlled transaction as a result of the acquisition of information, intellectual property rights, trademark rights and other intangible rights Transfer Pricing Handbook – Russia Baker & McKenzie 345 • Information on other factors influencing the price (profitability) in the controlled transaction, including information on the market strategy of the party to the controlled transaction, if such strategy influenced the price (profitability) in the controlled transaction • Information on voluntary transfer pricing adjustments performed by the taxpayer (if any) The Russian Tax Code does not establish a particular format of the documentation. The detailed methodological recommendations on the contents and preparation of transfer pricing documentation are established under the Federal Tax Service Letter No. OA-4-13/14433@ dated 30 August 2012 (the “Letter”). According to the Letter, it is recommended (and, presumably, will be expected by tax authorities upon a transfer pricing audit) that the documentation include the following sections: • Description of the main characteristics of the industry and of the types of activities of the taxpayer necessary for understanding the pricing process • Analysis of related parties and description of the main characteristics of the group • Description of the controlled transaction and functional analysis • Choice of transfer pricing method and information sources • Determination of the market price/profitability range 3.3 Language of documentation The documentation must be prepared in the Russian language. 346 Baker & McKenzie 3.4 Reviewing and updating documentation There are no particular requirements on the frequency of reviewing and updating of documentation. However, the Letter requires that the documentation be reviewed on an annual basis to confirm the validity of the applied transfer pricing methodology and information. 3.5 Recordkeeping duration The general rule for taxpayers is to keep any accounting and taxrelated records/documentation for a four-year period. The Letter establishes the same requirement with respect to transfer pricingrelated records/documentation. 3.6 Notification requirements Taxpayers are required to notify tax authorities on their controlled transactions performed in a given calendar year. The deadline for the filing of the notification form is 20 May of the year following the reporting calendar year. The statutory form of the notification was adopted under Federal Tax Service Order No. MMB-7-13/524@, dated 27 July 2012. 4. Tax Audit Procedures 4.1 Selection of companies for an audit There are no publicly available criteria used by the Federal Tax Service to select companies for a transfer pricing audit. 4.2 Authority to conduct transfer pricing audits Transfer pricing audits are performed separately from the regular tax audits. Transfer pricing audits may be performed by a special Department of the Federal Tax Service at the federal level that is responsible for transfer pricing control. Transfer pricing audits may be performed in-house only and may not be performed onsite as part of the regular tax audits of the taxpayer. Local tax inspectorates do not have the authority to conduct transfer pricing audits. Transfer Pricing Handbook – Russia Baker & McKenzie 347 The Special Interregional Tax Inspectorate of the Federal Tax Service on Transfer Pricing was established under the Ministry of Finance Order No. 43n dated 5 April 2012. This tax inspectorate is in charge of collecting, processing and systematizing the information on prices, analysis of potential mechanisms for tax minimization in transactions between related parties, automatic selection of taxpayers for transfer pricing tax audit, and other issues related to the administration of transfer pricing control. This tax inspectorate does not have the authority to conduct transfer pricing audits. 4.3 Scope of a transfer pricing audit The transfer pricing audit may cover three calendar years immediately preceding the year when the decision on the tax audit is made. If one of the parties to a particular controlled transaction has been audited and no transfer pricing adjustment has been made, the other parties to the same transaction may not be separately audited in connection with the same transaction. 4.4 Maximum period for a transfer pricing audit The maximum term for a transfer pricing audit is six months, with the possibility for extension in extraordinary cases for up to 12 months. In case of the need for receipt of information from foreign state authorities and/or translation of such information into Russian, the maximum term may be extended for another six months. In case the information requested from the foreign state authorities is not received within six months, the maximum term may be extended for another three months. 4.5 Burden of proof The price applied by the parties to a transaction is deemed to be at the market level unless tax authorities prove otherwise or the taxpayer performs a voluntary transfer pricing adjustment. If the taxpayer prepares and submits to tax authorities upon request the transfer pricing documentation justifying the application of a 348 Baker & McKenzie particular transfer pricing method, tax authorities may apply a transfer pricing method different from the one used by the taxpayer, only if they prove that the method used by the taxpayer does not allow establishing comparability between the terms of the controlled transactions and the comparable transactions. 4.6 Secret comparables Russian transfer pricing rules specifically provide that the information constituting confidential tax information under the Russian Tax Code or other information restricted for disclosure under the Russian legislation may not be used for transfer pricing purposes (except when the information related to the taxpayer is being subjected to the transfer pricing audit). Thus, the rules basically prohibit the use of “secret comparables” by tax authorities (i.e., the information on prices or the profitability of other taxpayers, which is not publicly available). 4.7 Internal comparables Russian transfer pricing rules prohibit tax authorities from using any outside comparables, provided there are comparable transactions performed by the same taxpayer with independent parties. 4.8 Scope of information powers As part of the transfer pricing audit procedures, the Federal Tax Service may request from the taxpayer transfer pricing documentation (see Paragraph 3 above). The Federal Tax Service may issue requests for the provision of documents/information from the other parties to a controlled transaction subject to the transfer pricing audit. The Federal Tax Service is authorized to engage independent experts, specialists and/or translators for particular tasks during a transfer pricing audit. 4.9 Tax audit procedures The Federal Tax Service must draw up a Tax Audit Act and present it to the taxpayer within two months after the completion of the transfer pricing audit. The Act must document all instances of price deviations from the market price (if any) and must be handed over to the Transfer Pricing Handbook – Russia Baker & McKenzie 349 taxpayer within five business days. The taxpayer may provide written objections to the Federal Tax Service within 20 business days after the receipt of the Act. Within 10 business days after the expiration of this 20-day period, the Federal Tax Service must conduct a meeting for the purpose of considering the audit materials, and issue a Tax Audit Decision. The taxpayer may attend this meeting and provide comments. The term for the delivery of the Tax Audit Decision may be extended for one month. The Tax Audit Decision comes into force after 10 business days from the date it is received by a taxpayer. 4.10 Transition rules Under the transition rules, a transfer pricing audit for 2013 may be initiated not later than 31 December 2015. For 2014 and thereafter, a transfer pricing audit may be initiated within two years from the tax authorities’ receipt of the notification (please see Paragraph 3.6 above) or notice on reveal of controlled transactions as a result of a regular tax audit. A transfer pricing audit may cover three calendar years preceding the year when the decision on the tax audit is made. For 2013, the taxpayer may be subject to a transfer pricing audit only if the aggregate amount of controlled transactions with a given party exceeds RUB80 million (approximately USD1.5 million). 5. Dispute Resolution 5.1 Administrative appeal Generally, a taxpayer has two levels of appeal against an adverse Tax Audit Decision on the results of a regular tax audit: (1) an administrative appeal to a higher level within the tax inspectorate, which is an obligatory step before a taxpayer may file a court claim; and (2) an appeal to the court. Given that the transfer pricing audit is conducted by the Federal Tax Service, which is the highest authority in the administrative hierarchy of the Russian tax authorities, it is unclear whether and in what form an administrative appeal on the Tax Audit Decision on the results of a transfer pricing audit would be 350 Baker & McKenzie available. The Russian Tax Code does not contain any specific rules on the possibility and procedure for such an administrative appeal. 5.2 Court appeal Generally, after a Tax Audit Decision comes into force, the taxpayer may file a lawsuit with the court within three months. The court must try the case within three months. The court ruling comes into force within one month from the date it is issued in writing. During this onemonth period, the court ruling may be appealed in the Appellate Court The resolution of the Appellate Court becomes effective immediately on the date it is issued. Notably, the initial decision of the court may be appealed directly to the relevant Federal Appeal Court without first passing through the Appellate Court within two months after it comes into force (i.e., one month after it is issued). Within two months after the decision is issued by the Appellate Court, it may be challenged in a Federal Appeal Court of the relevant circuit. The resolution of the Federal Appeal Court becomes effective immediately on the date it is issued. As a final resort, within three months after the final decision issued on a case becomes effective, both the taxpayer and tax authorities may initiate a judicial review by the Supreme Arbitrazh Court of a decision of any court, on the grounds that it contradicts the law or is not properly substantiated. The Presidium of the Supreme Arbitrazh Court tries such an appeal. 5.3 Corresponding adjustments Russian transfer pricing rules provide for the right of a party to a controlled transaction to apply corresponding adjustments (i.e., to decrease its tax liabilities) in case a transfer pricing adjustment is made to another party of such transaction as a result of a transfer pricing audit. A corresponding adjustment may be applied based on a special notification issued by the tax authorities. The corresponding adjustments may be enjoyed by Russian legal entities only. Transfer Pricing Handbook – Russia Baker & McKenzie 351 The rules do not provide for a corresponding adjustment mechanism in a cross-border context. 5.4 Competent authority In cases covered by double taxation treaties, competent authorities of foreign countries may initiate competent authority procedures with the Russian competent authority, which is the Russian Ministry of Finance. However, there is no special procedure established by local Russian legislation for such cases, and it is not quite clear how they should correspond with Russian court proceedings. In practice, competent authority procedures are not used very often in Russia, but there have been some situations where the initiation of such procedures have helped taxpayers to positively resolve a tax dispute with tax authorities. 5.5 The EU Arbitration Convention Russia is not a member of the EU; thus the EU Arbitration Convention is not applicable in Russia. 6. Interest and Penalties 6.1 Late payment interest If additional tax is assessed based on a tax adjustment as a result of a transfer pricing audit, the taxpayer is subject to late payment interest in the amount of 1/300 of the Russian Central Bank refinancing rate (currently 8.25 percent per annum) per each day of the tax payment delay. Currently, the applicable late payment interest rate is approximately 10 percent per annum. No late payment interest applies in case the taxpayer performs a retrospective upward transfer pricing adjustments as of the end of the year (please see Paragraph 2.5 above). 352 Baker & McKenzie 6.2 Tax penalties A 40 percent tax penalty will apply in case the taxpayer fails to submit to the tax authorities in a timely manner the transfer pricing documentation upon their request and the transfer pricing adjustment is made (please see Paragraph 3.1 above). 6.3 Transition rules For tax periods 2014-2016, the tax penalty will be 20 percent. Starting in 2017, a regular tax penalty of 40 percent will apply. 7. Advance Pricing Agreement Procedures 7.1 Applicability criteria Under the Russian transfer pricing rules, only Russian legal entities that are regarded as the “largest taxpayers” under the Russian Tax Code are entitled to conclude APAs with the Federal Tax Service. 7.2 Bilateral (cross-border) APAs The Russian transfer pricing rules envisage a possibility of concluding bilateral/multilateral APAs that cover cross-border transactions with a party resident in a state with a double tax treaty with Russia under the competent authority procedures, with the participation of the relevant foreign tax authority. 7.3 APA procedures Applications for APAs must be submitted to the Federal Tax Service and must be considered within a maximum period of nine months. The state fee for the initial APA application or for application for changes to the existing APA is RUB1.5 million (approximately USD27,000). APAs may be concluded for a maximum of three years, with the possibility of a subsequent two-year extension. Breaching the terms of an APA may result in the early termination of the APA, wherein the taxpayer will have to pay the relevant amount of tax, penalty and late payment interest. Transfer Pricing Handbook – Russia Baker & McKenzie 353 The terms of an APA in case of future changes in the relevant Russian tax legislation on APAs are grandfathered. The procedures for APA preparation and conclusion are established under the Letter of the Federal Tax Service No. OA-4-13/85@, dated 12 January 2012. 8. Interest Deduction and Thin Capitalization 8.1 Interest deductibility Generally, under the Russian Tax Code, interest is deductible for tax purposes as long as it does not deviate by more than 20 percent from market interest rates paid on comparable loans in the same calendar quarter. Any excessive part of the interest is not deductible. If no such comparable loans exist (or at the choice of a taxpayer), interest is deducted within certain limits. For the tax period of 2014, deductible interest for ruble loans may not exceed a factor of 1.8 of the Russian Central Bank refinancing rate (i.e., 14.85 percent at the currently effective 8.25 percent refinancing rate), and for loans denominated in a foreign currency, the deduction is limited to a factor of 0.8 of the Russian Central Bank refinancing rate (i.e., 6.6 percent at the currently effective 8.25 percent refinancing rate) per annum. Starting on 1 January 2015, interest deductibility will be governed by the transfer pricing rules only (i.e., only borrowings that qualify as “controlled transactions” for transfer pricing purposes will be covered). Safe harbor limitations will apply if one of the parties to a controlled transaction is a bank. The safe harbor range would depend on the loan currency. For instance, the applicable range for ruble loans would be from 75 percent to 180 percent of the Russian Central Bank refinancing rate for 2015 (75 percent to 125 percent starting in 2016). For loans denominated in euro or US dollars, the applicable range would be from EURIBOR or USD LIBOR plus 4 percentage points to EURIBOR or USD LIBOR plus 7 percentage points. 354 Baker & McKenzie 8.2 Thin capitalization The Russian Tax Code introduces a 12.5:1 debt-to-equity ratio limit for banks and leasing companies, and a 3:1 ratio limit for all other companies. If the ratio of the Russian borrower’s internal capital to its outstanding debt owed to a more than 20 percent direct or indirect foreign shareholder (including debt owed to a Russian affiliate of the foreign shareholder and debt guaranteed by the foreign shareholder or its Russian affiliate) exceeds these limits, the deductibility of interest paid on the excess debt is limited. Nondeductible interest is also considered a dividend payment to the foreign shareholder and hence is subject to 15 percent withholding tax, unless the latter is reduced by an applicable tax treaty. Transfer Pricing Handbook – Spain Baker & McKenzie 355 Spain Bruno Dominguez, Partner Bruno Dominguez has extensive experience in tax planning and consultancy, as well as representing clients that face tax inspections and administrative procedures in Spain. He specializes in tax issues affecting multinational groups, with particular expertise in the design of transfer pricing systems and analysis of intragroup transactions, consolidated tax regimes, business restructurings and the sale and purchase of companies and real estate. [email protected] Tel: +34 93 206 08 20 Baker & McKenzie Barcelona S.L.P. Avda. Diagonal, 652 Edif. D, 8th Floor Barcelona 08034 Spain 356 Baker & McKenzie Raul Salas, Partner Raúl Salas heads the Firm’s Corporate Tax and Transfer Pricing practice groups in Madrid. His practice also covers M&A transactions and tax unit regimes, particularly those related to the automotive and financial services industry. Mr. Salas began his career in Landwell PriceWaterhousecoopers in 1995, and joined Baker & McKenzie in 2005. He was appointed Firm partner in 2006. [email protected] Tel: +34 91 230 45 31 Baker & McKenzie Madrid S.L.P. Paseo de la Castellana, 92 Madrid 28046 Spain Davinia Rogel, Associate Davinia Rogel´s major areas of practice are tax controversy, tax planning for multinational groups and business restructuring with particular expertise in transfer pricing. She is regularly involved in cross-border transactions, mergers and acquisitions with international and local tax implications. [email protected] Tel: +34 93 206 08 20 Baker & McKenzie Barcelona S.L.P. Avda. Diagonal, 652 Edif. D, 8th Floor Barcelona 08034 Spain Transfer Pricing Handbook – Spain Baker & McKenzie 357 1. Statutory Rules and Administrative Regulations 1.1 Introduction Spanish transfer pricing rules follow the OECD Transfer Pricing Guidelines, including the arm’s length principle by which transactions with related parties must be valued using the same conditions that would be agreed upon between non-related parties in the same or similar market conditions. In 2006, Spanish laws on tax fraud prevention modified the transfer pricing rules in Article 16 (18 as of FY2015) of the Spanish Corporate Income Tax Act, which shifts the burden of proof that intragroup transactions are valued at fair market value to the taxpayer and establishes that taxpayers could be required to produce contemporaneous supporting documentation that justifies the arm’s length nature of their related party transactions. On 28 November 2014, the definitive wording of the Spanish Tax Reform was published in the Spanish Official Gazette. The Spanish Tax Reform basically comprises amendments relating to Personal Income Tax, Non-Resident Income Tax, Corporate Income Tax and Value Added Tax. In general terms, these measures come into effect on 1 January 2015. In summary, current Spanish transfer pricing regulations contain: (i) guidance for applying the arm’s length principle; (ii) requirements for tax deductions on cost contribution and shared-services arrangements with related companies; (iii) general documentation requirements for the group and for the company itself; (iv) procedures to follow in tax audits on transfer pricing; and (v) rules regarding the tax treatment of adjustments carried out as a result of a tax audit procedure. Finally, the regulations also outline the procedure to be followed when a mutual agreement procedure is initiated. 358 Baker & McKenzie 1.2 Related party concept In the regulations, the “related party” concept for transfer pricing purposes in Spain is a widely defined term and applies to a very broad range of situations. The following individuals and entities are deemed to be related parties for these purposes: (i) A corporation or a company, or partnership with legal personality, or any other type of entity and its shareholders or partners; nevertheless, in order for there to be relevant relationships between a company and its shareholders or partners, there must be a holding equal to or greater than 25 percent for non-quoted shares. (ii) A company and its directors (both “de jure” and “de facto” directors) but with regard to its remuneration (iii) A company and the spouses, lineal ascendants and lineal descendants of its shareholders or directors (iv) Two companies which, in accordance with the provisions of Article 42 of the Commercial Code, meet the requirements to form part of a single group of companies; a group exists when one company has or could have control over another or others under the criteria established in Article 42 of the Commerce Code, regardless of residence or the obligation to prepare consolidated annual accounts. (v) A company and the directors of another company, provided that both companies belong to the same group of companies as defined in Article 42 of the Commercial Code (vi) A company and the spouses, or lineal descendants or ascendants of the shareholders, or partners of another company when both companies belong to the same group (vii) Two companies, when one of them indirectly holds an interest – either share capital or equity – of at least 25 percent in the other Transfer Pricing Handbook – Spain Baker & McKenzie 359 (viii) Two companies in which the same shareholders or partners, or their spouses or lineal descendants or ascendants, hold in both companies, directly or indirectly, at least 25 percent of either the share capital or the equity (ix) A company resident in a Spanish territory and its permanent establishment abroad 1.3 Meaning of “group” A group exists when one company has or could have control over another or others under the criteria established in Article 42 of the Commerce Code, regardless of the residence of the parties or their obligation to prepare consolidated annual accounts. 1.4 Meaning of “control” Control exists when a company meets any of the following conditions with respect to another or other companies: (i) ownership of the majority of voting rights; (ii) entitlement to appoint or to dismiss majority of corporate directors; (iii) the possibility, together with other shareholders, of obtaining the majority of voting rights; or (iv) power to appoint the majority of corporate directors at the time when consolidated accounts are prepared and within the two preceding financial years. 1.5 Transactions in scope Spanish transfer pricing rules apply to any type of transaction between related parties where both parties are Spanish tax residents as well as to transactions where one party is a Spanish resident and the other is not. Only the following transactions between related parties are exempt from documentation obligations: (i) Transactions carried out between entities belonging to a group of companies that has elected to apply the special consolidated tax regime for Spanish corporate income ax purposes (regardless of the enterprise size) 360 Baker & McKenzie (ii) Transactions between economic interest groupings (AIEs) and unincorporated joint ventures (UTEs), with some exemptions (iii) Transactions carried out in the context of public offerings (OPAs) or tender offers (OPVs) (iv) As a general rule, transactions with the same related party carried out in a given year, which are not in excess of EUR250,000, are exempt from documentation obligations (regardless of the enterprise size). However, entities with a turnover under EUR45 million are expected to meet simplified documentation requirements, which will be set out by CIT regulations and will be issued in 2015. In any event, the following transactions must be documented in full (i.e., these are not eligible for the simplified documentation regime previously referred to): • Transactions carried out between certain individuals acting as entrepreneurs and entities that are related to them • Transfers of a business • Transfers of shares in non-listed entities • Transfers related with real estate assets (i.e., not just transfers of the property but also lease agreements, assignments, etc.) • Transactions with regard to intangible assets It should also be noted that those transactions that are exempted from documentation obligations do not need to be reported in the Corporate Income Tax return either. 1.6 Statute of limitation for transfer pricing adjustments The general statute of limitation in Spain is four years (five to 10 years in the case of criminal offenses to the tax administration) from Transfer Pricing Handbook – Spain Baker & McKenzie 361 the last day of filing the relevant tax return under the terms of voluntary compliance. This term applies to the rights of tax authorities to assess tax liability, to collect any tax previously assessed, and to impose penalties, as well as to the taxpayer’s right to obtain the refund of any excess tax paid, should that be the case. 1.7 Attribution of profit The Spanish rules follow the OECD Report on the Attribution of Profit to Permanent Establishments, which describes how profits should be attributed to permanent establishments in accordance with the OECD Model Tax Convention’s tax treaty provisions. 1.8 Advance pricing agreements The taxpayer may, before the transactions take place, submit to the tax administration a proposal for the appraisal of those transactions between related parties based on the fair market value. This type of proposal may also refer to the value of research and development contributions, or intragroup management services, as well as to thin capitalization. 2. Transfer Pricing Methods 2.1 Constructing the legislation The Spanish regulations are in line with the latest OECD Guidelines and with the conclusions of the Transfer Pricing European Forum, permitting five different methods in order to determine the normal market value of related-party transactions. 2.2 Selection of method The Spanish legislation provides five different methods that can be applied to establish whether the conditions of controlled transactions are consistent with the arm’s length principle: comparable uncontrolled price method, cost-plus method, resale price method, 362 Baker & McKenzie profit split method and transactional net margin method. However, when these methods could not be applied, other generally accepted methods and valuation techniques could be accepted, provided they respect the arm´s length principle. 