Transfer pricing in 2022

In the Slovak Republic, the topic of transfer pricing is becoming more important as it is the subject of an increasing number of tax audits.

Transfer pricing is the process of pricing controlled transactions between related parties for tax purposes. The requirements of the tax authorities were clear, the pricing of transactions between dependants must be at arm’s length, i.e. on terms that the entrepreneur would have agreed with independent persons.

The objective of transfer pricing is:

• Preventing unnatural profit shifting between dependants;
• Influencing the amount of tax liability, where there is a loss to the state budget.

Transfer pricing legislation

In the legislation of the Slovak Republic, the controlled transaction is regulated by Act 595/2003 Coll. on income tax as a legal relationship or other similar relationship between two or more dependent persons, where at least one of the persons is a taxpayer with income according to § 6 or a legal person who earns taxable income (revenue) from an activity or from the disposal of property.

A lease from which income is derived pursuant to Section 6(3) shall not be considered a controlled transaction if the property is not classified as commercial property and the lessee is a natural person who uses the property for personal purposes.

In a controlled transaction, the actual content of the legal relationship or other similar relationship is taken into account. A transaction is a controlled transaction if it takes place between two dependants, which according to the Income Tax Act are:

• Loved ones;
• Persons economically or personally related;
• Otherwise related persons;
• Persons or entities that are part of the consolidated whole for the purposes of consolidation

Close person

The Civil Code defines a close person as a relative in the direct line, sibling and spouse, but also other persons in a family or similar relationship if the injury suffered by one of them would reasonably be perceived by the other as his or her own.

Persons economically or personally related

Under the Income Tax Act, an economic and personal relationship may be understood as a person’s participation in the property, control or management of another person or a mutual relationship between persons who are under the control or management of the same person or a close associate of the same person or in which the person or the close associate of the person has a direct or indirect property interest.

Other related persons

Otherwise connected persons or other connection means a relationship established between two persons, primarily for the purpose of reducing the tax base or increasing a tax loss. Where the relationship is not a close one, a person linked economically or personally, or persons who are part of a consolidated unit, if they are materially dependent, the tax authorities may also describe it as a relationship between dependent persons.

The concept of otherwise related persons has thus created a safe harbour for the tax authority , under which the tax administrator can also subsume the actions of persons who would otherwise not fall under the definition of dependants.

Persons or entities that are part of the consolidated whole for the purposes of consolidation

Persons belonging to a consolidated entity are interdependent. These are a group of subsidiary entities and their parent company, which is required to prepare consolidated financial statements for the group.
In practice, we may also encounter the frequently used term related or connected parties.

Conversely, we also refer to non-dependants as third parties or unrelated persons and parties.

Examples of a controlled transaction

An entrepreneur owns two sister companies, one of which shows a profit – Company A and the other a loss – Company B. Company B, the loss-making company, provides Company A with consultancy services. On invoicing for such services, Company A will reduce its tax liability to the tax authorities and, in turn, Company B will reduce its tax loss.

The above example transaction is carried out for the purpose of reducing the tax base and at the same time reducing the tax loss in the sister companies. Company A and B can be subsumed under the definition of dependants, namely persons belonging to the consolidated entity. Under the Income Tax Act, the above transaction would meet the characteristics of a controlled transaction and would therefore be subject to transfer pricing conditions. And it would probably also meet the elements of the offence of tax and insurance fraud.

Another frequently occurring example might be the following:

An individual who is a shareholder and director in a company “puts” money into his own company, i.e. gives his company an interest-free loan.

A shareholder who has more than 25% shareholding in the company is a close person according to the above criteria and thus, the company will have to pay market interest on the loan as if the money had been given to it by a bank or an independent person.

Transfer pricing documentation

Transfer documentation is regulated by the Guideline of the Ministry of Finance of the Slovak Republic No. MF/014283/2016-724 on determining the content of documentation according to § 18 para. 595/2003 Coll. on income tax (hereinafter referred to as the “Guideline of the Ministry of Finance of the Slovak Republic”).

In the transfer pricing documentation, businesses shall demonstrate whether the controlled transactions meet the conditions that would be agreed between arm’s length parties and, therefore, that the transaction was carried out in accordance with the arm’s length principle. The definition of this principle can be found in the Income Tax Act as follows: “The arm’s length principle is based on a comparison of the terms agreed in controlled transactions between related parties with the terms that would have been agreed between related parties in comparable transactions in comparable circumstances in the relevant periods.”

Types of transfer documentation

There are three types of transfer documentation:

• Full documentation;
• Basic documentation;
• Abbreviated documentation.

The obligation to keep transfer pricing documentation in the scope of complete documentation is imposed on entrepreneurs who, according to the Guideline of the Ministry of Finance, carry out selected transactions, especially significant transactions with a cross-border element or transactions where a special procedure is applied. The obligation to keep full documentation applies to:

• taxpayers that report profit or loss in their separate IFRS financial statements (with certain exceptions) in relation to significant cross-border controlled transactions;
• taxpayers involved in a cross-border controlled transaction with a value of more than EUR 10 million EUR 10 per tax period;
• taxpayers who carry out significant transactions with dependants who are taxpayers of a non-Contracting State (i.e. in particular tax havens);
• taxpayers involved in controlled transactions for which they request the tax administrator to issue a decision on the approval of the valuation method;
• taxpayers claiming secondary treatment for a controlled transaction under international tax treaties;
• taxpayers who have controlled transactions for which a request has been made to initiate a dispute resolution mechanism under an international tax treaty;
• taxpayers claiming tax relief in the tax year in respect of significant cross-border controlled transactions.