2.3 Comparability analysis A comparison between the circumstances of related-party operations and the circumstances of comparable transactions between unrelated entities is always requested. This comparison should take into account the characteristics of the markets, and the goods or services involved, as well as the functions and risks assumed, or assets employed by the concerned parties. 2.4 Contemporaneous information Taxpayers must keep contemporaneous documentation and support the valuation of intragroup transactions by all means legally available. 2.5 Pricing adjustments There is no legal provision on year-end adjustments and retroactive adjustments in the Spanish regulations. A tax ruling from 2010 sets out, however, that any adjustments to the valuation of transactions carried out between related parties should be recorded into the annual accounts of the relevant entities (i.e., the taxpayer cannot just reflect the adjustment in the corporate income tax return but the accounts need to show such an adjustment). 3. Transfer Pricing Documentation and Filing Requirements 3.1 Statutory rules and administrative regulations The specific contents of the transfer pricing documentation requirements in Spain closely follow the European Union Transfer Pricing Documentation Model and the OECD Guidelines. Two levels of documentation need to be prepared: one relating to the group Transfer Pricing Handbook – Spain Baker & McKenzie 363 containing standardized information, commonly known as “Masterfile,” and another one referring specifically to the taxpayer, the so-called “Countryfile.” (a) The standard information for the group to which the taxpayer belongs (“Masterfile”) must include the following information: (i) A general description of the business, the group’s organizational, legal and operational structure, as well as any material change to it (ii) Identification of the group entities engaged in relatedparty transactions, as far as they are involved, directly or indirectly, in the transactions performed by the taxpayer (iii) A general description of the nature, amounts involved and flows of the related-party transactions between the group entities as far as they affect, directly or indirectly, the transactions performed by the taxpayer (iv) A general description of functions and risks assumed by the parties involved, as far as they directly or indirectly affect the transactions performed by the taxpayer, including changes compared to the preceding tax or assessment period (v) A list of the ownership of patents, trademarks, trade names and other intangibles as far as they affect, directly or indirectly, the transactions performed by the taxpayer, as well as the amount of consideration derived from their use (vi) A description of the group’s transfer pricing policy, where methods used are described to justify that transactions between related parties are based on the arm’s length principle 364 Baker & McKenzie (vii) A list of cost contribution agreements or any other kind of services agreement between related parties, as far as they affect, directly or indirectly, the transactions performed by the taxpayer (viii) A list of the advance pricing arrangements or mutual agreement procedures concluded or in progress in relation to the group entities as far as they affect, directly or indirectly, the transactions performed by the taxpayer (ix) The group’s notes to financial statements or an equivalent statutory annual report (b) The specific country documentation that must be kept by the taxpayer (“Countryfile”) must include the following: (i) First and last names, or full corporate or business name, tax domicile and taxpayer identification number of the taxpayer and of the persons or entities with whom the transaction is performed, as well as a detailed description of the nature, characteristics and amounts of the controlled transactions where the taxpayer is concerned (ii) A comparability analysis of the relevant transactions (iii) An explanation of the selection and application of the transfer pricing methods (iv) A description of the methods used to allocate services provided jointly to various related persons or entities, as well as the relevant agreements, if any, and the cost contribution arrangements (v) Any other relevant information used for valuation purposes of related transactions as well as any shareholder’s agreements that may affect the valuation of related transactions Transfer Pricing Handbook – Spain Baker & McKenzie 365 The content of the simplified documentation requirements that will be requested to entities with a turnover under EUR45 million is expected to be further developed by CIT regulations that will be issued in 2015. 3.2 Timing of evidence and analysis Transfer pricing documentation could be requested by the tax authorities after the conclusion of the voluntary period for filing the annual corporate income tax return, which is six months after the end of the fiscal year of the taxpayer (e.g., for fiscal year ending 31 December 2014, the due date is 25 July 2015). 3.3 Statutory documentation retention requirements The transfer pricing documentation may be held by the taxpayer or by the group’s parent company. When the latter is not a resident in Spanish territory, it must appoint a group entity resident in said territory to hold such documentation. In general terms, records must be kept for a period of four years from the conclusion of the voluntary period for filing the annual corporate income tax return for tax purposes, and six years from the end of the period concerned for accounting and corporate purposes. It should be noted, however, that to the extent that a corporate taxpayer has pending NOLs or tax credits generated before the fouryear statute of limitation period, it should keep the relevant documentation for at least 10 years according to the Spanish Tax Reform. 3.4 Language of documentation The regulations do not specify the language in which documentation must be presented. However, based on the EU Code of Conduct, it is assumed that the documentation may be presented in a generally understood language in the EU member states (such as English), unless the tax inspector specifically requests a translation. 366 Baker & McKenzie 3.5 Reviewing and updating documentation The documentation may be used in more than one fiscal year, as long as there are no significant changes in the ordinary transactions and operations of the group and/or the Spanish taxpayer. 3.6 Returning information There is no special tax return form for reporting connected party transactions. The corporate income tax return (Form 200), however, includes a section where the taxpayer must report and provide information with regard to its transactions with related parties. This section requires the taxpayer to report not only the identification details of the parties and the amounts of the transactions, but also to identify the relationship between the parties, the type of transaction (out of 11 standardized categories) and the valuation method that the parties have applied to determine the transfer price. Furthermore, Spanish companies must supply detailed information on transactions with related parties in their public annual financial statements, which are filed with the Commercial Registry and therefore publicly available and at the tax administration’s disposal. Additionally, the Treasury Department’s Regulation 3050 imposes further documentation requirements on transactions with related parties for listed companies in Spain to be filed with the National Stock Exchange Commission. 4. Tax Audit Procedures 4.1 Selection of companies for an audit Until recent times, transfer pricing audits in Spain were normally part of or arose from regular corporate income tax audits. Transfer pricing issues were usually considered part of a general tax audit and were not the subject of special investigations. However, this has changed following the approval of the new specific documentation requirements. The Spanish tax authorities’ approved Transfer Pricing Handbook – Spain Baker & McKenzie 367 guidelines regarding the General Tax Control Plan focus specifically on transactions between related parties whose sole purpose is to transfer, through intragroup transactions, income that should be taxed in Spain to other group entities in jurisdictions with lower tax rates. 4.2 Tax audit procedures Tax audits are usually initiated at the discretion of the tax authorities under the General Tax Control Plan’s guidelines (as approved every year) or if specific information comes to light, which may demonstrate that a taxpayer has not complied with tax obligations. Any adjustments or disputes that may arise from a tax audit assessment could eventually be settled within the actual tax audit. In the event that the taxpayer does not accept the tax inspector’s proposal of a tax assessment, a writ of allegations may be presented to the inspector’s superiors. Based on this writ and the tax inspector’s extended report, the superior inspector’s final tax assessment may confirm, modify or cancel the initial proposal of a tax assessment. 4.3 Administrative proceedings and resources available to the tax auditors The burden of proof in a tax dispute is governed by general principles of the Spanish General Tax Act. Consequently, the party that asserts the existence of a particular fact bears the burden of proving it by providing pertinent evidence. As a result, the taxpayer must prove its deductible expenses, while the tax authorities bear the burden of proof when they maintain that the taxpayer has not complied with his or her tax obligations. However, regarding transfer pricing audits, it should be noted that since related transactions must be agreed on an arm’s length basis, the burden of proving this in a tax audit is on the taxpayer and he must be able to support the transaction valuation in accordance with any of the valuation methods established in Article 16 (18 as of FY2015) of the Corporate Income Tax Act. The primary method of conducting a tax audit in Spain is through the examination of the books and records of the taxpayers in light of the 368 Baker & McKenzie information provided by the taxpayer in its corporate income tax returns. The tax inspectors are also empowered to collect all the information and data necessary to conduct the tax audit, and taxpayers are obliged to provide such information. The tax inspector may also sometimes question the taxpayer’s employees. Failure to provide any data, reports, receipts and information relating to the taxpayer’s tax situation may be considered as resisting or hindering the tax audit. The examination of the taxpayer’s books and records, as well as the interviews and questionnaires, may take place at either the taxpayer’s premises, at the place where the information is located, or at the tax inspector’s office. No prior notice is legally required for onsite inspection. However, the tax inspector normally gives prior notice. The tax inspectors may conduct the tax audit with the company’s representatives. However, during tax audits, taxpayers are typically represented by tax advisors. The facts from the proceedings are documented in writing and, eventually, the tax inspector may issue, for approval by the head of the tax inspection unit, a record including a proposal for reassessment. Finally, in transfer pricing issues, it is common practice for Spanish tax inspectors to request information on the pricing policies between the Spanish company and its foreign affiliates. 4.4 Recent audit developments and experiences According to the General Tax Control Plan for 2014, three areas that inspectors should consider a priority are the following: • Transfer pricing in major business restructuring operations, which may involve the export of unremunerated intangibles or a manifest lack of tax purposes • Intragroup services and cost-sharing agreements, as well as compliance with regulated documentation obligations Transfer Pricing Handbook – Spain Baker & McKenzie 369 • Prior evaluation agreements to prevent fraud, eliminating tax risks arising from the companies’ transfer pricing policies 5. Dispute Resolution 5.1 Transfer pricing adjustments Tax authorities may adjust the price or compensations agreed to by related parties and to include in their taxable base in Spain the profits or taxable income that would have accrued if the conditions to which the related parties agreed are considered not to be at arm’s length. Transfer pricing rules also establish the possibility of a second tier adjustment when the relationship between parties is defined as a shareholder-company relationship, which could lead the adjustment to be as equity remuneration if made to the shareholder and as a contribution to equity if made to the company. These rules, previously regulated in the Regulations, are now introduced into Law. It should be noted, however, that this second-tier adjustment can be avoided if at the end of the tax audit, the taxpayers involved agree to recognize and repair the effect of the adjustment. 5.2 Administrative appeals process Where the tax audit procedure leads to a transfer pricing adjustment, the concerned taxpayers may appeal the final tax assessment by means of an ordinary appeal filed against the Tax Administration. In this regard, the taxpayer may file a petition for the review of the issue before a tax tribunal (Tribunal Económico-Administrativo), which is an independent unit of the tax administration. The petition must be filed within 30 calendar days from the date of the notification of the assessment. 5.3 Litigation Once the administrative appeal procedure is completed, the rulings of the tax tribunals may always be appealed before an ordinary judicial 370 Baker & McKenzie court (Tribunal Contencioso-Administrativo). This application for judicial review must be filed within two months from the date of the notification of the tax tribunal’s decision. The court’s judgment may be appealed before the Supreme Court by means of a specific appeal (Recurso de casación) depending on the amounts involved. 5.4 Mutual agreement procedures All tax treaties entered into by Spain with its different partners include a mutual agreement procedure (as set out in Article 25 of the OECD Model Income Tax Treaty), which may be used to resolve double taxation issues due to transfer pricing adjustments. 5.5 Arbitration As an alternative to the mutual agreement procedure, an EU taxpayer may request the application of the provisions included in the European Arbitration Convention on the Elimination of Double Taxation (90/436/EEC of 23 July 1990), in connection with the adjustments of profits of associated enterprises. 6. Interest and Penalties 6.1 Interest Where additional corporate income tax or other taxes such as valueadded tax or transfer tax become due following a transfer pricing adjustment, any late tax payment will carry interest. 6.2 Penalties The Spanish specific transfer pricing penalty regime is very much linked to adequate compliance with the documentation requirements. Taxpayers’ failure to comply gives the tax administration the power to impose penalties of up to EUR1,000 for each non-documented “single relevant data,” or EUR10,000 for each non-documented “group of relevant data” if no correction of the valuation of the transaction between related parties results from the lack of documentation. Transfer Pricing Handbook – Spain Baker & McKenzie 371 However, the amount of this penalty will have a maximum limit in the lesser of the two following quantities: • 10 percent of the amount of the transactions carried out by the company in a given year • 1 percent of the net sales of the company When the tax authorities adjust the transfer price of the transaction, however, the penalty will amount to 15 percent of the adjustment. The regulations define a “group of relevant data,” for specific transfer pricing penalties purposes, as those aggregate data describing: (i) the group’s structure and composition; (ii) the related transactions and amounts involved; (iii) the functions, risks and assets regarding related transactions; (iv) the group transfer pricing policy and valuation methods used by the group; and (v) the statutory annual financial report of the group. Furthermore, the regulations define “single relevant data” as: (i) the identification of any of the members of the corporate group; (ii) the identification of any intangible and/or fees involved; and (iii) any intragroup agreement, advance pricing agreement or competent authority procedures initiated by the group. 7. Advance Pricing Agreement (APA) Procedures 7.1 Availability of APAs The Spanish Corporate Income Tax Act stipulates that the taxpayer may, before the transactions take place, submit to the Tax Administration a proposal for the appraisal of transactions between related parties based on the fair market value. This type of proposal may also refer to the value of research and development contributions or intragroup management services, as well as to thin capitalization. 7.2 Application process The procedure begins with a pre-filing step during which the taxpayer should provide the tax authorities with information regarding the 372 Baker & McKenzie entities involved in the related transactions, a description of the prospective related transactions, and a summary of the contents of the entire future proposal that will finally be filed. The tax authorities may examine the documents and inform the taxpayers whether an APA ruling on the questions raised in the initial report submitted by the taxpayer may be possible or not. The taxpayer will also be informed of the basic elements of the procedure and its possible effects. After that communication, the actual filing will take place, where the taxpayer must provide detailed information regarding the methodology used, transactions included, parties involved, and so on. Once the proposal has been filed, the taxpayer may complete the documentation or file additional information. Similarly, the Tax Administration may require the taxpayer to file any necessary additional evidence. These steps, in practice, may include meetings with the pertinent tax inspectors in order to reach a common ground for the eventual tax authority ruling. The eventual ruling may approve, modify or dismiss the proposal filed by the taxpayer. In any case, it must include the reasons for the administrative decision. The procedure should not last for more than six months. If the tax authorities have not issued a ruling within that period, the proposal should be considered dismissed. The taxpayer cannot appeal against the ruling but is entitled to appeal against any subsequent administrative reassessment or action in connection with the contents of the ruling. 7.3 Monitoring the APA Both the taxpayer and the tax authorities are obliged to apply the APA. The tax administration may check that the facts and transactions described in the APA correspond to those actually existing, and that the APA has been properly applied. Should that not be the case, the tax administration may regularize the taxpayer’s tax situation. Transfer Pricing Handbook – Spain Baker & McKenzie 373 Where the tax administration has approved an APA, the taxpayer must file a report together with the Personal, Corporate or Non-Residents Income Tax return regarding the application of the APA in the corresponding tax year. 7.4 Term of the APA APAs will be generally valid during the period stated in the APA itself, with a maximum four-year period as of the date of its approval. It is possible, however, to request its application to the previous four years not covered by the statute of limitation period, provided that no tax audit has been initiated in that regard at the time of the conclusion of the APA. Extensions of an APA validity period are available provided that no significant changes are made in the transactions covered by the APA after the initial four-year period. Furthermore, if the economic situation that existed at the time the APA was approved changes drastically before the end of that period, the APA may be modified in accordance with the new economic circumstances. 8. Thin Capitalization Up to 31 December 2011, further to Section 20 of the Corporate Income Tax Act, when a Spanish resident entity’s net remunerated indebtedness with nonresident related parties, directly or indirectly, exceeds the ratio of 3:1 of the average annual amount of its so-called “fiscal capital,” the interest on the excess portion of the average annual indebtedness shall be deemed a constructive dividend. As of 1 January 2012, the limitation of the deductibility of financial expenses set forth in Section 20 (Article 16 as of FY2015) of the Corporate Income Tax Act has been extended to all companies, whether they are related parties or not. Corporate taxpayers can now only deduct their net finance costs up to a limit of 30 percent of their operating income. However, EUR1 million in net financial expenses is allowed without any limitation. Any amount in excess of EUR1 million can be carried forward to the subsequent tax periods, together 374 Baker & McKenzie with the net financial expenses of the relevant tax period until such excess is effectively deducted. If the net financial expenses in a tax year did not reach the abovementioned 30 percent limit, then the difference between the net financial expenses and the 30 percent limit would be added to the 30 percent during the five subsequent years until the difference is effectively deducted. With regard also to financial expenses, the Spanish Tax Reform includes an important modification on new intragroup profit participating loans signed as of 20 June 2014, which will be characterized for tax purposes as equity (rather than debt) and, therefore, interest payments on such loans would be treated as nondeductible expenses (just like dividends). Also with regard to intragroup financial expenses, there is a specific provision setting that intragroup financial expenses are not generally deductible unless there are valid economic reasons for the expense. This measure is mainly focused on intragroup leveraged buyout transactions in which the shares of a group company are acquired or capital contributions are made. Again concerning LBOs, an additional limit of 30 percent of the operating profits for financial expenses derived from debts granted to purchase stakes in any type of company is established. Not included in these operating profits are those from any other entity that has been involved in a restructuring transaction with the purchasing in the following four years and to which the tax neutrality regime has not been applicable. This limit is not applicable, however, in the year of acquisition if the debt does not exceed 70 percent of the acquisition price, nor in the subsequent years if debt is reduced on an annual basis by 5 percent, until reaching 30 percent of the acquisition price. Transfer Pricing Handbook – Sweden Baker & McKenzie 375 Sweden Linnea Back, Local Partner Linnea Back advises corporations in relation to the tax aspects of restructuring and reorganization. She has handled tax matters in order to list companies at the stock exchange, has advised in relation to establishment of businesses and mergers in Sweden, and advises on the tax treatment of various incentive programs. She devotes a large part of her practice to tax disputes and tax litigation and has represented numerous clients before the tax authority. She has also applied for advanced rulings to the Board for Advanced Rulings (Skatterättsnämnden), has appeared against the Swedish tax authorities in court, and has held seminars on tax news and restructuring issues. Linnea graduated from the University of Stockholm (LL.M, juris kandidat) in 1998. [email protected] Tel: +46 8 566 177 75 376 Baker & McKenzie Bo Lindqvist, Counsel Bo Lindqvist is a graduate of the University of Uppsala (LLM, juris kandidat, 1976). He served in the County Administrative Court 1977-1979, as a taxation superintendent in the County Fiscal Authority from 1979 to 1980, and in the Administrative Court of Appeal from 1981 to 1982. Bo, who has been a member of the Swedish Bar Association since 1985, has as his main practice areas corporate and tax law and litigation [email protected] Tel: +46 8 566 177 12 Baker & McKenzie Advokatbyrå KB Vasagatan 7 P.O. Box 180 SE-101 23 Stockholm Sweden Transfer Pricing Handbook – Sweden Baker & McKenzie 377 1. Statutory Rules and Administrative Regulations 1.1 Introduction The Swedish tax authorities adhere to the OECD Transfer Pricing Guidelines and apply a general arm’s length standard. The arm’s length principle is stated in Chapter 14 Sections 19-20 of the Swedish Income Tax Act. 1.2 Meaning of provision Chapter 14 Section 19 of the Swedish Income Tax Act states that where the net operating result of a business, due to the terms of an agreement, is lower than what would have been the case had the agreement been negotiated between independent parties, the net operating result shall be assessed as if such terms had not been applied provided that: (a) the other party to the agreement, realizing a higher operating result due to the agreement, will not be taxed in Sweden under the rules in the Swedish Income Tax Act or an applicable tax treaty; (b) there are reasonable grounds for assuming that there is a financial community of interest between the contracting parties; and (c) it is not apparent from the circumstances that the terms of the agreement are a result of other reasons than such financial community of interests. Since the Swedish arm’s length principle applies to any transaction affecting the net operating result in a company, no area of business activities is excluded from its application. All transactions dealt with in a Swedish company’s P&L are covered by the application of the arm’s length principle. 378 Baker & McKenzie 1.3 Meaning of control A community of interests is defined in Chapter 14 Section 20 of the Income Tax Act and is deemed to exist if a company, directly or indirectly, participates in the management or supervision of another company or owns part of the capital of another company, or where one company directly or indirectly participates in the management or supervision of two other companies or owns part of the capital of two other companies. If the common financial interest is a result of ownership only, documentation is required if the ownership exceeds 50 percent of the capital. The Swedish Tax Agency has declared that it may refrain from requesting documentation from all companies that might be included in the definition of having a “common financial interest” with another company. Documentation needs to be prepared, inter alia, if a Swedish company has a real influence over a foreign company; a Swedish company owns more than 50 percent of the capital of a foreign company; a foreign company has real influence over a Swedish company, and if a foreign company owns more than 50 percent of the capital of a Swedish company. 1.4 Documentation obligation Under Chapter 39 Section 15 of the Tax Procedural Act, the pricing between associated companies must be documented. Regulations SKVFS 2007:1 issued by the Swedish Tax Agency provide further detail on the documentation requirements. The documentation does not need to be filed with the Tax Agency unless specifically requested by the Tax Agency. Simplified documentation requirements apply for companies with transactions of “lesser value.” The definition of lesser value is a yearly market value per entity within the group of 630 basic amounts1 (SEK28,035,000 for income year 2015) for goods and 125 basic amounts (SEK5,562,500) for services and other transactions. Sales of intangible assets can, however, never be documented through a simplified procedure. 1 A basic amount is geared to the price index and is used for national social security purposes. In 2015, one basic amount is equal to SEK44,500. Transfer Pricing Handbook – Sweden Baker & McKenzie 379 1.5 Statute of limitations The arm’s length rule of the Income Tax Act is subject to the general corporate income tax statute of limitations in the Tax Procedural Act whereby reassessment may be made until two years after the expiry of the calendar year in which the fiscal year ended. If the taxpayer is found to have submitted so-called erroneous information, the statute of limitations is extended to six years after the expiry of the calendar year in which the fiscal year ended. In case of suspected crime, the statute of limitations may be extended further. 1.6 Allocation of profits to PEs The arm’s length rule of the Income Tax Act refers to transactions with affiliated companies abroad. Allocation of profit between a Swedish company and its foreign branch, or a Swedish branch of a foreign company will typically be determined through the application of the relevant profit allocation article of the applicable treaty (Article 7 of the OECD Model Convention). The Swedish Tax Agency has published two opinions regarding the applicability of documentation requirements, stating that documentation is not required for transactions between a Swedish partnership and a foreign related business, or between a Swedish business and a Swedish permanent establishment of a related company. As a main rule, all income of a foreign branch office of a Swedish company will be taxable in Sweden, and Sweden will have waived its tax claim over certain amounts of the income under a relevant treaty. Similarly, Sweden will impose taxation on profits from business activities conducted in Sweden by a foreign company’s branch office. Profit shall be allocated between the branch and the head office as if the two were independent parties, and the allocation shall be made based on GAAP. 1.7 Advance pricing agreement (APA) An APA procedure became available when the Swedish APA Act entered into force 1 January 2010. The legislation applies to 380 Baker & McKenzie businesses liable to tax under the Swedish Income Tax Act and subject to a double taxation treaty entered into by Sweden. An advance ruling under the new APA Act will be given for a period between three and five years unless special circumstances apply. Under the APA Act, the taxpayer will have an obligation to provide the Tax Agency with information relevant for the APA, i.e., whether the factual circumstances on which the APA is based have changed or whether the APA is not applied by the taxpayer. Information on applicable APAs will also have to be provided in corporate income tax returns and be encompassed by the rules on information submission obligation for partners of a Swedish partnership, for instance. Although the arm’s length rule of the Income Tax Act merely refers to transactions with affiliated companies abroad, the APA Act is applicable to profit allocation between headquarters and branch offices as well. 2. Transfer Pricing Methods 2.1 General acceptance of OECD guidance The preparatory works of legislation, which are an important source for interpreting Swedish law, relating to the Swedish arm’s length rule in the Income Tax Act refer to the OECD Transfer Pricing Guidelines. The Swedish Supreme Administrative Court has also ruled that the OECD Transfer Pricing Guidelines should serve as reference when applying the Swedish arm’s length rule. It is the Tax Agency’s view that the OECD Guidelines should serve as guidance when applying the Swedish arm’s length rule. 2.2 Hierarchy of methods There is little guidance from Swedish case law on the choice of method. According to the Swedish Tax Agency, all methods accepted under the OECD Guidelines have strengths and weaknesses and the most appropriate method must be determined on a case-by-case basis. Transfer Pricing Handbook – Sweden Baker & McKenzie 381 2.3 Level of knowledge and timing The taxable income reported in the corporate income tax return is based on the profit accounted for in the annual accounts (with a few tax-related adjustments). A taxpayer subject to the provisions of the Income Tax Act and the Tax Procedural Act is obliged to submit all relevant and necessary information to the Tax Agency in order for the agency to assess tax at the right amount. A breach of that obligation is considered a submission of erroneous information, which renders the taxpayer liable to tax surcharges and an extended statute of limitations. The taxpayer can therefore be said to have an obligation to be sufficiently informed of the factual circumstances of the business, and of the relevant arm’s length price. The relevant time of knowledge is submitting the corporate income tax return for the relevant fiscal year, in the sense that anything known but not accounted for, which is relevant for the assessment of taxable income, will be seen as erroneous information. The obligation to submit correct and sufficient information is not limited in time. If the taxpayer discovers that erroneous information has been submitted in a corporate income tax return for a previous year the risk of tax surcharges (and potential criminal liability for the directors) is eliminated if a voluntary disclosure is filed before the Tax Agency finds reason to investigate the matter. 2.4 Year-end adjustments and retroactive adjustments Year-end adjustments and retroactive adjustments in order to achieve a pricing at arm’s length are accepted. The Tax Agency considers that comparability adjustments should be used with caution as too extensive adjustments would mean that the comparability of the transaction at hand may not be sufficient. 382 Baker & McKenzie 3. Transfer Pricing Documentation and Filing Requirements 3.1 Statutory rules and administrative regulations According to Chapter 39 Sections 15 and 16 of the Tax Procedural Act, documentation is required. Regulations SKVFS 2007:1 issued by the Tax Agency set out that the documentation should include a description of the company’s and group’s legal and operational structure, information regarding the characteristics and scope of the transactions, a functional analysis, a description of the pricing method chosen, and a comparability analysis. The functional analysis should provide an analysis of the arm’s length price, taking into consideration the functions, risks and resources of the related parties. Notwithstanding the fact that the documentation requirements did not come into effect until 1 January 2007, companies involved in transactions with related companies must, upon request by the Tax Agency, also be able to provide supporting documentation for the methodology used in previous fiscal years. The Tax Agency has the burden of proof for showing that the pricing method used has resulted in a price, which is not at arm’s length. If the Tax Agency is able to show that the pricing used is not at arm’s length, the burden of proof for showing that the pricing is justified is transferred to the taxpayer. Regulations SKVFS 2007:1 state that the documentation should contain sufficient information in order to make a correct assessment of whether prices and other conditions for transfer pricing are at arm’s length and the documentation only needs to contain information necessary for the Tax Agency to make a reasonable assessment in this regard. Those regulations require that: (a) the documentation must contain a description of the legal structure of the group; substantial changes during the fiscal year must be accounted for, including relevant financial information on the applicability of the chosen pricing and circumstances relevant for the trade at hand as well as the characteristics of the business activities that have affected the intragroup pricing; Transfer Pricing Handbook – Sweden Baker & McKenzie 383 (b) the documentation must contain a description of the internal transactions regarding each company with which the company has had transactions, either with a specific description for each transaction or in aggregated form based on comparison criteria including information regarding: (i) the type of transaction; (ii) the value; (iii) the quantity; (iv) other conditions of the agreement; (v) connection with other transactions relevant for the pricing, if any; and (vi) cost basis, allocation model and profit mark-up for cost-based indirect service charges; (c) the documentation must include relevant agreements or a list of such agreements; companies with a great number of agreements may instead provide a description of the main categories of agreements and the pricing methods used for the different categories of agreements. APAs, advance rulings or similar notifications issued by Swedish or foreign authorities shall be included; (d) the functional analysis must provide a description of the functions performed by the companies involved and include a specified list of the company’s functions, assets and risks, as well as the economic impact of these factors; the company must also describe how it has used the pricing method applied; (e) a comparability analysis must describe the use of internal and external comparable transactions, and the method for choosing the comparable transactions and adjustments made. If no comparable transactions have been identified, the documentation shall include a description of how the company has concluded that the pricing method used is at arm’s length; and (f) documentation using the European Union Transfer Pricing Documentation standard (EUTPD) is accepted and will be considered to meet the Swedish requirements; the documentation can be construed in Swedish, Norwegian, Danish or English, and must be retained for 10 years. As, 384 Baker & McKenzie however, the 10-year retention period in the Swedish Bookkeeping Act has been changed to seven years, the corresponding retention period under the transfer pricing regulations will be changed to seven years shortly. In addition, the Tax Agency has published an explanatory notification document SKV M 2007:25 (not legally binding) with a general overview of the Swedish transfer pricing rules, explanatory examples and a more detailed discussion on the interpretation of applicable rules. In this notification, the Tax Agency clarifies that there is no requirement to summarize transactions on a yearly basis, and that the Tax Agency does not prefer any pricing method over another. There is no express requirement for contemporaneous documentation, but the preparatory works of law concerning the introduction of mandatory documentation specify that in practice, it is required that the companies concerned continually work with transfer pricing issues and that there are practices in place to this end. Even if it is not generally required that the companies compile documentation before or in connection with a specific transaction, normally there must already be an analysis available that makes it possible to compile documentation showing the arm’s length character of the transaction, if such documentation is requested by the tax agency. Companies are, however, not required to provide documentation on a current basis to the Tax Agency. The due date for filing corporate income tax returns depends on the fiscal year of the company, and typically falls six months after the expiry of the fiscal year. The taxpayer should have its transfer pricing documentation in place for the fiscal year in question at the time of filing the corporate income tax return in questions. The documentation is, however, not to be filed with the Tax agency unless specifically asked for by the Tax agency. The taxpayer shall be given the opportunity to comply with such a request within a reasonable period of time. The documentation may be submitted as a hard copy or electronically. Transfer Pricing Handbook – Sweden Baker & McKenzie 385 4. Tax Audit Procedures 4.1 Selection of companies and expected frequency of audit In general, larger corporations and multinational companies are more frequently subject to tax audits than individuals or smaller companies. Special audit projects are carried out by the Tax Agency on a yearly basis with shifting targets. In general, it is not possible to give an estimate of how often a company should expect to be subject to a tax audit. All submitted tax returns undergo certain basic controls before they will be accepted. After this initial stage, the Tax Agency makes a selection of a number of individuals and companies each year to be investigated more extensively, and also selects companies or individuals to be audited more extensively with respect to a specific field. When selecting the companies to audit, the Tax Agency will take into consideration a number of factors such as the probability of the audit correcting intentional errors and contributing to voluntary cooperation, as well as how the audit conforms to the general purpose of strengthening the taxpayer’s compliance with the tax laws and tax system in general. Tax audits are intended to focus on serious and obvious errors in the tax returns or to assist in the early detection of “new” errors. Audits are also meant to focus on sectors where tax avoidance is considered to be particularly offensive to the general public and to continually check on companies or individuals who have been known to commit errors in the past. The Tax Agency may, inter alia, use the following sources as basis for a decision on which companies to target: information from the public, information from various databases – both within the Tax Agency and external databases – income statements submitted by employers and selfemployed individuals, information from the Companies Registration Office, the Social Insurance Office or the Swedish Enforcement Authority. Information from third parties, from other governmental and municipal authorities such as the post office and the Swedish Customs, may also be used to form the basis of a decision to initiate a tax audit. 386 Baker & McKenzie 4.2 Tax audit and appeals procedures Under the Tax Agency’s internal guidelines and under the Tax Procedural Act, a tax audit should be carried out in a spirit of cooperation and in good atmosphere, and in such a way that the business of the taxpayer is not unnecessarily hindered. A decision to initiate a tax audit must be issued in writing and must include information revealing the scope of the audit, what will and will not be audited, which periods of time are covered by the audit, and the possibility of exempting certain types of documents from the audit. The taxpayer should also be informed of its rights from the outset; the Tax Agency has issued an information folder on tax audits in which some of the rights of an audited party are described. This folder should be provided along with the written decision. The decision to audit will generally be sent in advance by mail. The time and place for the audit should be decided after the consultation with the taxpayer. If the purpose of the audit may otherwise be compromised, the notification to the audited company and the actual audit may take place simultaneously. A tax audit is normally not carried out within the business premises of the audited entity. However, an audit may be carried out within the premises if the company being audited agrees to this. The company being audited is obliged to produce the documents and other information needed for the audit. The taxpayer is also required to give access to premises primarily used by the company and to generally give all necessary assistance to the auditors. If the audited company fails to comply with these provisions, the Tax Agency may issue a conditional fine. Documents that may be audited include bookkeeping, accounts and all other documents attributable to the business, including electronic documents, internal memoranda and the like. In addition, books, records and verifications used in bookkeeping must be maintained for a period of at least seven years (10 years before 1 January 2011). The documents included in the audit should be specified in the decision to audit. The audit may include the investigation of cash registers, machines and equipment, inventories, Transfer Pricing Handbook – Sweden Baker & McKenzie 387 and the premises and buildings connected to the business. It may also include documents subject to confidentiality. Certain documents may be exempted from the audit, such as documents containing information, which a lawyer, consultant, physician or some other professional has received in his or her line of work subject to professional confidentiality and other documents of special importance and/or of a confidential nature. The audited company’s own assessment on whether or not a certain document may be exempted from the audit should be respected by the Tax Agency. The question of whether or not documents may be exempted is handled by the administrative court. An audited company wishing to exempt a certain document from a tax audit should file a petition with the court. The administrative court’s decision in the matter may be appealed to the Administrative Court of Appeal. The audit will be concluded by an audit memorandum released by the auditors. A draft copy of an audit memorandum will be presented to the taxpayer before the memorandum is finalized in order to give the taxpayer the opportunity to express its views. After the audit memorandum has been finalized and sent to the taxpayer, the taxpayer will again be given the opportunity to express its views. Generally, the taxpayer has up to one month to submit its statement, which should include a critical analysis of the conclusions and estimated tax assessments, if any, proposed in the memorandum. On the basis of the memorandum and the statement by the taxpayer, the Tax Agency will decide on possible tax reassessments. If this takes place within a year after the tax year in question, the decision will be in the form of a review of the tax decision for the tax year in question. After that time, the Tax Agency will need to show that erroneous information has been submitted by the taxpayer in order to make a reassessment. 4.3 Appeals procedures If the Tax Agency makes a reassessment decision, the taxpayer will have the opportunity to either request a re-appraisal, i.e., that the Tax Agency re-examine their decision, or file an appeal to the 388 Baker & McKenzie administrative court. If the taxpayer chooses to directly file an appeal, it must be addressed to the Administrative Court but sent to the Tax Agency. The Tax Agency will then examine whether the appeal has been submitted in due time, and if so, of their own accord re-examine their decision and possibly change it. Should the Tax Agency change its decision, the appeal will be automatically dropped. If not, the appeal will be passed over to the administrative court. Both the taxpayer and the Tax Agency may initiate a re-appraisal of a tax assessment. The taxpayer must file its request for a re-appraisal within five years from the end of the year of assessment in question, whereas the Tax Agency’s limit is set at five years from the end of the year of assessment in the case of a favorable decision for the taxpayer; otherwise, it will be set to one year. If the Tax Agency finds that the appeal has not been submitted in due time, the appeal will be rejected. A separate appeal against the decision to reject an appeal may be filed with the administrative court. 4.4 Duties and rights of the taxpayer in the course of an audit The taxpayer has no option of settling a matter with the Tax Agency. If a tax audit is initiated, the taxpayer will receive an audit memorandum when the audit is finalized. The taxpayer will be given the opportunity to present his or her views on the matter at hand, and the Tax Agency will subsequently make a decision based on the memorandum and the views submitted by the taxpayer. The only real choice available is to decide whether or not to appeal the decision to the administrative court. In addition, negotiations between an audited taxpayer and the Tax Agency regarding the outcome of the audit are very rare. 4.5 Burden of proof The Tax Agency and the administrative courts have an obligation to investigate each matter to the extent necessary with regard to the state, complexity and nature of the matter. The taxpayer has an obligation to provide information within the framework of the regular tax proceedings, and must submit information necessary for the assessment of its taxes due to the Tax Agency. If the taxpayer fails to Transfer Pricing Handbook – Sweden Baker & McKenzie 389 fulfill its obligation to provide information, the Tax Agency has the right to serve an injunction on the taxpayer to submit the information needed under penalty of a fine. If the taxpayer does not submit sufficient or correct information in its tax return, or other mandatory filings, the Tax Agency will make an arbitrary assessment, but must present information in support of the arbitrary assessment. If the Tax Agency claims that the taxpayer has had unaccounted revenues, the Tax Agency has the burden of proof to present evidence to this end. If the taxpayer wishes to deduct costs, it has the duty to verify the existence and extent of these costs. Both case law from the administrative courts and various official standpoints and notifications from the Tax Agency provide a number of rules on when the burden of proof can be presumed to have been transferred to the opposing party, and when these presumptions can be rebutted if sufficient evidence to the contrary is presented. Generally, the existence of agreements or other documents which are valid from a civil law standpoint make a strong presumption for the validity of a transaction for tax purposes. In such cases, the burden of proof will be placed on the Tax Agency if the Tax Agency wishes to question such agreements or documents. Both the Tax Agency and the administrative courts are free to examine any documents submitted as evidence at their own discretion. 4.6 Obligation to disclose The tax auditors may request, for practical purposes, virtually all documents and information related to the business under audit. This includes, but is not limited to, the right to request the names of creditors and payees. However, if the documents and/or other information disclosing the name of certain individuals and businesses are of significant interest to the audited business, measures may be taken to exempt such documents from the audit process. The taxpayer has to show sufficient evidence to support any deduction claims regarding costs in the business activities. The BookKeeping Act states that, with a few exceptions, legal entities are obliged to keep books on the business activities of the entity. According to the Tax Procedural Act, anyone who is obliged to submit tax returns is also obliged to 390 Baker & McKenzie make sure, by taking notes, keeping books or through other suitable measures that the obligation to submit information is fulfilled. 4.7 Coercive measures An audited company or individual may be subject to coercive measures under the Tax Procedural Act. Coercive measures may be used to carry out an audit within the business premises regardless of whether the business has given its consent, if there are particular grounds; to search for documents and other information within the business premises, which documents may be seized if there is a risk that the audited company will otherwise seek to withhold any information; to discover documents of relevance in regard to the obligation to submit income statements if there are particular grounds; and to cordon off premises, a repository or other areas if the documents or information stored there cannot be moved from the location and there is a risk that such documents or information may be compromised if left onsite. Documents and information which may be exempted from the audit process may also be exempted from the coercive measures described above. 4.8 Third-party audits The Tax Agency may initiate an audit of an unrelated company (Company B) to obtain information regarding another company (Company A), even if the scope of the audit does not involve Company B. Third-party audits may also take place as general investigations to gather information in preparation for more in-depth investigations. If an audit includes an investigation and search for information regarding certain third parties or the search for documents and/or legal acts which have already been targeted by the Tax Agency, this information should be disclosed in the decision to initiate the audit sent to the taxpayer. However, if the Tax Agency can establish that there are particular grounds for doing so, they may withhold information on which companies, persons or legal acts the audit is targeting. The Tax Agency decides whether there are particular grounds to withhold information in each individual case, and there is no possibility of appeal against such a decision. Transfer Pricing Handbook – Sweden Baker & McKenzie 391 4.9 Injunctions The Tax Agency may request information via injunctions by which someone else may be investigated for the purpose of gathering information on legal acts of audited company and another party. 