Basic documentation

In other cases, the taxpayer is obliged to keep basic documentation on:

• cross-border controlled transactions with an annual value of more than CZK 1 million EUR;
• insignificant transactions with dependants who are taxpayers of a non-Contracting State (i.e. mainly tax havens);
• significant cross-border controlled transactions in respect of a taxpayer with total economic and financial activity income for the tax period exceeding EUR 8 million. EUR;
• significant domestic controlled transactions, if the taxpayer claims a tax credit.

The contents of the complete and basic documentation shall include all facts that affect the valuation of those controlled transactions.

Abridged documentation

If neither complete nor basic documentation is prepared for a controlled transaction, the taxpayer shall maintain at least abbreviated documentation, which shall be completed in the prescribed structure issued by the Ministry of Finance, except where proper disclosure of the controlled transactions in the income tax return is sufficient. Should the taxpayer fail to disclose the controlled transactions in the tax return, the taxpayer is obliged to prepare abbreviated documentation on these transactions.

Transfer pricing methods

In selecting a transfer pricing method, the taxpayer shall select a method whose use is consistent with the best method principle. Transfer pricing methods are defined in § 18 para. :

• methods based on price comparisons (arm’s length method, subsequent sales method, mark-up method);
• methods based on profit comparisons (profit split method, net trading margin method);
• methods that are a combination of price-comparison and profit-comparison methods;
• other methods not listed in the preceding points, if their use is consistent with the principle of an independent relationship.

PenaltiesIfan entrepreneur fails to comply with any of his obligations under the transfer pricing conditions, the tax authority may impose a penalty during a tax audit.

The most common fines imposed include:

• penalty for failure to increase the income tax base;
• fine for failure to produce transfer documentation;
• a penalty for an unjustified corresponding adjustment of the tax base.

Penalty for failure to increase the income tax base

The adequacy of the amount of the failure to increase the tax base shall be assessed in the case of a penalty for failure to increase the tax base. If the taxpayer fails to increase the tax base, a penalty for failure to increase will be imposed and the tax authority will also increase the tax. The amount of the penalty is 3 times the ECB interest rate per annum on the amount, or 10% per annum of the amount assessed . Pričom platí, že čím neskôr je daňová kontrola, tým vyššia je aj pokuta.

Penalty for failure to draw up transfer documentation

A penalty for failure to produce the transfer documentation will be imposed on the taxpayer if he fails to produce the transfer documentation within 15 days from the date of receipt of the notice. The maximum amount of the fine is EUR 3 000.

Penalty for unjustified corresponding adjustment of the tax base

The taxpayer may make a corresponding adjustment to the tax base only in certain

in the case of domestic transactions, if carried out by another dependent person, and in relation to foreign transactions, after prior authorisation by the tax authority. A breach of any of the above rules shall be deemed to be an unjustified corresponding adjustment of the tax base. If the tax authority finds a breach of the rules during the tax audit, it shall impose an increase in tax on the taxpayer and impose a penalty of 3 times the ECB base rate, similar to the case of a non-adjustment of the tax base.

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FAQ

Question – granting a loan

An individual who is a shareholder and director in a company “puts” money into his own company, i.e. gives his company an interest-free loan. Is this type of contribution subject to an adjustment of the taxable amount by the interest on the loan at the rate of interest normally charged by banks in the market?

Answer:

No, as the interest on the loan constitutes income from the capital assets of an individual for which no taxable amount is shown under Sections 17 to 29 of the Income Tax Act.

Question – supply of business-to-business services

Both spouses carry out business activities on the basis of a trade licence. They provide services to each other on the basis of invoices. They are accounting units. Are these entrepreneurs subject to transfer pricing and tax base adjustment?

Answer:

As the taxpayers are taxpayers carrying out business activities and are close persons, their business transactions are covered by the provision of Section 17 para. 5 of the Income Tax Act. On this basis, it is necessary for each spouse to keep separate documentation on the significant controlled transaction in the scope specified by the guidance of the Ministry of Finance, i.e. abbreviated documentation. If the use of different prices or terms in this controlled transaction results in a reduction of the tax base or an increase in the tax loss of the individual, then the individual will be obliged to adjust the tax base pursuant to section 17(1)(a) of the ITA. 5 of the Income Tax Act.

Question – rental property

An individual who is a partner and managing director in the company has entered into a lease agreement with the company to lease the property for business purposes. The income from the rental of the property is taxed by the natural person in accordance with Art. 3 of the Income Tax Act. The provisions of Section 17(1)(a) of the Act apply to this individual. 5 and 18 of the Income Tax Act?

Answer:

The lease of immovable property between an individual and a legal person who are dependants is a controlled transaction between persons who ascertain the taxable amount pursuant to Sections 17 to 29 of the Income Tax Act, and therefore the provision of Section 17(1) of the Income Tax Act applies to such persons. 5 as well as Section 18 of the Income Tax Act.

Question – sale of movable property

An individual, not a businessman, sells his brother a passenger car for less than the normal market price. As this is a transaction between close persons, is the individual liable to pay the difference in price from the sale of the car on his income tax return?

Answer:

As this is a business transaction between close persons who are natural persons who are not entrepreneurs, and the income from the sale of the car falls under other income taxed under Section 8 of the Income Tax Act, the procedure under Section 17(1) of the Income Tax Act does not apply to this business transaction. 5 of the Income Tax Act.

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