4.10 Cross-border exchange of information The cross-border exchange of information during tax audits is governed, inter alia, by the Act on Mutual Assistance in Tax Errands and the EC Directive on Administrative Assistance (77/799/EEC of 19 December 1977). Under the Act on Mutual Assistance, mutual assistance means the exchange of information, including the participation in tax investigations and in simultaneous tax investigations, assistance during collections, including security measures, and the service of process. Voluntary and automatic exchange of statements of earnings and income is also included. Further, Sweden has entered into double taxation treaties with more than 80 countries. As a general rule, only information covered by domestic laws may be requested according to the treaty provisions. The treaty procedure should be used only when all other means of obtaining the sought-after information within the other country have been exhausted. Simultaneous tax audits occur when two or more states enter into an agreement to conduct a simultaneous investigation and each state retains responsibility for the investigation in its respective jurisdiction. Simultaneous tax audits may be carried out in accordance with the Nordic Agreement on Mutual Assistance and the Convention by the European Council and the OECD, as well as bilateral double taxation treaties. Simultaneous tax audits are fairly infrequently used, but the method was described in a report from the Swedish Tax Agency in 2002 as being the “method of investigation of choice for the future,” and there is a strong recommendation to increase the number of simultaneous tax audits each year. Apart from simultaneous tax audits, Swedish auditors may be present at an audit in another country. During secondments abroad, the Swedish tax auditor may not 392 Baker & McKenzie participate actively in the investigation, and the same applies when a foreign tax auditor is present during a Swedish tax audit. 4.11 Conversion of audit to criminal investigation The Tax Agency has a far-reaching obligation to report suspected crimes discovered during their auditing activities to the public prosecutor. The taxpayer is under no obligation to voluntarily assist in the criminal investigation, as that would potentially lead to penal consequences for the taxpayer, whereas he or she has an obligation to submit information regarding his or her income to the Tax Agency. 5. Dispute Resolution 5.1 Competent authority procedure Most Swedish double taxation treaties contain a provision on a competent authority procedure in accordance with Article 25 of the OECD Model Tax Treaty. The competent authority in Sweden is the Swedish Tax Agency for routine matters and the Ministry of Finance and the Minister of Finance for more complicated matters. In practice, the cases where the competent authority procedure is used are few and far between. It is possible, however, to initiate a competent authority procedure and simultaneously proceed with litigation over the same decision by the Tax Agency to make a reassessment. A competent authority procedure can be initiated if a taxpayer feels that it has been taxed in breach of the applicable double taxation treaty. 5.2 European Arbitration Convention Sweden has also ratified the EU Arbitration Convention (90/436/EEC of 23 July 1990) and the protocol to extend the application of the Convention as of 2000. The Convention establishes a mandatory dispute resolution procedure in cases where the member states involved are unable to reach a mutual agreement on the elimination of double taxation as regards companies in a community of interest within two years from the date the case was first submitted to one of the competent authorities of the states involved. Because its application is mandatory, the Convention has an important advantage Transfer Pricing Handbook – Sweden Baker & McKenzie 393 over the procedure described above. The application of the Arbitration Convention is handled by the Ministry of Finance, but it has not yet been used in practice. 6. Interest and Penalties 6.1 Interest and penalties There are no specific transfer pricing penalties. The Tax Agency is authorized to issue an injunction for a company to comply with any obligations under the Tax Procedural Act including documentation obligations. The injunction may be issued with a fine if there are reasonable grounds for suspecting that the company will not adhere to the injunction. If the taxpayer submits insufficient information to the Tax Agency, an arbitrary assessment will be made. An arbitrary assessment must be based on what is reasonable and fair in light of what has been established during the Tax Agency’s investigation. Transactions which are deemed to have been made solely for the purpose of avoiding tax may be disqualified by the Tax Agency. If an arbitrary assessment is issued, a tax surcharge varying from 2 percent to 40 percent of the taxable amount will be levied in addition to the actual tax due. Late payment interest (currently between 1.25 percent and 16.25 percent) may apply. Surcharges may not apply in cases where the taxpayer has a reasonable excuse, there has been an obvious error, the taxpayer has voluntarily corrected an error or the amount of tax is insignificant. 6.2 Personal payment liability Under the Tax Procedural Act, the representative of an organization is personally responsible, together with the organization, for any due taxes unpaid if he or she by intent or gross negligence omits to make required deductions or administer due taxes to be paid. This means that such a person is personally responsible for covering any shortfall of unpaid taxes. 394 Baker & McKenzie 7. Advance Pricing Agreement Procedures 7.1 Procedure under the APA Act When the taxpayer has submitted an application for an APA, the Tax Agency reviews the material and forms its opinion on the basis of the material. Next, the Tax Agency contacts the tax authorities of the other country concerned. So-called opinion papers are exchanged between the Swedish Tax Agency and the tax authorities of the other state within a negotiation procedure, possibly followed by one or several meetings between the representatives of the two administrations. The negotiations hopefully result in an agreement between administrations. During the course of the application procedure, the Tax Agency may find that essential circumstances or conditions for the APA have changed, and in such a case the application may be adjusted accordingly. If the Tax Agency requests certain information or documents, such requests may be a sign of the Tax Agency’s standpoint on different matters, but the Tax Agency will most likely not give the taxpayer any indications on how it assesses different relevant circumstances. Such indications could, in any case, not be relied on by the taxpayer as only the final APA ruling will be binding on the Tax Agency. If, for instance, services are compensated on a cost plus basis, the scope of the cost base on which the mark-up will be applied will be encompassed by the continuous dialogue with the Tax Agency during the application procedure. The Tax Agency will not make any comfort statements as to what costs may or may not be included, and it is not authorized to do so. It will also be binding for the foreign tax administration involved, in accordance with that administration’s procedures. It is expected that an application procedure will require substantial preparation and documentation. In addition to the cost for preparation and documentation, an application fee of SEK100,000 to SEK150,000 is payable. 7.2 Time frame Although APA applications are prioritized matters, the entire process from the submission of an application to issuing a ruling could take Transfer Pricing Handbook – Sweden Baker & McKenzie 395 well up to two years with no certainty at all on the outcome, neither in part or in whole. One reason for uncertainty is that it is impossible for the Swedish Tax Agency to assess how interested and efficient the foreign authorities will be during the process. If the taxpayer realizes that the process is not going well or is in an adverse situation, the APA application can be withdrawn. 7.3 Scope of APA procedure As of 1 January 2010, an APA procedure became available. The procedure is also applicable to permanent establishments. A representative of a Swedish branch may apply for an APA regarding transactions with its head office. Informal agreements or rulings are not available. Sweden does not issue unilateral rulings on transfer pricing. The APA procedure is structured as a bilateral or multilateral procedure in which the ruling issued consists of an agreement between the competent authorities of the countries concerned. The APA procedure is designed to remove the risk of double taxation. Under the APA rules, it is not possible to obtain any conclusive ruling on the matter of whether a PE exists in Sweden for the affiliate of the Swedish entity, although the potential existence of a PE for a foreign parent company can constitute an intrinsic part of the conditions on which the APA is based. This would be evident if, e.g., the Tax Agency would consider denying the Swedish company an APA because it feels that the transfer pricing should be determined as an issue between a foreign company and its Swedish branch. As a general rule, however, the PE question, if subject to the Tax Agency’s attention, will be handled under the regular tax residency procedural rules. Apart from the APA procedure, a procedure of advance rulings from the Board of Advance Rulings is available in theory, but questions depending on the individual circumstances of a case are normally not answered, and it is not certain whether a question submitted to the Board of Advance Rulings will be handled or rejected without a ruling by the board. Obtaining an advance ruling from the Board of Advance 396 Baker & McKenzie Rulings may take approximately six months, provided that the board grants leave to examine the matter. The potential existence of a PE, but not the transfer pricing issue, can be subject to the regular advance ruling procedure before the Board of Advance Rulings. A ruling by the board can be appealed to the Supreme Administrative Court. 7.4 Observations The Swedish APA procedure is considerably different from the APA process as followed in other countries. The Swedish procedure closely resembles the competent authority process, especially in its emphasis on negotiations between two governments, and the relatively limited opportunity for the taxpayer to engage in active discussions with the APA office during the negotiations. Since this is a new procedure in Sweden, there is little experience so far on how much activity or involvement on the taxpayer’s part will be required. It is likely, however, that the Tax Agency would seek active involvement from the taxpayer, as the taxpayer is better equipped to provide relevant factual background and financial analysis than the Tax Agency. Even if Swedish authorities expect that this procedure will proceed along the lines of a competent authority negotiation, the taxpayer may have an opportunity to play a more active role in the discussions through interventions on the side of the foreign tax administration. Transfer Pricing Handbook – Switzerland Baker & McKenzie 397 Switzerland Hans-Andrée Koch, Partner Hans Koch, co-head of the Firm’s Tax Practice Group in Zurich, is ranked among the leading lawyers in his area of practice by various publications, including Legal 500 and Chambers Europe. Prior to joining Baker & McKenzie, Hans worked at KPMG as a tax consultant. [email protected] Tel: +41 44 384 1201 Robert Desax, Associate Robert Desax advises corporations and private clients. He practices in the areas of national and international taxation, specializing in international corporate taxation, double tax treaties, tax aspects of wealth management as well as tax controversy. He frequently represents clients before Swiss authorities, especially in transfer pricing audits and regarding cross-border restructurings [email protected] Tel: +41 44 384 13 25 Baker & McKenzie Holbeinstrasse 30 Zurich 8034 Switzerland 398 Baker & McKenzie Denis Berdoz, Partner Denis Berdoz is a partner at the Geneva office. Denis’ practice focuses on tax. He has experience in domestic and international tax planning, corporate taxes, tax treaties, mergers and acquisitions, post-acquisition and redisposition restructuring, spin-offs and dispositions, and intercompany pricing. He also represents clients in competent authority and advanced pricing procedures. Denis is a former chairman of the Geneva Appellate Commission in Tax Matters. He teaches at the Académie de la Chambre Fi-duciaire, at the LLM Tax Program (Master of Advanced Studies) of the University of Geneva and at the Master of Advanced Studies in International Taxation (MASIT) of the University of Lausanne. [email protected] Tel: +41 22 707 98 15 Transfer Pricing Handbook – Switzerland Baker & McKenzie 399 Aïcha Ladlami, Associate Aïcha Ladlami is an associate of the Geneva office. Aïcha advises corporations and private clients. She handles domestic and international tax issues, restructuring, wealth planning, inbound and outbound investments, as well as real estate tax planning. She holds a master’s degree in business law and international taxation, as well as in finance. [email protected] Tel: +41 22 707 98 71 Baker & McKenzie Geneva Rue Pedro-Meylan 5 Geneva 1208 Switzerland 400 Baker & McKenzie 1. Statutory Rules and Administrative Regulations 1.1 General rules Switzerland has not enacted any specific transfer pricing rules. The notion of dealing at arm’s length is, however, embedded in Swiss tax laws. Intercompany transactions are subject to the general principles and rules pursuant to Swiss tax legislation and practice. The OECD guidelines are generally observed by the Swiss tax authorities. Based on general rules of Swiss tax laws, operations that are reflected in the statutory accounts and which are compliant with Swiss commercial law are also binding for Swiss tax purposes. Thus, the statutory accounts are the basis for the determination of the taxable profit, and hence, for the tax assessment. Swiss taxpayers can, in general, rely on the tax authorities recognizing their statutory accounts: tax follows accounting (Massgeblichkeitsprinzip - a principle according to which the statutory accounts are determinative for tax purposes). Intercompany transactions that are reflected in the financial statements are therefore recognized for tax purposes as well. The tax administration may, however, take tax-corrective measures and depart from the financial statements and take corrective measures where: (a) charges are not commercially justified; (b) income is not properly recorded as such; (c) a systematic tax realization takes place (e.g., transfer of assets or activities abroad); or (d) related parties do not deal with each other at arm’s length conditions (i.e., at conditions corresponding to what would have been agreed on between unrelated parties), which may result in income tax adjustments and in constructive dividend distributions or constructive capital contributions. In the above cases, the tax authorities may adjust the net taxable profit shown in the financial statements. The tax authorities are also allowed to adjust net taxable profits if a substance-over-form analysis determines that the legal structure chosen does not correspond to the economic reality implemented. Transfer Pricing Handbook – Switzerland Baker & McKenzie 401 1.2 Arm’s length principle Under Swiss precedents, the arm’s length principle is considered to be violated if (i) a Swiss company grants an advantage without receiving an adequate consideration in return; (ii) the advantage is granted to a shareholder or a party close the shareholder; (iii) the advantages would not have been granted under similar conditions to a third party; and (iv) the disproportion between the advantage granted and the consideration received in return is recognizable by the company’s bodies. In this case, a company suffers an economically unjustified loss because the compensation paid for goods, services or financial transactions to a related party is excessive, or because the compensation it receives for goods, services or financial transactions is too low. A related party is not necessarily a shareholder or a person related to the shareholder of the company in question. Related parties can also be persons who have control of the company (e.g., directors) or with whom the shareholder has a close relationship or who are authorized by the owner to use the company as if it were their own. Arm’s length concerns may, inter alia, arise with regard to excessive charges, such as the rate of interest payments applied between related parties or the determination of the level of the debt-equity ratio. In this specific context, the Swiss federal tax administration (SFTA) regularly issues guidelines that define safe harbors interest rates (i.e., maximum payable interest rates if the Swiss entity is a borrower or minimum receivable interest rates if the entity is a lender) that will apply to related parties’ loans. In a similar manner, a circular letter dating from 1997 determines appropriate debt-equity ratios for respective asset categories, that is, up to which certain classes of assets may be debt-financed (e.g., the 1997 circular letter allows a maximum debt ratio of 85 percent on trade receivables and 70 percent on investments in subsidiaries). It should be noted, though, that taxpayers may always demonstrate, through appropriate documentation and evidence, that transfer pricing in a specific case complies with the arm’s length principle even where the safe haven rates are not observed. In any case, if it is sufficiently evident that a certain transaction is not at arm’s length and therefore, that a payment 402 Baker & McKenzie effectively qualifies as a deemed dividend, the company should report it as such and pay the taxes related thereto. Failure to do so could expose the company to tax evasion or even tax fraud investigations. 1.3 Substance-over-form / anti-abuse practice Under the substance-over-form concept, the tax administration, when having to appreciate a set of facts, may take an economic approach when a tax provision refers to economic notions rather than to civil law notions and thus disregard the legal form selected by the parties for a given transaction. This approach should be distinguished from anti-abuse considerations, where a tax provision refers to civil law notions, but the tax administration considers that while a structure adopted is legally valid, it has, nevertheless, to be disregarded because it is deemed to be abusive. This is essentially the case if (cumulatively): • the arrangement chosen appears to be unusual, improper or strange, in any event completely inappropriate to the economic circumstances; • the arrangement in question was intentionally and abusively chosen in order to save taxes, which would otherwise be due if the circumstances were properly arranged; or • the procedure chosen would result in a substantial tax savings if it were accepted by the tax administration. In such cases, the tax administration may base its assessment on facts as they “should have” been realized were it not for abusive tax motives. 1.4 Potential tax implications of adjustments If a tax authority considers a transaction as not at arm’s length, it will increase the taxable income (or the taxable capital for that matter) of the company accordingly. In addition, administrative practice considers the shareholder of the company in question to have received Transfer Pricing Handbook – Switzerland Baker & McKenzie 403 a taxable dividend payment for income tax purposes. If the beneficiary of the transaction was effectively another related person, such as a sister company, the constructive dividend would be considered to have first been paid to the shareholder and then contributed to the subsidiary by the common parent company (the “Triangular theory”). In addition to income taxes, any deemed dividend would be subject to withholding taxation (WHT) at the rate of 35 percent (subject to treaty relief). Since it is mandatory by law that the WHT burden be borne by the recipient of the dividend, the entity paying the dividend must claim the withholding tax payment on the constructive dividend from the beneficiary; otherwise, it may be grossed up and the beneficiary may be deemed to have effectively received only 65 percent of the advantage. The company is therefore liable for the payment of the remaining 35 percent. This gross-up results in an effective withholding tax rate of 53.8 percent of the tax adjustment. The person who effectively received the payment is considered the recipient. Thus, for WHT purposes, the “Direct Beneficiary theory” applies (instead of the Triangular theory referred to above, which is applicable to income taxes and which attributes the taxable income to the common parent). In a double tax treaty context, the WHT due may be reduced on the basis of the treaty (depending on the tax residence of the recipient), but the application of the Direct Beneficiary theory may limit the treaty relief in cases where the direct beneficiary is not the direct shareholder. In a domestic context (i.e., where the recipient is also a taxable person in Switzerland), the WHT payment may, in general, be replaced by a mere notification of the deemed dividend payment to the SFTA. This is, however, limited to cases where the recipient would have obviously been entitled to credit the WHT against his or her own income tax liability or to obtain a refund. In principle, the same holds true in international situations where a double tax treaty applies. The federal tax authorities then may grant advance permission (upon request) to replace the dividend WHT with a mere notification and to pay the dividend net of withholding tax. Swiss entities have to report dividends, as well as constructive dividends and pay the withholding tax (when due) within 30 days 404 Baker & McKenzie from their due date. In case of constructive dividends, which are usually not spontaneously disclosed but assessed in the course of tax audits, the 30-day deadline is often not complied with. The consequence is that the withholding tax is payable in full, plus a 5 percent late interest thereon. The beneficiary has then to apply for a refund based on tax treaties, if applicable. 1.5 Statute of limitation for transfer pricing adjustments Corporate income taxes may be assessed up to 10 years after the tax year in which the taxable transaction took place. This statute of limitation can be extended (interrupted) by the tax administration up to a total of 15 years (after the end of the tax period in question) through official acts, such as sending letters or tax forms as reminders, carrying out tax audits and forming appeals, among others. This means that the absolute statute to assess income taxes is 15 years. Tax may be collected up to five years after a tax assessment has entered into force, that is, became final. This statute of limitation, too, may be extended (interrupted) up to 10 years after the year in which the tax assessment has entered into force. As a consequence, tax could, in principle, be collected up to 25 years after the tax year in question. If after an income tax assessment became final the tax administration became aware of facts or evidentiary proof that were not and could not have been known to the tax administration, and as a result of which a tax assessment was omitted or a final tax assessment is incomplete, or if it appeared that a tax assessment is incomplete due to a tax offence or crime, the tax administration can open a new assessment procedure within 10 years after the tax assessment in question became final (“late taxation procedure”). The tax must then be assessed within 15 years after the tax year in question. Transfer pricing audits could, therefore in principle, be executed within 10 years after the tax year in question has elapsed. Valuation matters can, in principle, not be reassessed subsequently. For withholding tax purposes, the tax authorities may audit companies without having to justify their decision to do so. The right to levy the Transfer Pricing Handbook – Switzerland Baker & McKenzie 405 withholding tax expires after a period of five years from the expiration of the calendar year in which the tax claim arose. The running of the statute of limitation can, however, be interrupted indefinitely (i.e., there is no absolute statute of limitation as for income taxes). 1.6 Relationship to permanent establishment allocation of profits provisions Under the Swiss tax legislation, a permanent establishment (PE) is constituted if a company carries out its business in a fixed place of business located in a different jurisdiction or canton as the seat of the company. The question whether a mere dependent agent of a foreign company with no fixed place of business in Switzerland can also constitute a Swiss PE (as provided in the OECD Model convention) is the subject of controversial discussions, but is in principle admitted by the tax authorities. While it is possible in theory that a subsidiary constitutes a PE of its parent company, it is, in practice, quite unlikely that the Swiss tax authorities will come to such a conclusion. Experience shows, however, that the Swiss tax authorities usually proceed to tax adjustments of transactions (i.e., increase the profit taxable in Switzerland) or consider a foreign company a tax resident of Switzerland based on the place of effective management criterion (i.e., claiming that the foreign company is being effectively managed within Switzerland and should thus be subject to Swiss taxes). The assessment that a foreign company has a Swiss PE is rarely seen in a transfer pricing context. The determination of PE income is either based on the PE’s own books (direct method) or on an apportionment method (indirect method). 1.7 Advance pricing agreements (APAs) / other ruling procedures In a Swiss domestic context, APAs or advance tax rulings can be obtained from any Swiss tax authorities that are in charge of assessing the taxes that are affected. This permits companies to have legal certainty with regard to their operations. APAs and advance tax rulings are binding for the tax authorities under the principle of good faith, as long as the relevant facts and the applicable legal framework do not change. It is standard practice in Switzerland to discuss 406 Baker & McKenzie transactions in advance with the tax administration and to obtain binding rulings that cover transfer pricing issues. APAs may also be negotiated at the international level between competent authorities. In Switzerland, APAs are granted by a division of the State Secretariat for International Financial Matters. The tax authorities do not charge any fees for the issuance of tax rulings or the negotiation of international APAs. 2. Transfer Pricing Methods 2.1 General acceptance of OECD guidance OECD guidelines are generally followed by tax authorities in Switzerland. OECD methods are fully acceptable and taxpayers are free to choose what method they deem appropriate for their business as long as the results obtained are at arm’s length. Switzerland does not impose a rigid hierarchy of methods. Nevertheless, should a comparability analysis show that more than one method may be applied in an equally reliable manner, traditional methods (i.e., the Comparable Uncontrolled Price [CUP] Method, the Resale Price Method [RPM] and the Cost Plus Method [CPM]) are preferable to transactional methods (i.e., the Transactional Net Margin Method [TNMM] and the Profit Split Method [PSM]). Among the traditional methods, the CUP has priority over the other two. The choice of the method has to be substantiated by a comparability analysis. However, the taxpayer is not required to provide in-depth evidence of having tested the rejected methods under the so-called best method analysis. 2.2 Year-end adjustments and retroactive adjustments There is no legal provision on year-end and retroactive adjustments under Swiss laws or regulations. Year-end adjustments prior to the closing of the financial statements are in principle accepted. According to the practice of the federal tax administration, it is possible to book retroactive adjustments if the adjustment is made Transfer Pricing Handbook – Switzerland Baker & McKenzie 407 before any control is initiated or questions are raised by the federal tax administration. If the financial statements during which a constructive dividend took place are closed and have been accepted by the shareholders, a subsequent correction is only possible if: • the accounting rules have not been violated (e.g., income was not properly recorded, or fictitious invoices have bee recorded as charges); and • the taxpayer did not act in bad faith, such as when the constructive dividend that is “corrected” was not obvious or intentionally made. 3. Transfer Pricing Documentation and Filing 3.1 Requirements There are no specific documentation requirements, apart from the general obligation to keep and maintain books in accordance with commercial law. Transfer pricing documentations are usually very helpful in defending a case, which is why they are frequently used. English is generally accepted in transfer pricing documentations. Another correspondence with the SFTA usually needs to be made, in one of the official languages (German, French or Italian). 4. Tax Audit Procedures As a rule, every company may be subject to tax audits, and companies are selected on a random basis or based on a specific annual program (not disclosed) to audit companies of a specific industry. In practice, however, large companies may face more frequent and detailed tax audits than smaller ones. Tax audits are closed by formal decisions, which may contain tax adjustments. Except in cases where a taxpayer did not cooperate as legally required, such decisions may be appealed without restrictions. Frequently, when late taxation procedures are initiated as a consequence of an audit (i.e., recapture of taxable items), 408 Baker & McKenzie criminal proceedings could be opened as well. In such case, the taxpayer may not be forced to cooperate and may then exercise its right to remain silent (involving the privilege against selfincrimination). While for cantonal and federal corporate income tax purposes, audits can only be undertaken if facts or evidentiary proof were not known to the tax administration, as a result of which tax assessment was omitted, or final or omitted tax assessment is incomplete, or if a tax assessment is incomplete due to a tax offence or crime, no such conditions exist for withholding tax audits. 5. Dispute Resolution In international disputes, the Swiss tax authorities are generally willing to defend their taxpayers in mutual agreement procedures (MAPs), especially if they are convinced of the economic justification of the undertakings. Most recent Swiss double tax treaties frequently include a mandatory arbitration clause (i.e., the taxpayer has an enforceable right that competent authorities reach an agreement and avoid double taxation). If a MAP has been successfully closed, the corresponding and (depending on the case) secondary adjustments can be made without adverse tax consequences (pursuant to the outcome of the MAP). 6. Interest and Penalties In 2014 and 2015, the interest rate on overdue federal corporate income tax is 3 percent per annum. The interest rate on overdue cantonal corporate income taxes varies, depending on the cantons involved. In the canton of Zurich, for instance, the rate is 4.5 percent, and 3 percent in the canton of Geneva. The interest rate on overdue withholding tax is 5 percent per annum. This is especially relevant in the case of deemed dividend distributions, which may initially not have been considered as such. In the case of tax evasion (i.e., non-declaration of taxable factors such as items of income), the penalty is usually a fine equivalent to the Transfer Pricing Handbook – Switzerland Baker & McKenzie 409 amount of tax evaded. Depending on the case, the fine can be reduced to a third or can be increased up to three times of the amount of the tax evaded. Cases of tax fraud may be punishable with imprisonment. It is possible for Swiss taxpayers, including legal entities, to opt for a one-time voluntary self-disclosure that exempts them from any fine (voluntary self-disclosure is available only if the tax authorities were not yet aware of the tax infringement). 7. Other Topical Subjects/Trends Domestic business restructurings can usually be carried out in taxneutral ways. In contrast, cross-border restructurings frequently lead to tax consequences. If assets (be they tangible or intangible) are transferred to a foreign entity, the transferor could be considered to realize a profit from the transaction (usually in the difference between the book value and fair market value). If a business is transferred, the transferring company would need to be remunerated for goodwill. Further, a transfer of functions may be seen as a taxable disposal of intangible property if, for example, customer lists are transferred. A “transfer of profit potential” by way of terminating contracts should not lead to transfer pricing issues if the terms of the termination are at arm’s length (especially a period of notice and/or possible indemnities stipulated by law). It may, however, be that certain tax authorities would consider that the transferor should receive a remuneration for the loss of profit potential, that is, for an intangible asset such as client lists. For instance, if a Swiss company ceases to perform certain activities (which are then taken over by a foreign affiliate), the Swiss company could be considered to have been economically partially liquidated. As a consequence, the Swiss authorities could deem the shareholder of the company in question to have received a liquidation dividend. Such an assessment may lead to substantial income tax and withholding tax adjustments. The value of the deemed dividend payment might cause controversies and, in practice, may lead to a dispute on goodwill valuation (i.e., goodwill is seen to have been distributed). Transfer Pricing Handbook – Turkey Baker & McKenzie 411 Turkey Erdal Ekinci, Partner Erdal Ekinci is a partner in Baker & McKenzie’s Istanbul office, leading its growing tax practice in Turkey. He has led numerous restructuring, international tax, tax planning, transfer pricing, and indirect tax projects for Turkish holding companies and large international companies operating in various industries. [email protected] Tel: +90 212 376 64 47 Duygu Gültekin, Associate Duygu Gültekin is a senior associate in Baker & McKenzie’s Istanbul office. She advises local and foreign clients on taxation matters, mergers and acquisitions, and trade and commerce, across many sectors. She also advises foreign investors in companies on shareholder rights and disputes. Duygu offers clients insights into local taxation laws and customs duties, as well as their respective procedures. She ensures that clients are informed of the tax implications of their corporate and commercial actions. [email protected] Tel: +90 212 376 6400 Baker & McKenzie Istanbul Ebulula Mardin Cad., Gül Sok. No. 2 Maya Park Tower 2, Akatlar – Beşiktaş 34335 Istanbul Turkey 412 Baker & McKenzie 1. Statutory Rules and Administrative Regulations 1.1 Introduction Turkey’s transfer pricing rules came into effect on 1 January 2007. The transfer pricing provisions of Article 13 of the Turkish Corporate Income Tax Code (CIT) incorporate the arm’s length principle. In a transaction for the sale and purchase of goods and services between related parties, a price is considered to be at arm’s length if the price is such that the parties to the transaction could have reasonably agreed to the price, had they been unrelated. The regulations concerning transfer pricing are as follows: • Decree No. 2008/13490 Concerning the Amendment of the Resolution Concerning Disguised Profit Distribution through Transfer Pricing, promulgated on 13 April 2008 • Decree No. 2007/12888 Concerning Disguised Profit Distribution through Transfer Pricing, promulgated on 6 December 2007 • General Communiqué No. 1 Concerning Disguised Profit Distribution through Transfer Pricing, promulgated on 18 November 2007 • General Communiqué No. 2 Concerning Disguised Profit Distribution through Transfer Pricing, promulgated on 22 April 2008 Turkish transfer pricing regulations: (i) define disguised profit distribution through transfer pricing and transactions within the scope of the transfer pricing provisions; (ii) define related parties; (iii) define the arm’s length principle; (iv) specify general documentation requirements; (v) specify transfer pricing methods; (vi) provide information on advance pricing agreements (APAs); (vii) set penalties and adjustments; (viii) specify from the transfer pricing rules (adopted on 4 June 2008, and came into effect as of 1 January 2008); and (ix) Transfer Pricing Handbook – Turkey Baker & McKenzie 413 specify the authority of the Council of Ministers to set procedures related to transfer pricing rules. As an OECD member, Turkey’s transfer pricing rules generally follow OECD Transfer Pricing Guidelines. 1.2 Related parties Article 13 of the CIT deems the following individuals and entities to be related parties: (a) Company shareholders (b) Real persons and entities with ongoing relations with companies or their shareholders (c) Real persons and entities to which the corporations or their partners are directly or indirectly affiliated with regard to management, auditing or capital (d) Real persons or entities under the control of the a company with regard to management, auditing or capital (e) Spouses of partners (f) For real persons, any relative up to and including a third-degree relation by blood or marriage In addition to the above, Turkish tax authorities take into consideration whether the taxation system of the country where the gain has been generated offers taxation opportunities at a level equal to the tax legislation under the Turkish tax system. To avoid any tax abuse, therefore, all transactions with persons residing in countries or jurisdictions designated by the Council of Ministers are deemed to have been with related parties. The Council of Ministers has not yet published a list of designated countries; this list is expected to consist of countries that have been characterized as “tax havens.” 414 Baker & McKenzie 1.3 Scope of rules Turkey’s transfer pricing rules apply to transactions where both parties are Turkish tax residents, as well as to transactions where only one party is a Turkish resident. The law also applies to transactions between a company and its permanent establishment. The transfer pricing rules apply to all types of business transactions, including, for example, sales and purchases, manufacturing and construction, leasing, borrowing and lending, as well as any other transaction requiring the payment of salary, bonus or other benefits. Even though intragroup services and intangible rights are not mentioned specifically in the CIT, based on General Communiqué No. 1, they will fall as well within the scope of the transfer pricing rules. Transfer pricing rules would be applicable if there is a “treasury loss” with respect to domestic transactions of a corporate taxpayer. The term treasury loss is defined as deficient or late accrual of all types of taxes from transfer prices that do not comply with the arm’s length principle. 1.4 Compliance Turkish corporate taxpayers are obligated to self-assess the arm’s length nature of their related party transactions. Under General Communiqué No. 1, companies must submit, with their corporate tax returns, a questionnaire reporting all related party transactions during the relevant fiscal period. Taxpayers registered with the Tax Office for Major Taxpayers are required to prepare an “annual transfer pricing report” containing the details of their transactions with related parties both in Turkey and abroad. 1.5 Time limits for assessment The Tax Procedure Code’s general statute of limitations’ rules apply equally to transfer pricing matters; taxes not levied or communicated to the taxpayer within five years are subject to the statute of limitations starting from the year following the calendar year in which tax became due. Turkish tax authorities are entitled to conduct an Transfer Pricing Handbook – Turkey Baker & McKenzie 415 audit in a given fiscal year until the end of the fifth fiscal year following the one in which the tax was due. 1.6 Attribution of profit Turkish law contains an expansive interpretation of permanent establishment. According to Article 156 of the Tax Procedure Code, a permanent establishment is defined as a place allocated to the performance of commercial, industrial, agricultural or professional activities such as stores, offices, executive offices, clinics, factories, branches, warehouses, hotels, cafés, entertainment and sport areas, fields, vineyards, orchards, farms, livestock facilities, fishery locations, mines, quarries and construction sites. While double tax treaties between Turkey and other countries generally include the standard definition of permanent establishment, Turkey’s approach to determining whether a permanent establishment has been created differs substantially from that taken in most countries, relying on Turkey’s reservations in the OECD Model Tax Convention. For corporate income tax purposes, companies whose legal and business headquarters are located outside of Turkey are treated as “limited taxpayers” (non-residents). Limited taxpayers are subject to Turkish taxation only on income “generated in Turkey,” through a permanent establishment or a permanent representative located in Turkey. 1.7 APAs Resident entities may apply to the Revenue Administration of the Minister of Finance for an APA for a period not exceeding three years with respect to arrangements between Turkish and foreign-related parties by submitting the documents designated by law. These arrangements may be in a unilateral, bilateral or multilateral form. Effective from 2009, all resident entities are entitled to apply for an APA. 416 Baker & McKenzie 2. Transfer Pricing Methods 2.1 Prescribed methods and general acceptance of OECD guidance According to Article 13 of the CIT, the following methods may be used to determine an arm’s length price: (i) the comparable uncontrolled price (CUP) method (ii) the cost-plus method (iii) the resale price method Taxpayers are allowed to use any one of these methods and set the price or value in accordance with that method. Where an arm’s length price cannot be achieved through the application of these “traditional methods,” depending on the nature of the transaction, “transactional profit methods” (namely, the profit split and transactional net margin methods) may also be used. If none of these methods result in a determination of an arm’s length price or value, any other method that the taxpayer deems appropriate, given the nature of the transaction, may be used, provided that the method selected honors the arm’s length principle. The Turkish tax administration is not legally bound by the official commentary on the OECD Model Tax Convention or the OECD Transfer Pricing Guidelines. OECD guidance, however, is an important source of interpretation to help determine an arm’s length price. 2.2 Acceptability and hierarchy of methods The CIT does not impose an explicit hierarchy among the traditional transfer pricing methodologies. Rather, it directs that the taxpayer choose the method most appropriate, given the nature of the transaction. General Communiqué No. 1 implies, however, that in first instance, the CUP method should be tested, and only if that method is inappropriate should other methods be tried. In this sense, therefore, Transfer Pricing Handbook – Turkey Baker & McKenzie 417 the CUP method has the highest priority. Before a transactional profit method may be applied, however, each of the traditional methods should be tested. Accordingly, the traditional transaction methods are preferable to the transactional profit methods. If a taxpayer applies for an APA, there is no need to determine whether the abovementioned tests have been applied. 2.3 Acceptability of year-end adjustments and retroactive adjustments General Communiqué No. 1 regulates both year-end and retroactive adjustments. Both the entity making the disguised profit distribution through transfer pricing and the entity receiving the payment may make an adjustment during the temporary tax period. After the temporary tax period, if the entity making the disguised profit distribution pays taxes by submitting a corrected tax return, the entity receiving the disguised profit distribution may make a corresponding adjustment in the following fiscal term. In such case, the tax authority evaluates the application, as provided in the Tax Procedure Code. 2.4 Calculation of comparability adjustments Turkey generally requires the calculation of comparability adjustments to ascertain levels of working capital and inventory when comparing equivalent business activities. The method chosen by the taxpayer must rely on a comparability analysis and available information on comparables. Data for unregulated transactions for economic and financial comparison analysis are not available, as there is no public disclosure requirement of financial statements by companies, except for listed companies. Turkish regulations do not provide any guidance as to whether a taxpayer may use pan-European or other foreign comparables. A recent tax court decision, however, stated that comparable companies should have similar functions, risk profiles and commercial activities 418 Baker & McKenzie with a Turkish taxpayer relying on such data, and accordingly, comparable companies should be located in Turkey. It should be noted that this is a lower court decision and a final decision will be taken by the Council of State. On the other hand, another problem very commonly observed under Turkish practice is the assessments based on secret comparables. There is, however, a recent court decision stating that use of secret comparables violate the principles of equality and the right for fair trial. This decision still requires approval of the appellate court. Under General Communiqué No. 1, the most reliable result is a single price or value based on comparisons. After such analysis, however, the value range may be formed by more than one price or value close to each other, rather than a single price or value. The arm’s length price range consists of arm’s length values derived from the application of the same method on different comparable uncontrolled transactions, or of different transfer pricing methods on the same data. The taxpayer may determine a transfer price through the application of the arithmetic average, mode, median or another appropriate measure within the range. However, in cases where the prices in the arm’s length range are very different from each other, the factors in the comparability analysis or the correction transactions should be evaluated once again. Adjustments may be required if, for example, distributor companies are being used to benchmark returns as a proxy for commission-based sales functions. 2.5 Business restructurings There is no specific Turkish regulation of business restructurings in terms of transfer pricing. Transfer Pricing Handbook – Turkey Baker & McKenzie 419 2.6 Safe havens and rules of thumb There are no published safe harbors or rules of thumb under Turkish law. Taxpayers in Turkey cannot rely on transfer-pricing safe havens, as arm’s length transfer prices must be determined on a case-by-case basis, taking into account all circumstances of the transaction. To avoid any tax abuse, all transactions with persons residing in jurisdictions designated by the Council of Ministers are deemed to be concluded with related parties. While the Council of Ministers has not yet published its list of countries subject to this rule, it is expected to consist of countries defined as “tax havens.” 3. Transfer Pricing Documentation and Filing Requirements 3.1 Recordkeeping According to General Communiqué No. 1, a special form (Attachment 2) must be submitted with the annual tax return listing all related parties’ transactions during the fiscal period by type and size. This form is a two-page listing of the various types of possible related party transaction where the taxpayer indicates, by checking boxes, that the company has undertaken any such transactions. This form provides a starting point for the tax office to consider whether to investigate transfer pricing matters. The form contains information on: (a) the company; (b) the related party relevant to transfer pricing issues (i.e., the company name, tax account number, country of residence, among others); (c) transactions with related parties; (d) pricing and valuation methods; and (e) the total amount realized under each method. Taxpayers registered with the Tax Office for Major Taxpayers are required to prepare an “annual transfer pricing report” containing details of transactions with related parties both in Turkey and abroad. Other companies, on the other hand, are required to prepare the report only for transactions with related parties abroad. The annual transfer pricing report must include the following: 420 Baker & McKenzie I- General information Summary information, including the taxpayer’s activities, economic conditions, market conditions, business strategies II- Information about related parties Information about related parties (their tax account numbers, addresses, telephone numbers, etc.), economic and market conditions, their business strategies, information on functions undertaken, risks assumed and assets used III- Detailed information about related party transactions All information about related party transactions and agreements concluded with related parties IV- Information about transfer pricing analysis Details about comparability analysis and criteria determined in comparable transactions, adjustments made, comparison of the method selected with other methods and reasons for the selection of that method, any information that justify that the selected method is the most appropriate, detailed information and calculations about the arm’s length price ranges V- Conclusion If deemed necessary, the revenue administration is authorized to request additional information or documentation from the taxpayer. 3.2 Timing of evidence and analysis The annual transfer pricing report is assumed to be complete up to the filing date of the corporate tax return and may be requested after the end of this period. The company should have sufficient evidence and analysis at that date to confirm that its transactions with related parties are at arm’s length. Transfer Pricing Handbook – Turkey Baker & McKenzie 421 3.3 Recordkeeping duration Records must be preserved for a period of five years. 3.4 Reviewing and updating documentation Documentation should be reviewed on an annual basis to determine if the historical, functional and economic analyses are still relevant. Additionally, if the circumstances of an intercompany transaction change such that they would be taken into account by an unrelated party, transfer pricing documentation should be updated without waiting for the year-end. 3.5 Language Documentation must be made in Turkish. Where the requested documents are written in a foreign language, Turkish translations must be presented. 3.6 Returning information The statutory filing date for corporate tax returns is 25 April in the year following the year in which the income is earned. An annual transfer pricing report is submitted if specifically requested. For taxpayers having a financial year other than a calendar year, the corporate income tax return must be filed before the 25th day of the fourth month following the end of the financial year. 4. Tax Audit Procedures 4.1 Risk assessment Transfer pricing audits are usually part of a regular audit for corporate income tax purposes. Neither Turkish law nor administrative guidelines indicate a tax audit threshold. 422 Baker & McKenzie 4.2 Indicators of high level of risk The Turkish tax authorities have not indicated what constitutes a high level of risk and have not issued any guidance as to what types of transactions would likely raise a transfer pricing concern. 4.3 Commencement of enquiry The general provisions regarding tax audits also apply for transfer pricing purposes. Accordingly, there is no obligation to pre-notify the taxpayer of an audit. Tax audits may even be for periods not yet complete. The competent tax authority, after determining the scope of a tax audit, generally notifies the taxpayer 15 days prior by written notice of the initiation of a tax audit, the taxes and periods to be covered, the contemplated date of the first visit, if any, and the name of the tax auditor. In principle, a taxpayer is required to provide requested information within 15 days. Failure to timely provide the requested information may result in an ex officio assessment and special irregularity penalty. In practice, tax inspectors will often extend the deadline upon the taxpayer’s request if more time is needed to gather all requested information (e.g., because information needs to be obtained from foreign group companies). Tax audits are usually held on the taxpayer’s premises, but may also be conducted at the tax office. The law does not prescribe a specific period for tax audits. 4.4 Burden of proof Under the self-assessment system, the taxpayer bears the burden of proof on the accuracy of information. A taxpayer with related party transactions should be able to substantiate that its transfer prices have been determined in accordance with the arm’s length principle. Transfer Pricing Handbook – Turkey Baker & McKenzie 423 4.5 Transfer pricing group The Turkish Revenue Administration has dedicated specialists handling transfer pricing enquiries. Pursuant to the Tax Procedure Code, tax audits are conducted by authorized tax inspectors affiliated with the revenue administration, finance inspectors, and tax inspectors and their assistants from the Ministry of Finance. 4.6 Tax auditor’s current focus Pharmaceutical companies are currently an area of transfer pricing focus. 4.7 Information powers Turkish tax auditors may use any source of information available to them, such as witnesses, documents and information from third parties and other taxpayers. Tax inspectors may contact all employees in a place of business if deemed necessary, and may request all types of information and documents from them. 4.8 Transfer pricing information In addition to actual accounting records, all other information that might have a bearing on taxation must be disclosed. Accordingly, the type of information available to the tax auditors might include the company’s transfer pricing documentation, documents used to prepare its corporate tax self-assessment, any further evidence of arm’s length pricing, the company’s transfer pricing manual, budgets for each function, management accounts, and even the financial statements of related entities. 5. Dispute Resolution 5.1 Mutual agreement procedures (MAPs) Turkey has concluded approximately 80 double tax treaties, almost all of which contain a MAP. Turkish tax authorities have issued guidelines for the application of MAPs as well. In transfer pricing issues, the competent authority is the Ministry of Finance. A taxpayer 424 Baker & McKenzie may present its case to the competent authority and ask for it to be resolved through a MAP if the actions of the contracting states would lead to double taxation. Despite the existence of MAP articles in the double tax treaties, they have only been used in a few cases. It is, therefore, reasonable to assume that the revenue administration has limited experience in the use of MAPs and the MAP procedure is not considered standard practice in Turkey. 5.2 Arbitration No arbitration procedure is available for tax disputes in Turkey. 5.3 Litigation When administrative appeals do not result in a settlement, the case may be brought before a court. Litigation may be initiated as soon as the tax penalty notice is received by the taxpayer, i.e., after the end of administrative appeals. 6. Interest and Penalties 6.1 Interest for delay If additional corporation tax becomes due following a transfer pricing adjustment, any corporation tax paid late will carry interest. 6.2 Penalties Pursuant to Article 11 of the CIT, profits that are distributed through transfer pricing are treated as a non-deductible expense. Accordingly, when making this determination during a tax audit, the total deemed disguised profit: (a) is added to the tax base and is subject to corporate tax at a rate of 20 percent; (b) is imposed with a “tax loss” penalty; and Transfer Pricing Handbook – Turkey Baker & McKenzie 425 (c) is also imposed with a withholding tax if such dividend is distributed to non-residents or residents not incorporated or subject to taxation in Turkey. The taxpayer is required to submit a request for a settlement, initiate legal action, or pay the total amount due within 30 days of receiving a notification of the tax penalty. 6.3 Amount of penalty Currently, the monthly delay interest rate is 1.40 percent and a penalty equal to the unpaid tax is imposed. If the tax authorities determine that the “tax loss” should have been paid, the taxpayer has the following alternatives: (a) Settlement with the tax authorities, in which case the tax authorities generally reduce the penalty by 90 to 95 percent, and the outstanding amount is paid along with the original tax due together with delay interest (b) Non-settlement with the tax authorities, in which case the taxpayer must file a lawsuit within 15 days; if the taxpayer loses the lawsuit, the full tax penalty, due tax and interest will be due. In cases where a settlement is concluded, the taxpayer cannot initiate litigation against the revenue administration. 7. Advance Pricing Agreement Procedures 7.1 Availability of unilateral/bilateral APAs Turkish law only provides for unilateral and bilateral APAs. 7.2 Who can apply for an APA? An APA may be requested by any Turkish taxpayer involved in transactions to which the Turkish transfer pricing law applies. 426 Baker & McKenzie 7.3 Procedure Pursuant to Article 16 of Resolution 2007/1288 Concerning Disguised Profit Distribution through Transfer Pricing, the APA procedure is as follows: (a) The potential applicant submits a written expression of interest to the revenue administration containing all the relevant information and documentation. (b) The Revenue Administration pre-evaluates the issue. (c) The tax authorities commence fact finding, and select and analyze comparable transactions, the assets used, other corrections, the applicable methods, the conditions of the agreement and other basic factors. (d) After the analysis, an agreed position may be reached (either wholly or subject to conditions) or the revenue administration may reject the application. 7.4 Information required Pursuant to General Communiqué No. 1, taxpayers may apply to the Revenue Administration for APAs. In this case, in addition to the information submitted in the annual transfer pricing report, the applicant must provide: (a) a written application; (b) information on the critical assumptions and their justifications (explanations and analyses on the transfer pricing method, and conditions and assumptions on the selection and application of that method, and other relevant studies); (c) information on the ownership of intangible assets and the cost of intangible assets received or paid; Transfer Pricing Handbook – Turkey Baker & McKenzie 427 (d) financial statements of the related parties for the last three years, their income statements or copies of their corporation tax returns, and copies of their agreements relating to transactions conducted with companies abroad; (e) financial data relating to the last three years supporting the transfer pricing method proposed, and supporting documentation; and (f) other documents required for the determination of the arm’s length price. 7.5 Fees Code of Charges No. 492, regulates application and renewal charges, respectively, as TRY50,202.80 and TRY40,162.10. 7.6 Monitoring an APA APAs are concluded with specific taxpayers and only concern their specific situations. Therefore, APAs cannot be used as precedents by other taxpayers. The revenue administration examines the taxpayer’s annual reports throughout the period covered by the APA as to whether the conditions specified in the APA have been adhered to. 7.7 Term of an APA APAs are concluded for a maximum of three years, and the agreements are considered to be in force as of the date of their signature. 7.8 Renewal of an APA A taxpayer may request the renewal of an existing APA upon its expiry. In such case, an application must be submitted to the revenue administration at least nine months prior to the expiry date. In the renewal application, the taxpayer must inform the revenue administration whether a change should be introduced in the APA during the renewal period and submit the required information and 428 Baker & McKenzie documentation showing that the method that has been implemented meets the arm’s length principle for the transactions covered in the APA in the most appropriate manner. At the end of its evaluation of the application, if the Revenue Administration determines that the conditions and assumptions of the APA are still valid, and that the method applied meets the arm’s length conditions, it may extend the APA with the same conditions, assumptions and the method for another year. If, however, the revenue administration determines that the nature of the transactions, conditions and the assumptions specified in the original APA have changed, the taxpayer is required to submit an application for a new APA. 7.9 Revision of an APA The taxpayer may apply to the revenue administration to revise an existing APA. In the application, the taxpayer must explain the reasons for the revision. An APA may be revised if: (i) a critical assumption stated in the APA is not fulfilled; (ii) a basic condition of the APA has changed or is no longer valid; (iii) existing legal regulations (including double tax treaties) that affect the APA have changed; and (iv) with regard to bilateral and multilateral APAs, the administration of one of the countries revises, abolishes or terminates the APA procedure. If the revenue administration agrees to revise the APA, the revised conditions remain in effect for the period between the revision and the date of termination of the existing APA. If the revenue administration declines to revise the APA, it remains in effect in its present format. Taxpayers, however, are authorized to demand the cancellation of the APA due to the reasons specified above. The revenue administration may also determine the reasons for the revision of an existing APA. If the taxpayer refuses to revise the APA, the revenue administration is authorized to terminate the APA unilaterally. Transfer Pricing Handbook – Turkey Baker & McKenzie 429 7.10 Termination of an APA Where an APA is terminated, the provisions lose their effectiveness as of the date on which the termination of the agreement is signed. The revenue administration is authorized to terminate an APA unilaterally as of the date of its initial signature and, if necessary, audit the taxpayer as if the APA had never been signed, if: (a) the taxpayer does not abide with the conditions specified in the APA; or (b) the taxpayer presented incomplete, false or misleading documents, whether during the application or during the subsequent stages (including the annual reports). Also, if the annual report submitted to the revenue administration at the time of the filing of the corporate tax return is not timely submitted, the existing APA can be terminated as of the beginning of the accounting period to which the report relates. 7.11 Country-specific experiences with APA procedures In 2011, the revenue administration concluded only one APA; in 2013, two APAs were concluded; and one APA has been concluded in 2014. Several applications are currently pending before the revenue administration. Transfer Pricing Handbook – Ukraine Baker & McKenzie 431 Ukraine Hennadiy Voytsitskyi, Partner Hennadiy Voytsitskyi is a principal at the Kyiv Office of Baker & McKenzie and heads its Tax and Customs Practice Groups. He specializes in advising multinational and domestic clients on international tax planning and tax structuring, including cross-border inbound and outbound investment, tax controversy and litigation, and wealth management. [email protected] Tel: +38 044 590 0101 Viktoria Stavchuk, Associate Viktoria Stavchuk is an associate with Tax Practice Group at the Kyiv Office of Baker & McKenzie. She specializes in advising clients on general tax planning, transfer pricing, VAT and indirect taxes, tax controversy and litigation. Most recently, she has been involved in projects involving international tax structuring and implementation of employee benefit programs. [email protected] Tel: +38 044 590 0101 Baker & McKenzie – CIS, Limited Renaissance Business Center 24 Vorovskoho St. Kyiv 01054 Ukraine 432 Baker & McKenzie 1. Statutory Rules and Administrative Regulations 1.1 Introduction Transfer pricing rules have been introduced into the Tax Code of Ukraine as of 1 September 2013, with the adoption of the Law “On Amendments to the Tax Code of Ukraine on Transfer Pricing” (“Transfer Pricing Law” or “TPL”). The TPL generally follows the OECD Transfer Pricing Guidelines. In general, the TPL introduced concepts of the arm’s length price, related parties, principles of transfer pricing, controlled transactions, as well as the methods of determination of the arm’s length (usual) price in controlled transactions. Simultaneously, the Transfer Pricing Law established specific transfer pricing reporting requirements and introduced a special type of tax audit focused on transfer pricing compliance. 1.2 Related parties Parties are considered to be related for tax purposes if their relationship can influence the conditions and/or results of transactions between themselves and/or affect the economic results of their activities or the activities of the parties that they represent. In particular, parties would be deemed related for tax purposes under the following circumstances: • A legal entity/individual directly or indirectly owns more than 20 percent participation interest in the other legal entity. • Legal entities have the same shareholder with more than 20 percent direct or indirect participation interest in each legal entity. • A legal entity/individual has control over the appointment of (i) individual executive body; (ii) at least 50 percent of the Transfer Pricing Handbook – Ukraine Baker & McKenzie 433 executive board; or (iii) at least 50 percent of the supervisory board of the other legal entity. • Legal entities share the legal entity/individual with an authority to appoint (i) individual executive body; (ii) at least 50 percent of the executive board; or (iii) at least 50 percent of the supervisory board in each legal entity. • Individual executive bodies of each legal entity have been appointed by the same legal entity/individual. • Legal entities have the same individuals representing more than 50 percent of the executive board and/or the supervisory board of each legal entity. • An individual performs the functions of individual executive body of a legal entity. • Legal entities share the same individual performing the functions of their respective individual executive bodies. • The total amount of all (i) loans/non-refundable financial assistance provided by a legal entity/individual to the other legal entity; and/or (ii) loans/non-refundable financial assistance provided by third parties and guaranteed by such legal entity/individual, three, five or more times exceeds the amount of own capital of the borrowing legal entity (for financial organizations and companies that conduct leasing activity - 10 or more times). • Individuals are close relatives (spouses, parents, children, brothers and sisters, etc.). The parties to the transaction may, at their own discretion, declare themselves related for purposes of transfer pricing, on grounds not specifically mentioned in the Transfer Pricing Law. 434 Baker & McKenzie By the motion of a tax office, the parties to the transaction may be recognized as related parties by the court if (i) one legal entity/individual exercised practical control over business decisions of another legal entity; or (ii) the legal entities share a legal entity/individual who exercised practical control over business decisions of each legal entity. 1.3 Controlled transactions Generally, a transaction should be considered as controlled and subject to transfer pricing rules if it is conducted: • with a non-resident related party; • with a non-resident party from listed “low-tax” jurisdictions; or • through a non-resident commissionaire. Transactions between related parties that are conducted through a formally independent intermediary may also be recognized as controlled, unless it is proven that such intermediary performs significant functions or bears significant risks. The above transactions are considered to be controlled only if the following criteria are satisfied simultaneously: (i) The gross income of the taxpayer and/or its related parties within the reporting period exceeds UAH20 million (approximately USD1.3 million). (ii) The sum of the transactions exceeds UAH1 million (approximately USD64,000) or 3 percent of the annual taxable income of the taxpayer. 1.4 Definition of arm’s length price According to the Tax Code of Ukraine, the amount of taxable income received under the controlled transaction is assumed to comply with Transfer Pricing Handbook – Ukraine Baker & McKenzie 435 the arm’s length principle if the terms in the controlled transaction are not different from those in the uncontrolled one. 1.5 Regulated prices If the price is subject to state regulations by establishing a particular price or price formula, such price is regarded as an arm’s length price for transfer pricing purposes. The abovementioned clause does not cover situations where there are officially established minimal or indicative prices. In this case, the arm’s length price is determined according to the general transfer pricing rules but can not be lower than established minimal or indicative price. Additionally, the Tax Code of Ukraine presumes compliance with the arm’s length principle in the following instances: (i) When the price is determined as a result of an auction (ii) In cases of enforced sale of pledged property 1.6 Adjustments The TPL allows for transfer pricing adjustments with respect to corporate income tax and value added tax liabilities. The price adjustments for tax purposes can be carried out in several forms, namely: (i) by tax authorities as a result of tax audits; (ii) by taxpayers through self-adjustment; and/or (iii) through corresponding adjustments. Taxpayers are permitted to make a self-adjustment of prices by filing the transfer pricing adjustment sheet with its regular tax return (for current tax liabilities) or with adjusted tax return (for liabilities of previous tax periods). 436 Baker & McKenzie Furthermore, where the income of the related party is subject to a primary transfer pricing adjustment made by the tax authorities of the other jurisdiction, the taxpayer is eligible to the corresponding adjustment of his income in his own jurisdiction. The corresponding adjustments are allowed only upon application of the taxpayer to, and approval by, the State Fiscal Service of Ukraine. A reversal adjustment, in the case of cancellation of the primary transfer pricing adjustment, is also possible. In a cross-border context, the corresponding adjustments are allowed only if they are consistent with the provisions of the relevant double tax treaty. 1.7 Sources of information Under the TPL, the following sources of information may be used for transfer pricing purposes: (i) Information on internal comparable transactions of the taxpayer or its counterparty with non-related parties (ii) Any publicly available sources of information on comparable transactions and parties Tax authority shall be obliged to use the same sources of information that were applied by the taxpayer, unless it is proved that other sources of information provide better comparability of terms. Tax authorities are not allowed to use sources of information that are not publicly available. 2. Transfer Pricing Methods 2.1 General The Ukrainian transfer pricing rules generally follow the OECD Transfer Pricing Guidelines and recognize five transfer pricing methods: • Comparable uncontrolled price method or CUP Transfer Pricing Handbook – Ukraine Baker & McKenzie 437 • Resale price method • Cost plus method • Net margin method • Profit split method 2.2 Selection of method Following the principles of the OECD Transfer Pricing Guidelines, CUP is considered to be the primary method. If CUP cannot be applied, other methods may be used, provided the chosen method is the most appropriate to verify if the price in a controlled transaction complies with the market price range. The net margin method can be applied if the resale price or cost plus methods cannot be applied, including in the case of the absence or insufficiency of relevant information. The profit split method remains the method of last resort. 2.3 Selection of comparables Selection of comparables and, where relevant, determination of comparability adjustments are the essential preconditions of choice and application of transfer pricing methods. The choice of the most appropriate comparables is undertaken based on the characteristics of the goods or services as subject of the transaction; functions of the parties to the transaction; risks, benefits and responsibility division between the parties to the transaction; market characteristics and economic circumstances; commercial policies of parties, etc. When the choice of comparables with identical terms is limited, it is acceptable to introduce comparability adjustments of the terms and results of the comparable transactions. 438 Baker & McKenzie Internal comparables, that is, the taxpayer’s own transactions with non-related parties, have to be investigated first before the resort to the external comparables can be taken. The Transfer Pricing Law requires at least one comparable for purposes of transfer pricing analysis. 3. Transfer Pricing Documentation and Filing Requirements 3.1 General The TPL provides for two-level reporting requirements: (1) filing of notice on all controlled transactions as an annex to the annual CIT report; and (2) filing of special transfer pricing report by 1 May of the year following the reporting year, covering only controlled transactions exceeding UAH5 million (approximately USD312,500). All taxpayers are obliged to prepare, maintain and file upon the request of the tax office a complete set of the transfer pricing documentation. 3.2 Transfer pricing reporting a) Scope and form Taxpayers who carry out controlled transactions exceeding UAH5 million (approximately USD312,500) are required to file a transfer pricing report. The form of the transfer pricing report is adopted by the State Fiscal Service of Ukraine. The transfer pricing report is filed directly to the State Fiscal Service of Ukraine and must include information regarding all qualified controlled transactions of the taxpayer performed during a given reporting year. Transfer Pricing Handbook – Ukraine Baker & McKenzie 439 b) Due date The transfer pricing report should be filed by 1 May of the year following the reporting year. A taxpayer’s failure to file the transfer pricing report, as well as the inability to meet the given deadline, may serve as grounds for the authorities to conduct an unscheduled tax audit. 3.3 Transfer pricing documentation a) Scope and form There is an explicit requirement under the TPL to maintain transfer pricing documentation. Such documentation may be requested from the taxpayer by the Ukrainian tax authorities at any given time, but not earlier than 1 May of the year following the reporting year. According to the TPL, the transfer pricing documentation should include: • information about related parties and description of the taxpayer’s corporate group, including information on the group’s structure, business and transfer pricing policy; • description of the controlled transaction(s) and its (their) terms; • description of the goods/services involved in controlled transaction(s); • indication of factors that influenced the formation of price in controlled transaction(s); • payment terms; • factors that influenced the price formation; 440 Baker & McKenzie • information on the functions, risks and used assets of the parties of the controlled transaction(s); • transfer pricing study of the controlled transaction(s) (with indication of implied TP method, choice of comparables, adjustment of terms and results of comparable transactions, calculation of market price range, sources of information relied on, etc.); and • information on transfer pricing adjustments performed by the taxpayer (if any). The above information may be provided in the form of a single or several documents. b) Due date The term for submission of the transfer pricing documentation is one month upon receiving the request of the tax authority. If the taxpayer failed to submit the requested transfer pricing documentation in full, tax authorities have the right to file additional request for documentation, which must be satisfied within 10 calendar days. A taxpayer’s failure to file the transfer pricing documentation in full may serve as ground for conducting an unscheduled tax audit. 4. Tax Audit Procedures 4.1 General Tax audits on compliance with transfer pricing rules are conducted upon the decision of the head of the State Fiscal Service of Ukraine. The decision is then sent to taxpayer by the local tax authorities within 10 calendar days after the issuance, but not later than 10 calendar days prior to commencement of the audit. Transfer Pricing Handbook – Ukraine Baker & McKenzie 441 Simultaneously, local tax authority directs the request for documentation on controlled transaction(s). The taxpayer has 10 days to submit the relevant documentation. It is prohibited to conduct two transfer pricing audits within the same calendar year. 4.2 Grounds Transfer pricing tax audits may be scheduled on the following grounds: (i) Filing of the transfer pricing report by a taxpayer (ii) Identification by the tax office of the unreported controlled transactions; (iii) Failure to file or filing with violations of the transfer pricing report and/or transfer pricing documentation; (iv) Documentary information evidencing the deviation from the arm’s length principle of terms in a controlled transaction 4.3 Authority to conduct Transfer pricing tax audit is conducted by the local tax authority and is led by an official of the State Fiscal Service of Ukraine. 4.4 Scope and burden of proof The transfer pricing audit may be initiated with respect to controlled transaction(s) executed within not more than seven calendar years immediately preceding the year when the decision on the tax audit is made. If the taxpayer applied, in particular, the most appropriate transfer pricing method, tax authorities are obliged to apply the same method unless they prove that the method used by the taxpayer does not allow 442 Baker & McKenzie establishing comparability between the terms of the controlled transactions and the comparable transactions. 4.5 Duration Tax audits are performed under a procedure to be established by the State Fiscal Service of Ukraine and may not last longer than 18 months. In certain cases, such as submission of the request to foreign tax authorities and price expertise, the period of tax audit may be extended for another 12 months. It is prohibited to conduct two transfer pricing audits in respect of one controlled transaction of one taxpayer within the same calendar year. 4.6 Objections Results of the transfer pricing audit are formalized in the form of: (i) a tax audit report (if no deviation is identified); or (ii) a tax audit act (if deviation identified). The taxpayer may challenge the results of the tax audit by filing written objections on the tax audit act within 30 calendar days after receiving the copy of the act. The tax office, in turn, must respond to the written objections of the taxpayer within 30 business days. 5. Dispute Resolution 5.1 General If the tax authority finds deviation of price in the controlled transaction upon results of a tax audit, it issues the formal tax assessment notice. As a general rule, formal tax assessment notice is issued: (i) within 10 business days after the delivery of the act to a taxpayer; or Transfer Pricing Handbook – Ukraine Baker & McKenzie 443 (ii) within three business days after the delivery of the response of the tax office to the objections of the taxpayer. The tax assessment notice issued in respect of transfer pricing violation may be challenged by the taxpayer under general procedure of the Tax Code of Ukraine either through (i) the administrative appeal procedure, or (ii) the court appeal procedure. 5.2 Administrative appeal Once the tax assessment notice has been received by the taxpayer, the taxpayer may challenge the assessment by pursuing an administrative appeal procedure, which automatically suspends the tax assessment notice. In order to launch the administrative appeal procedure, the taxpayer must lodge a complaint with the regional-level tax office. Such complaint must be filed within 10 calendar days after the receipt by the taxpayer of the tax assessment notice. If the taxpayer’s complaint is rejected by the regional level tax office in full or in part, the taxpayer may appeal this decision to the nationallevel tax office. In order to be eligible to appeal a decision of a lowerlevel tax office, the taxpayer must lodge its appeal with the higherlevel tax office within 10 calendar days after he receives the relevant decision. The application of administrative appeal procedure to assessment of liabilities based on transfer pricing rules, even though formally envisaged by the Tax Code of Ukraine, remains disputable. This is because the question of transfer pricing compliance is reserved to the domain of the Sate Fiscal Service of Ukraine, which is the highest tax authority of Ukraine, and therefore may not be resolved by lowerlevel tax offices. 444 Baker & McKenzie 5.3 Court appeal According to the applicable legislation, the validity of the tax assessment notice is suspended once a lawsuit has been filed by the taxpayer with the court of first instance. As a general rule, the lawsuit may be filed within three years upon the receipt of such notice by the taxpayer (this term is rather disputable, the risk of application of shortened terms shall be specifically considered, i.e., one month from the date of completion of the administrative challenging procedure or 10 calendar days from the date upon receipt of the notice by the taxpayer). This notice is normally suspended until the decision of the first instance court comes into legal force. The decision of the first instance court may be appealed to the appellate administrative court within 10 calendar days. The appellate administrative court may: (i) uphold the decision of the first instance court; (ii) change the decision of the court of first instance; (iii) cancel it and render a new decision in the case; or (iv) terminate the proceedings. The decisions of the appellate administrative court may be further appealed by filing of a cassation complaint. As a general rule, a cassation complaint may be filed with the Supreme Administrative Court of Ukraine within 20 calendar days from the date the decision was rendered or the ruling was given by the appellate administrative court. In exceptional circumstances, a motion for judicial review may be filed with the Supreme Court of Ukraine. 5.4 Settlements under DTT In the case of a transfer pricing adjustment in cross-border transactions, the taxpayer risks double taxation if a foreign tax Transfer Pricing Handbook – Ukraine Baker & McKenzie 445 adjustment does not correspond to the Ukrainian tax adjustment. This issue can be resolved by a request for a corresponding adjustment. The request can be made under the mutual agreement procedure (MAP) stated by the relevant double tax treaty. Ukraine has entered into a significant number of double tax treaties and most of them contain a MAP article. The taxpayer will address the acting Ukrainian competent authority in order to request that a MAP be initiated. The MAP may also be requested in a case where the Ukrainian tax authorities have made the primary adjustment. As the transfer pricing rules were introduced in Ukraine recently, the MAP procedure has not yet been tested. 6. Interest and Penalties 6.1 Late payment penalties and interest If the tax authorities assess an additional tax liability in connection with the taxpayer’s understatement, the following fines shall apply: • 25 percent of the understated tax liability for the first violation; • 50 percent of the understated tax liability for the second violation. If the taxpayer independently identifies an underpayment of its tax liability, makes a self-adjustment and voluntarily discloses and extinguishes understated tax liability, the following fines shall apply: • 3 percent of such understated liability, if it is identified via the adjusted tax return and paid prior to filing such adjusted tax return; • 5 percent of such understated liability, if it is identified via the consecutive tax return and paid thereafter. 446 Baker & McKenzie Where additional corporate income tax or value added tax liabilities become due following a transfer pricing adjustment, any late tax payment will also carry interest. According to the general rules of the Tax Code of Ukraine, late payment interest is established to be 120 percent of the rate of refinancing of the National Bank of Ukraine. With the current rate of refinancing of 14 percent per annum, penalty interest, therefore, is 16.8 percent per annum. 6.2 Reporting penalties If the taxpayer fails to file a transfer pricing report and/or transfer pricing documentation, or if the taxpayer has not reflected all controlled transaction in the transfer pricing report, the following fines shall apply: • 100 times the minimum statutory salary (currently UAH121,800 or approximately USD9,400) for failure to submit a transfer pricing report (including failure to submit the transfer pricing report timely) • 5 percent of the sum of the controlled transactions that were not reflected in the transfer pricing report • 3 percent of the sum of the controlled transactions with respect to which transfer pricing documentation was not filed for all of the unreported controlled transactions, but not more than 200 times the minimum statutory salary (currently UAH243,600 or approximately USD16,000) 7. Advance Pricing Agreement (APA) Procedures 7.1 Applicability criteria Under the Ukrainian transfer pricing rules, only large taxpayers are entitled to conclude APAs with the State Fiscal Service of Ukraine. Transfer Pricing Handbook – Ukraine Baker & McKenzie 447 7.2 Scope The TPL provides for more detailed rules concerning advance pricing arrangements (APA) as compared to the previously effective legislation. The APA takes the form of an agreement between a taxpayer and the State Fiscal Service of Ukraine. The subject of agreement may relate to the types of goods or services; prices; the list of sources of information that may be used for the determination of arm’s length prices; the period of APA; allowed deviations in prices; and the procedure, terms and the list of supporting documents. 7.3 Procedures The APA may be concluded only with regard to the contemplated transaction(s) but may not cover the arrangements of a taxpayer that are already in place. APA applications must be filed with the State Fiscal Service of Ukraine, with the aim to establish, in advance, the methodology of determination of prices of the controlled transactions over a fixed period of time. The terms of an APA are further negotiated between the State Fiscal Service of Ukraine and the taxpayer on an individual basis. There is no formal guidance on the possible duration of such negotiations. 7.4 Cross-border APAs The Ukrainian transfer pricing rules provide for the possibility of concluding bilateral/multilateral APAs that cover cross-border transactions with a party resident in a state with a double tax treaty with Ukraine under the competent authority procedures, with the participation of the relevant foreign tax authority. Transfer Pricing Handbook – UK Baker & McKenzie 449 UK Richard Fletcher, Principal Tax Advisor Richard Fletcher heads the UK Transfer Pricing Group in London. A seasoned professional with many years of experience as an international tax adviser, he has published a number of articles in various tax technical journals. Richard has presented at the International Tax Review’s Global Transfer Pricing Conference for a number of years and at meetings of tax directors of UK multinationals for the UK branch of the International Fiscal Association. [email protected] Tel: +44 20 7919 1771 Nigel Dolman, Director (Partner equivalent) Nigel Dolman works in the UK Transfer Pricing Group in London, leads the valuations practice and has worked in transfer pricing for 15 years. Nigel has experience in global transfer pricing for a multitude of clients in a range of different industries, focusing on the design and defense of transfer pricing policies, intellectual property and business restructuring arrangements. [email protected] Tel: 44 207 919 1369 450 Baker & McKenzie Thomas Brennan, Economist Tom Brennan is a senior economist in the UK Transfer Pricing Group in London. Tom has worked with a range of clients across a number of industries, including telecommunications IT, finance, aerospace, mining and oil, consumer products and real estate. [email protected] Tel: +44 (0)20 7919 1266 Baker & McKenzie LLP 100 New Bridge Street London EC4V 6JA, UK Transfer Pricing Handbook – UK Baker & McKenzie 451 1. Statutory Rules and Administrative Regulations 1.1 Introduction The UK’s transfer pricing legislation follows the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the “OECD Guidelines”) and applies where a “provision” is made between two persons by means of a transaction or a series of transactions where those persons are under common control or management. If the provision has not been made at arm’s length and, consequently, a potential tax advantage has been conferred, then the transaction must be recomputed for tax purposes as if it had occurred on arm’s length terms. 1.2 Meaning of provision “Provision” is not defined in UK legislation but the UK tax authorities (HM Revenue & Customs or HMRC) have issued guidance stating that the meaning is broadly equivalent to “conditions” in Article 9 of OECD model treaty and is similarly wide in scope. For example, “provision” embraces all the terms and conditions attaching to a transaction or series of transactions whether or not they are, or are intended to be, legally enforceable. A UK court has held (in DSG Retail v. Revenue & Customs Commissioners) that the term includes indirect provision of a business facility by one company to a company connected with it in circumstances where there is no contractual relationship between those companies. 1.3 Meaning of “control” Control exists for transfer pricing purposes where either one person controls the other or the same person controls both parties to the transaction. Control can be direct or indirect (e.g., through the attribution of rights of connected parties) and controlling persons can be partnerships or individuals as well as companies. The rules apply to transactions where: • one of two persons was or is, directly or indirectly, participating in the management, control or capital of the other; 452 Baker & McKenzie • the same person (or persons) was (or were), directly or indirectly, participating in the management, control or capital of each of the affected persons; or • the participants in a joint venture (broadly, a company with two owners each with a 40 percent interest or greater) transact with the joint venture company. 1.4 Scope of the rules The UK’s transfer pricing rules apply to transactions where both parties are UK tax residents, as well as to transactions where one party is a UK resident and the other is not. The rules apply to a wide range of related party transactions, including goods and services and financing transactions, as well as licensing and sale of intellectual property. There is an exemption for dormant companies and for smalland medium-sized enterprises (SMEs). Tax haven transactions are not exempt from the transfer pricing rules. UK-to-UK transfer pricing will usually only be an issue where the results of the parties cannot be consolidated for tax purposes or where, for example, an adjustment means that one party is unable to use a carried-forward loss. Generally, where a UK-to-UK transfer pricing adjustment is made to a party, the other UK party may apply for a compensating adjustment to adjust their taxable profits. In 2013, new legislation was enacted to restrict the availability of compensating adjustments on UK-to-UK transactions. The new measures withdraw the ability of individuals (including the partners in a partnership) to claim compensating adjustments where the counterparty to the transaction is a company. This measure is targeted towards a perceived abuse of the compensating adjustment mechanism, which exploited the differential between personal income tax rates and corporation tax rates. Transfer Pricing Handbook – UK Baker & McKenzie 453 1.5 Application to financing arrangements The rules apply specifically to finance arrangements, which are defined as “...arrangements made for providing or guaranteeing, or otherwise in connection with, any debt, capital or other form of finance.” The general concept of control is extended in the context of financing arrangements. Control, in these circumstances, is also determined by amalgamating the rights and powers of any persons that have “acted together in relation to the financing arrangements.” These changes are mainly targeted at preventing private equity funds from working in concert to thinly capitalize their joint acquisitions. 1.6 Compliance Self-assessment applies to UK corporation taxpayers who must decide whether the taxable profits they enter on their self-assessment return reflect an application of the arm’s length principle where relevant. 1.7 Time limits for assessment HMRC normally has up to four years from the end of the relevant accounting period in which to raise a corporation tax assessment, unless there has been careless behavior on the part of the taxpayer leading to a loss of tax, in which case the limit is six years. Where tax loss arises from deliberate behavior by the taxpayer, such as failure to notify liability, the limit is 20 years. Where an assessment is open, for example, because of an ongoing tax enquiry in a period, a transfer pricing adjustment is possible even if the adjustment is made more than four years after the end of the relevant accounting period. 1.8 Attribution of profit The UK rules follow the OECD Report on the Attribution of Profit to Permanent Establishments, which describes how profits should be attributed to permanent establishments in accordance with the OECD Model Tax Convention’s tax treaty provisions. UK practice is broadly consistent with the OECD’s described method, although UK legislation precludes a deduction for purely internal interest or royalty 454 Baker & McKenzie payments by the permanent establishment to any other part of the nonUK resident company. 1.9 Advance pricing agreements HMRC offers advance pricing multilateral and unilateral agreements (APAs) in respect of arrangements between UK and non-UK related parties and within the same enterprise for attributions, for example, between the head office of a company in one country and its branch in another country, or between branches where the head office or branch is subject to UK tax. 2. Transfer Pricing Methods 2.1 Construing the legislation The UK transfer pricing legislation is required to be construed in a way that best ensures consistency with the OECD Guidelines. 2.2 Selection of method The OECD Guidelines (2010 version) provide that the transfer pricing method selected should be the most appropriate method in the circumstances of the case. However, where a traditional transactionbased method (CUP, resale price minus or cost plus) and a profit method (transactional profit split or transactional net margin method) are both equally valid in the circumstances, the traditional transaction method is preferable. Similarly, where a CUP method and another traditional transaction method are both equally reliable, the CUP method should be used. Consideration of which method to apply from a UK perspective should therefore always begin with a consideration of whether any CUPs, either internal or external, are available. HMRC continues to target for enquiry cases where the transactional net margin method (TNMM) has been used, although CUPs were available. Transfer Pricing Handbook – UK Baker & McKenzie 455 2.3 Contemporaneous information Hindsight cannot be used to determine whether a price was at arm’s length; only information that was available to the parties at the time (including reasonably foreseeable information) may be relied upon (see DSG Retail v. Revenue & Customs Commissioners). Also, UK legislation does not adhere to the commensurate-with-income standard. 2.4 Pricing adjustments Year-end and retrospective pricing adjustments may be acceptable, for example, to take into account actual circumstances that have occurred where only budgeted indicators were initially used to set transfer pricing policies. Other factors (for which adjustments need to be made) may also be relevant, such as indirect taxes. 2.5 Working capital/inventory UK does not generally require calculation of comparability adjustments to ascertain levels of working capital/inventory when comparing equivalent business activities. Adjustments may be required if, for example, distributor companies are being used in benchmarking returns as a proxy for commission-based sales functions. 2.6 Business restructurings The addition in 2012 of guidance on business restructurings to the OECD guidelines is also critical in determining the UK transfer pricing approach and the impact of changes in functions, risks and assets of UK taxpayers. 2.7 Safe harbors There are no legislative safe harbors, nor are there any “rules of thumb” contained in HMRC’s published guidance. 456 Baker & McKenzie 3. Transfer Pricing Documentation and Filing Requirements 3.1 Recordkeeping The UK rules laid down in statute are general. However, HMRC’s guidance sets out the transfer pricing documentation that should be kept by a UK taxpayer. This includes the following: 1. Primary accounting records – These are records of transactions occurring in the course of a business’s activities, which are needed to produce accounts (in particular, a balance sheet and a statement of profit or loss). These records include the results (in terms of value) of the relevant transactions. In the context of transfer pricing rules, these are the actual results. They may or may not be arm’s length results. 2. Tax adjustment records – These identify adjustments made by a business because of tax rules to move from profits in accounts to taxable profits, including the value of those adjustments. These might include the adjustment of actual results to arm’s length results to comply with transfer pricing rules. 3. Records of transactions with associated businesses to which the transfer pricing rules apply 4. Evidence to demonstrate an arm’s length result – Businesses must have evidence to show that pricing was at arm’s length at the time of the transaction. This requires evidence of comparable transactions, or comparison with the profitability of third parties, including a detailed analysis of risks borne, functions undertaken and assets owned by related parties. Based on the general principles set out in the OECD guidelines and on practical experience in applying transfer pricing rules, a number of specific suggestions can be made as to what constitutes a reasonable attempt to demonstrate an arm’s length result. A business: Transfer Pricing Handbook – UK Baker & McKenzie 457 • should make documentation available and accessible to HMRC (including, where appropriate, translation from another language); however, the form in which the documentation is stored should be at the discretion of the business; • should identify the associated businesses with which relevant transactions took place and the nature of the association; • should describe the nature of the business in the course of which relevant transactions took place and the property (tangible and intangible) used in that business; • should set out the contractual or other understandings between associated businesses and the risk assumed by each party; • should describe the method used to establish an arm’s length result and explain why that method was chosen; • need not provide evidence about associations or transactions between businesses if those associations or transactions are not within the scope of UK transfer pricing rules; • need not provide evidence related to each relevant transaction but may provide aggregated evidence related to a class of similar transactions; • need not create new evidence in relation to transactions that occur after evidence has been created in relation to transactions that are similar if there have been no material changes in the circumstances for determining an arm’s length result; • need not commission the production of evidence from a professional adviser if the business is able to produce appropriate evidence itself; • may choose to explain its general commercial and management strategy or that of the group of businesses of which it is a 458 Baker & McKenzie member, as well as the current and forecast business and technological environment, competitive conditions and regulatory framework; or • may choose to make documentation in relation to relevant transactions available to HMRC before the tax return in which those transactions are reflected is due to be made. 3.2 Timing of evidence and analysis The statutory filing date for corporation tax self-assessment returns is normally 12 months from the end of the accounting period. A UK taxpayer should have sufficient evidence and analysis at the date of lodging its tax return to be able to confirm that its transactions with related parties are at arm’s length. 3.3 Record-keeping duration Records must be preserved until the latest of: • six years from the end of the period concerned; • the date on which any enquiry into the return is completed; or • the date on which HMRC is no longer able to open an enquiry. 3.4 Reviewing and updating documentation Documentation should be reviewed on an annual basis to determine if historical, functional and economic analyses are still relevant, but there is no requirement to update formal documentation on an annual basis unless circumstances have changed. 3.5 Senior accounting officer regime There is a separate UK obligation for larger UK companies or groups for a “senior accounting officer” to certify that their business has proper accounting systems in place to enable accurate tax reporting. The requirement applies to UK companies with turnover (either alone Transfer Pricing Handbook – UK Baker & McKenzie 459 or combined with other UK resident group companies) of more than GBP200 million and/or a balance sheet total of more than GBP2 billion in the preceding financial year. 3.6 Form and depth of documentation HMRC has indicated that documentation in the form of the European “Masterfile” should generally be adequate and sufficient, but emphasize that the depth of documentation and analysis should be commensurate with the complexity and materiality of the transaction. Action 13 of the OECD’s Base Erosion and Profit Shifting (BEPS) project will require a new three-tiered approach to transfer pricing documentation involving a MasterFile, a Local Country File and a Country-by-Country Report. The UK has committed to adopt the Country-by-Country reporting template. 3.7 Returning information There is no special corporation tax return form for reporting connected party transactions. However, these must be reflected in the normal annual corporation tax return, on an arm’s length basis. Information regarding transfer pricing will, in the first instance, be gathered by HMRC from the tax return, and supplemented by further information disclosed as a result of specific enquiries. 4. Tax Audit Procedures 4.1 Risk assessment HMRC will not open a transfer pricing enquiry without a fully considered assessment of the amount of tax that is likely to be at risk. HMRC’s view is that the cases where significant amounts of tax are at stake are those that result from manipulation rather than insufficient attention to the arm’s length principle. Where there is no, or minimal, opportunity to secure a tax advantage through manipulation, and a business has clearly taken some steps to apply transfer pricing rules, HMRC is less likely to initiate an enquiry. 460 Baker & McKenzie 4.2 Indicators of transfer pricing risk HMRC gives the following examples of international situations that might present a transfer pricing risk: • The UK company’s profits or losses appear inconsistent either with its business activities or with worldwide group results over a cycle of, say, five years. • The UK company provides intangibles but receives no or low royalties, and it does not seem to be generating an entrepreneurial reward for its research and development. The other party to the transaction has a high net margin given what is known about its business activities. • Interest expense appears high in relation to the business’s ability to service the debt from its operating profits before tax and interest payable. What constitutes “high” is a complex issue, and the question is whether the debt burden appears sustainable, alongside the company’s other requirements and obligations. • Transactions do not appear to make commercial sense (e.g., insertion), for no apparent commercial purpose, of a new UK group holding company with substantial debt, particularly in comparison to the previous position. • Transactions are with related parties in low-tax territories. • Notes in UK accounts or other forms of information such as press or Internet articles mention restructuring, acquisition/merger activity, transfer of UK activities to related parties, and/or changes to the way in which the company is rewarded. HMRC’s guidelines indicate that a detailed risk assessment should be undertaken before a case is selected for a transfer pricing enquiry. There is an extensive list of factors to consider, such as the markets in which the group operates, the group’s accounts, the group structure Transfer Pricing Handbook – UK Baker & McKenzie 461 and the principal intragroup transactions, the intellectual property it owns, its processes, and its main competitors. The initial information request will aim to establish the nature and volume of transactions between the company and its related parties, how the transactions were priced, and whether these prices were at arm’s length. The aim is to fully understand how the business trades; to identify who carries out what functions; to understand the nature, scope and volume of relevant inter-company transactions; and to see what profit accrues where. It must be tailored as far as possible to the circumstances of the particular case, based on the gaps in HMRC’s knowledge identified in the risk assessment. The next stages are: for the business to respond; for HMRC to consider that response; where relevant, for HMRC to exchange information with tax authorities in other countries; and finally, to arrive at a settlement. 4.3 HMRC transfer pricing group There is a body of tax and other specialists within HMRC, drawn from various HMRC teams, who are dedicated to working transfer pricing and thin capitalization enquiries. HMRC officers and customer relationship managers (for large businesses) are encouraged to liaise with the transfer pricing group specialists at an early stage in the process. 4.4 Progress of enquiry Each case proceeds through a series of “stage gates” that each centers on a key decision to be made before the enquiry proceeds toward the next stage. The stages range from “Does the case justify an enquiry?” to “At which point must HMRC decide to close the enquiry without adjustment, seek a negotiated settlement with the business, or proceed to litigation?” 462 Baker & McKenzie 4.5 HMRC current focus Key areas of transfer pricing focus for HMRC include the following: • Identification of intangible assets and determination of whether an intangible asset has been transferred, for example, in business restructuring • Substance of operations in a specific country and in particular, the location of significant people functions • Whether a service activity is sufficiently routine to be characterized as a cost plus service or whether greater returns calculated on a different basis such as profit split should be associated with the activity 4.6 HMRC information powers HMRC is allowed, under their general information powers, to issue information notices to require a person to provide information or documents. The information or document(s) must be reasonably required by HMRC for the purpose of checking a taxpayer’s tax position. In practice, HMRC will usually make an informal request for the information they require before issuing an information notice. HMRC can enter business premises and inspect any documents on the premises, but only those documents that can be covered by an information notice. HMRC cannot force entry or search premises. 4.7 Transfer pricing information The type of information available to HMRC might include the company’s transfer pricing documentation, everything that the company has prepared for its corporation tax self-assessment for transfer pricing purposes, any further evidence of arm’s length pricing, the company’s transfer pricing manual, budgets for each function, and management accounts. In assessing the company’s position, HMRC may also include in their business case sensitive Transfer Pricing Handbook – UK Baker & McKenzie 463 information or confidential information that the company itself has not provided to HMRC. 5. Dispute Resolution 5.1 Litigation and settlement strategy HMRC has a Litigation and Settlement Strategy (LSS), which sets out guidance for HMRC officers on how to select cases for litigation. The LSS generally requires a focus on high-risk cases with significant mounts of tax at stake, but it was recently updated to confirm a more targeted approach to tax disputes involving greater use of alternative (collaborative) dispute resolution/mediation processes. This follows a successful mediation pilot, and HMRC is now using alternative dispute resolution techniques more generally. HMRC has also published a Code of Governance to provide transparency about the decision-making process for tax disputes. 5.2 UK domestic appeals process At a domestic level, a company may appeal against an HMRC assessment that involves a transfer pricing adjustment. The appeal is to the First Tier Tax Tribunal and notice must be given to HMRC within a specified time limit. The next stage is either to request an internal HMRC review or to notify the appeal to the tribunal. An appeal from the First Tier Tribunal’s decision can be made, on a point of law only, to the Upper Tribunal, and from there, to the Court of Appeal and ultimately to the Supreme Court. 5.3 Mutual agreement procedure UK has a significant number of double tax treaties, almost all of which contain a mutual agreement procedure (MAP) article. The extent to which the MAP procedure is available is, to a large extent, dependent upon the discretion of HMRC (which is the UK’s competent authority). The granting of corresponding adjustments is a matter for HMRC (acting as the UK’s competent authority). HMRC’s general approach is that a transfer pricing adjustment in relation to an 464 Baker & McKenzie international transaction that increases profits in one contracting state should be matched by a corresponding reduction in profits elsewhere. The treaty will generally require the competent authorities to endeavor to apply the MAP in such a way that double taxation is eliminated, and this result will be achieved in majority of cases. There is no formal statutory method to set a case in motion. 5.4 Interaction of MAP and domestic transfer pricing enquiry Any request to initiate the MAP should not delay the progress and settlement of a domestic transfer pricing enquiry, nor should it delay the making of claims, including protective claims. Subsequent claims may arise as a result of the conclusion of the domestic enquiry, such as group relief, and there may also be an impact from secondary adjustments in other jurisdictions. The trigger for a MAP claim would normally be the finalization of the transfer pricing enquiry, which results in double taxation. In some cases, HMRC will admit a case to the MAP before first notification that double taxation will or is likely to arise, and may agree to discuss the underlying principles of a case with the other taxing authority even prior to the finalization of the enquiry. 5.5 The European Arbitration Convention The Arbitration Convention is a potentially useful mechanism but some uncertainty still surrounds it. It does not appear that the inclusion of mandatory arbitration provisions in new treaties is a current priority for HMRC, although recently negotiated UK treaties for example, with France, Germany and the Netherlands have included such provisions. In 2011, HMRC published a statement of practice revising its guidance on both the MAP and the procedure under the arbitration convention. This statement mainly clarified the existing practices and approach of HMRC and is now incorporated in its internal guidance. Transfer Pricing Handbook – UK Baker & McKenzie 465 5.6 Leading transfer pricing litigation in the UK • DSG Retail Limited v. Revenue & Customs Commissioners: The court ruled that a company’s profit was generated purely as a result of a series of transactions with related parties and that the pricing structure used would not have been used had the parties been operating at arm’s length. • Waterloo Plc and others v. CIR: Interest-free loans from a parent company to enable a trust to buy shares for its subsidiaries’ employee share option schemes amounted to the provision of a business facility to which an arm’s length price should have been applied. • Meditor Capital Management v. Feighan: The court ruled that HMRC may demand information (on a limited basis) from a related party outside the UK where it was only by looking at a transaction from the perspective of the non-resident party, as well as the UK resident, that an arm’s length price could be determined. The UK company, or representatives of the UK company, must have the power themselves to obtain the information for it to be available to HMRC but “power” in this context is widely interpreted and can mean, for example, a document not in possession of the UK company, but which the company can request from another person (even if that person has a legal right to refuse the request). See HMRC v. Parissis (2011). 5.7 Current areas of potential transfer pricing litigation in the UK Pricing of transfers of intellectual property – A particular hypothetical question that is raised by HMRC, on the basis of the wording of UK legislation, is “Would the taxpayer have transferred the IP in an arm’s length situation?” This is particularly pertinent for UK companies owning either intellectual property critical to the UK operations or to such property where there is potential for substantial upside, such as early-phase drug or technology developments. 466 Baker & McKenzie 6. Interest and Penalties 6.1 Interest Where additional corporation tax becomes due following a transfer pricing adjustment, any corporation tax paid late will carry interest. 6.2 Penalties Penalties may be imposed where a tax return is submitted that is not in accordance with the arm’s length principle and which contains a careless, deliberate, or deliberate and concealed inaccuracy resulting in a loss of UK tax, or an increased claim to a loss or a repayment. The onus is on HMRC to show that there has been a careless inaccuracy before any penalty can be charged. 6.3 Meaning of careless/deliberate/concealed There is no statutory or judicial definition of “careless,” “deliberate” or “concealed” in the context of penalties for inaccuracies or incorrect returns. In the context of transfer pricing, the guiding principle is that a person is not careless if he or she has done what ‘a reasonable person would do’ to ensure that returns are made in accordance with the arm’s length principle. This might involve using commercial knowledge and judgment to make arrangements and set prices that conform to the arm’s length standard (or to make computational adjustment in returns where they do not); being able to show (for example, by means of good quality documentation) that an honest and reasonable attempt to comply with the arm’s length standard and with the legislation has been made; and seeking professional help where it is needed. HMRC’s internal guidance contains some useful examples of what constitutes carelessness or deliberate/concealed inaccuracies in transfer pricing cases. 6.4 Amount of penalty The penalty is based on the potential lost tax. The maximum amounts are as follows: careless inaccuracy - 30 percent; deliberate but not concealed inaccuracy - 70 percent; deliberate and concealed Transfer Pricing Handbook – UK Baker & McKenzie 467 inaccuracy (for example submitting false evidence in support of an inaccurate figure) - 100 percent. Penalties can be mitigated by disclosing an inaccuracy to HMRC. The amount of mitigation depends on the type of inaccuracy (careless, deliberate, deliberate and concealed) and whether the disclosure is prompted (by HMRC) or unprompted. Where a taxpayer can show it has taken reasonable care, there will be no penalty even if an adjustment is subsequently made. 7. Advance Pricing Agreement Procedures 7.1 Who can apply for an APA? An APA can be requested by any UK business, including a partnership, with transactions to which the UK transfer pricing legislation applies; any non-resident trading in the UK through a permanent establishment; or any UK resident trading through a permanent establishment outside the UK. 7.2 HMRC approach HMRC offers APAs for which they do not charge a fee. They may consider unilateral APAs in some circumstances, but where there is a double taxation agreement between the UK and the other relevant jurisdiction that includes a mutual agreement procedure article, HMRC (on behalf of the UK) will, unless representations are made on certain grounds, always approach the other tax administration at least to notify that other administration, if not to seek their participation. 7.3 Typical APA transaction Generally, HMRC will be looking for a case where the transfer pricing issues are complex rather than straightforward (i.e., there is doubt as to how the arm’s length standard should be applied), where the taxpayer’s transfer pricing policies or issues would not be regarded as “low risk” and there is a strong likelihood of double taxation, or where the taxpayer seeks to implement a method that is highly tailored to its own particular circumstances, e.g., it is innovative (but it should not be overly aggressive). Examples would be a complex business restructuring potentially involving exit of soft intangibles from the 468 Baker & McKenzie UK, or implementation of an inbound franchising arrangement involving such intangibles. 7.4 Procedure The procedure is as follows: • The potential applicant makes an expression of interest to HMRC (this can be on a no-names basis). • A formal application is made. • HMRC appoints a team to take responsibility for the APA and the process. • HMRC commences its fact-finding task. • An agreed position is (it is hoped) reached. • HMRC aims to complete APAs within 18 to 21 months from the receipt of application. 7.5 Information required HMRC has published a statement of practice (now incorporated in their internal guidance) on how they interpret the APA legislation and apply it in practice. This includes guidance on the sort of information to set out in the formal application, namely the applicant’s understanding of the effect of the relevant legislation, including the effect of any double tax treaty in relation to the transfer pricing issues under consideration; the areas where, because of the difficulty of the transfer pricing issues, clarification of the effect is required; and a proposal for clarifying the effect of the legislation in accordance with the applicant’s understanding. 7.6 Monitoring an APA The terms of an APA must include a commitment from the business to demonstrate adherence to the agreed method for dealing with the Transfer Pricing Handbook – UK Baker & McKenzie 469 transfer pricing issues during the term of the APA in the form of a regular (annual) compliance report (normally submitted with the business’s tax return). The terms of the APA will also include the identification of critical assumptions material to the reliability of the method and which, if subject to change, may render the APA invalid. 7.7 Term of an APA An APA will be operative for a specified period from the date of entry into force as set out in the APA. Typically, the term is from three to five years. 7.8 Renewal of an APA Ideally, the business should request renewal of an APA not later than six months before the expiry of its current term, but HMRC will accept requests made before the end of the first chargeable period affected by the renewal. The renewal application should expressly consider any changes or anticipated changes in facts and circumstances since the existing APA was reached, whether any amendments are necessary, and should demonstrate that the proposed methodology is, or is still, appropriate. 7.9 Real-time working Until recently, the only way to obtain legal certainty in the UK as to whether the pricing methodology for intragroup transactions meets the arm’s length test has been the APA process. However, HMRC will now provide a “general opinion” about any transfer pricing methodology used by a taxpayer as part of their “real-time working,” that is, the ongoing discussion and fact-finding process by HMRC, including the process by which HMRC assesses the likely transfer pricing risks inherent in the taxpayer’s business operations. This is a welcome development, especially in cases where the time and cost involved in a full APA would not be justified. 470 Baker & McKenzie 7.10 HMRC inward investment support HMRC offers a facility for accelerated rulings to foreign companies making a substantial investment in the UK. The level of investment must normally be at least GBP30 million, although this is not a rigid minimum and in some cases, it might be possible to invest this amount over a period of time and not all at once. The application, which will be handled by a single, dedicated HMRC officer, must be presented with all the relevant facts. The inward investment support service applies not only to APAs and real-time working, but to other tax issues affecting multinational groups, such as permanent establishment, withholding taxes and the UK’s anti-arbitrage rules. 8. Thin Capitalization 8.1 Advance thin capitalization agreement (ATCA) with HMRC ATCAs fall within the statutory procedure for APAs. Applications for an ATCA can be made for transactions relating to funding, which is the subject of a treaty clearance application or those which are not linked to a treaty claim (loans with no withholding tax implications). Early in 2012, HMRC published updated guidance as well as a revised “Model” ATCA. An ATCA does not have the effect of a pretransaction ruling, but an application will usually be submitted ahead of the return covering the period of the relevant transaction. 8.2 Safe harbor In the UK, there is no legislative safe harbor and HMRC reiterates in its guidance that the arm’s length position must be determined by reference to the specific facts and circumstances of the borrower and the lender (along with any relevant guarantees provided to the borrower). 8.3 Recharacterization Interest paid by a thinly capitalized entity will not be recharacterized as a dividend, but a deduction may be disallowed in whole or in part. Transfer Pricing Handbook – UK Baker & McKenzie 471 8.4 Factors to be taken into account HMRC will look at a number of factors including the amount and purpose of the loan, and the commercial motivations for it, the trading and financial strategy of the business/company/group, the cost/benefit equation, and the tax risks. The analysis will generally involve examining comparables from similar businesses, as well as financial ratios such as interest cover and/or debt cover. Transfer Pricing Handbook – Our contributors Baker & McKenzie 473 Our contributors Austria, Vienna Imke Gerdes Azerbaijan, Baku Rena Eminova Altay Mustafayev Belgium, Brussels Gery Bombeke Matthias Doornaert Czech Republic, Prague Pavel Fekar Denmark, Copenhagen Anders Oreby Hansen Finland, Helsinki Janne Juusela France, Paris Benoit Granel Laura Nguyên-Lapierre Caroline Silberztein Germany, Dusseldorf Stephan Schnorberger Hungary, Budapest Timea Bodrogi-Szabó Gergely Riszter Ireland, Dublin Joseph Duffy John Ryan Italy, Milan Mario D’Avossa Luxembourg Ludovic Deflandre Amar Hamouche André Pesch The Netherlands, Amsterdam Margreet Nijhof Hub Stolker Norway, Oslo Anders Heieren Poland, Warsaw Tomasz Chentosz Portugal, Lisbon Miguel Teixeira de Abreu Russia, Moscow Roman Bilyk Maria Kostenko Arseny Seidov Spain, Barcelona Bruno Dominguez Davinia Rogel Spain, Madrid Raul Salas Sweden, Stockholm Linnea Back Bo Lindqvist 474 Baker & McKenzie Switzerland, Geneva Denis Berdoz Aïcha Ladlami Switzerland, Zurich Hans-Andrée Koch Robert Desax Turkey, Istanbul Erdal Ekinci Duygu Gultekin Ukraine, Kyiv Viktoria Stavchuk Hennadiy Voytsitskyi United Kingdom, London Thomas Brennan Nigel Dolman Richard Fletcher Transfer Pricing Handbook – Baker & McKenzie Offices Baker & McKenzie 475 Baker & McKenzie Offices Office phone numbers and addresses change from time to time. Please refer to www.bakermckenzie.com for current contact information. Austria - Vienna Diwok Hermann Petsche Rechtsanwälte GmbH Schottenring 25 1010 Vienna Austria Tel: +43 1 24 250 Fax: +43 1 24 250 600 Azerbaijan - Baku Baker & McKenzie - CIS, Limited The Landmark Building 90A Nizami Street Baku AZ1010 Azerbaijan Tel: +994 12 497 18 01 Fax: +994 12 497 18 05 Bahrain - Manama Baker & McKenzie Limited 18th Floor, West Tower Bahrain Financial Harbour PO Box 11981 Manama Kingdom of Bahrain Tel: +973 1710 2000 Fax: +973 1710 2020 Belgium - Antwerp Baker & McKenzie CVBA/SCRL Meir 24 Antwerp 2000 Belgium Tel: +32 3 213 40 40 Fax: +32 3 213 40 45 Belgium - Brussels Baker & McKenzie CVBA/SCRL Louizalaan 149 Avenue Louise Eleventh Floor Brussels 1050 Belgium Tel: +32 2 639 36 11 Fax: +32 2 639 36 99 Belgium - ELC Baker & McKenzie CVBA/SCRL 149 Avenue Louise Eleventh Floor 1050 Brussels Belgium Tel: +32 2 639 36 11 Fax: +32 2 639 36 99 Czech Republic - Prague Baker & McKenzie, v.o.s., advokátní kancelár Klimentská 46 110 02 Prague 1 Czech Republic Tel: +420 236 045 001 Fax: +420 236 045 055 Egypt – Cairo Baker & McKenzie Helmy, Hamza & Partners Nile City Building, North Tower 21st Floor 2005C, Cornich El Nil Ramlet Beaulac Cairo Egypt Tel: +2022 461 9301 Fax: +2022 461 9302 476 Baker & McKenzie England - London Baker & McKenzie LLP 100 New Bridge Street London EC4V 6JA England Tel: +44 20 7919 1000 Fax: +44 20 7919 1999 France - Paris Baker & McKenzie SCP 1 rue Paul Baudry 75008 Paris France Tel: +33 1 4417 5300 Fax: +33 1 4417 4575 Germany - Berlin Baker & McKenzie Partnerschaft von Rechtsanwälten, Wirtschaftsprüfern und Steuerberatern mbB Friedrichstraße 88/Unter den Linden 10117 Berlin Germany Tel: +49 30 2200281 0 Fax: +49 30 2200281 199 Germany - Dusseldorf Baker & McKenzie Partnerschaft von Rechtsanwälten, Wirtschaftsprüfern und Steuerberatern mbB Neuer Zollhof 2 40221 Dusseldorf Germany Tel: +49 211 3 11 16 0 Fax: +49 211 3 11 16 199 Germany - Frankfurt Baker & McKenzie Partnerschaft von Rechtsanwälten, Wirtschaftsprüfern und Steuerberatern mbB Bethmannstrasse 50-54 60311 Frankfurt/Main Germany Tel: +49 69 29 90 8 0 Fax: +49 69 29 90 8 108 Germany - Munich Baker & McKenzie Partnerschaft von Rechtsanwälten, Wirtschaftsprüfern und Steuerberatern mbB Theatinerstrasse 23 80333 Munich Germany Tel: +49 89 55 23 8 0 Fax: +49 89 55 23 8 199 Hungary - Budapest Kajtár Takács Hegymegi-Barakonyi Baker & McKenzie Ügyvédi Iroda Dorottya utca 6. 1051 Budapest Hungary Tel: +36 1 302 3330 Fax: +36 1 302 3331 Transfer Pricing Handbook – Baker & McKenzie Offices Baker & McKenzie 477 Italy - Milan Studio Professionale Associato a Baker & McKenzie Piazza Meda 3 Milan 20121 Italy Tel: +39 02 76231 1 Fax: +39 02 7623 1620 Italy - Rome Studio Professionale Associato a Baker & McKenzie Viale di Villa Massimo, 57 Rome 00161 Italy Tel: +39 06 44 06 31 Fax: +39 06 4406 3306 Kazakhstan - Almaty Baker & McKenzie - CIS, Limited Samal Towers, 8th Floor 97, Zholdasbekov Street Almaty Samal-2, 050051 Kazakhstan Tel: +7 727 330 05 00 Fax: +7 727 258 40 00 Luxembourg Baker & McKenzie 10 - 12 Boulevard Roosevelt 2450 Luxembourg Luxembourg Tel: +352 26 18 44 1 Fax: + 352 26 18 44 99 Morocco - Casablanca Baker & McKenzie Maroc Ghandi Mall - Immeuble 9 Boulevard Ghandi 20380 Casablanca Morocco Tel: +212 522 77 95 95 Fax: +212 522 77 95 96 The Netherlands - Amsterdam Baker & McKenzie Amsterdam N.V. Claude Debussylaan 54 1082 MD Amsterdam P.O. Box 2720 1000 CS Amsterdam The Netherlands Tel: +31 20 551 7555 Fax: +31 20 626 7949 Poland - Warsaw Baker & McKenzie Gruszczynski i Wspolnicy Attorneys at Law LP Rondo ONZ 1 Warsaw 00-124 Poland Tel: +48 22 445 3100 Fax: +48 22 445 3200 Qatar - Doha Baker & McKenzie LLP Al Fardan Office Tower 8th Floor Al Funduq 61 Doha, PO Box 31316 Qatar Tel: +974 4410 1817 Fax: +974 4410 1500 Russia - Moscow Baker & McKenzie - CIS, Limited White Gardens 9 Lesnaya Street Moscow 125047 Russia Tel: +7 495 787 2700 Fax: +7 495 787 2701 478 Baker & McKenzie Russia - St. Petersburg Baker & McKenzie - CIS, Limited BolloevCenter, 2nd Floor 4A Grivtsova Lane St. Petersburg 190000 Russia Tel: +7 812 303 9000 Fax: +7 812 325 6013 Saudi Arabia - Jeddah Legal Advisors in Association with Baker & McKenzie Limited Bin Sulaiman Center, 6th Floor Office No. 606 Prince Sultan Street and Rawdah Street Intersection Al-Khalidiyah District P.O. Box 128224 Jeddah 21362 Saudi Arabia Tel: + 966 12 606 6200 Fax: + 966 12 692 8001 Saudi Arabia - Riyadh Legal Advisors in Association with Baker & McKenzie Limited Olayan Complex Tower II, 3rd Floor Al Ahsa Street, Malaz P.O. Box 4288 Riyadh 11491 Saudi Arabia Tel: +966 11 265 8900 Fax +966 11 265 8999 South Africa – Johannesburg Baker & McKenzie Johannesburg 4 Sandown Valley Crescent Sandton, 2196 Johannesburg South Africa Tel: +27 11 911 4300 Fax: +27 11 784 2855 Spain - Barcelona Baker & McKenzie Barcelona S.L.P. Avda. Diagonal, 652, Edif. D, 8th floor Barcelona 08034 Spain Tel: +34 93 206 0820 Fax: +34 93 205 4959 Spain - Madrid Baker & McKenzie Madrid S.L.P. Paseo de la Castellana 92 Madrid 28046 Spain Tel: +34 91 230 4500 Fax: +34 91 391 5149 Sweden - Stockholm Baker & McKenzie Advokatbyrå KB P.O. Box 180 Vasagatan 7, Floor 8 Stockholm SE-101 23 Sweden Tel: +46 8 5661 7700 Fax: +46 8 5661 7799 Switzerland - Geneva Baker & McKenzie Geneva Rue Pedro-Meylan 5 Geneva 1208 Switzerland Tel: +41 22 707 9800 Fax: +41 22 707 9801 Transfer Pricing Handbook – Baker & McKenzie Offices Baker & McKenzie 479 Switzerland - Zurich Baker & McKenzie Zurich Holbeinstrasse 30 Zurich 8034 Switzerland Tel: +41 44 384 14 14 Fax: +41 44 384 12 84 Turkey – Istanbul Baker & McKenzie Istanbul Ebulula Mardin Cad., Gül Sok. No. 2 Maya Park Tower 2, Akatlar – Beşiktaş 34335 Istanbul Turkey Tel: +90 212 339 8100 Fax: +90 212 339 8181 Ukraine - Kyiv Baker & McKenzie - CIS, Limited Renaissance Business Center 24 Vorovskoho St. Kyiv 01054 Ukraine Tel: +380 44 590 0101 Fax: +380 44 590 0110 United Arab Emirates – Abu Dhabi Baker & McKenzie LLP - Abu Dhabi Level 8, Al Sila Tower Sowwah Square, Al Maryah Island P.O. Box 44980 Abu Dhabi United Arab Emirates Tel: +971 2 696 1200 Fax: +971 2 676 6477 United Arab Emirates - Dubai Baker & McKenzie Habib Al Mulla Level 14, O14 Tower Al Abraj Street, Business Bay P.O. Box 2268 Dubai United Arab Emirates Tel: +971 4 423 0000 Fax: +971 4 447 9777 Level 3, Tower 1 Al Fattan Currency House, DIFC P.O. Box 2268 Dubai United Arab Emirates Tel: +971 4 423 0005 Fax: +971 4 447 9777 480 Baker & McKenzie About our contributors Abreu Advogados Av. das Forças Armadas, 125 - 12. 1600-079 Lisbon – Portugal Tel: +351 21 723 18 00 www.abreuadvogados.com Abreu Advogados is one of the largest law firms in Portugal with over 300 people through offices in Lisbon, Porto, Madeira, Angola, Mozambique and EastTimor. Abreu assists a great number of clients in transfer pricing disputes, as well as with the preparation and/or review of transfer pricing files. Arntzen de Besche Advokatfirma AS Bygdøy allé 2 P.O. Box 2734 Solli, 0204 Oslo Tel: +47 23 89 40 00 www.adeb.no Arntzen de Besche has substantial expertise and experience in advising Norwegian and foreign clients on all aspects of domestic and cross-border tax matters. Attorneys at law Borenius Ltd Yrjönkatu 13 A FI-00120 Helsinki, Finland VAT FI01034608 Tel: +358 9 615 333 www.borenius.com Borenius is one of the leading law firms providing tax services in the Finnish market. Bech-Bruun Langelinie Allé 35 2100 Copenhagen Denmark Bech-Bruun is one of the leading law firms in Denmark providing advice on all aspects of corporate and commercial law. Matheson 70 Sir John Rogerson’s Quay Dublin 2 Tel: +353 1 232 2000 www.mop.ie Matheson is Ireland’s largest law firm and its leading tax practice has netted its practitioners significant transfer pricing experience. Your Trusted Tax Counsel.® © 2015 Baker & McKenzie. All rights reserved. Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a “partner” means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an “office” means an office of any such law firm. This may qualify as “Attorney Advertising” requiring notice in some jurisdictions. Prior results do not guarantee a similar outcome. Baker & McKenzie has been global since inception. Being global is part of our DNA. Our difference is the way we think, work and behave – we combine an instinctively global perspective with a genuinely multicultural approach, enabled by collaborative relationships and yielding practical, innovative advice. Serving our clients with more than 4,100 lawyers in over 40 countries, we have a deep understanding of the culture of business the world over and are able to bring the talent and experience needed to navigate complexity across practices and borders with ease. www.bakermckenzie.com