Transfer pricing under the microscope: How to prepare for tax audits and minimise risks?

The company VGD SLOVAKIA s.r.o. in cooperation with the Association of Industrial Unions and Transport held at the end of April a tax seminar on the topic Transfer Pricing Rules and Experience from Tax Audits in the Area of Transfer Pricing. Experts from the company VGD SLOVAKIA s.r.o., Frederika Totkovič and Peter Schmidt, shared their findings within the seminar dedicated to this issue. In the first block of the seminar they addressed the rules of transfer pricing, and in the second block the topic was tax audits focused on transfer pricing.

Developments in tax audits

Based on the information published by the Financial Administration, we see increased effort by the tax administrator in the area of transfer pricing. According to statistics for 2023, 81.3 %  of all audits in the area of transfer pricing were concluded with a finding. The sum of the identified shortcomings reached up to 105 million EUR, which is almost three times more than in the previous year, when the sum of findings was 33.8 million EUR. This trend points to the need for thorough preparation and caution by companies in order to avoid potential financial sanctions.

Given that the average amount of a finding per audit in 2023 represented more than 3.2 million EUR, it is clear that the consequences for companies can be significant. Therefore it is essential that companies be aware of the risks and pay due attention to the correct setting of transfer prices, as well as to comprehensive documentation that is in compliance with the applicable regulations and guidelines. This approach can significantly reduce the risk of negative financial impacts from tax audits.

The formal side of a tax audit

In a tax audit, it is first and foremost important that the company be able to sufficiently prove that the transactions it declared in the audited period were actually carried out. At the same time, it is essential that companies be able to prove that the declared transactions within the group were carried out for the purpose of achieving, securing and maintaining the company's taxable income. This fact is examined through the so-called benefit test. This test also verifies whether the audited company, under comparable circumstances and conditions, would be willing to pay an independent party for such transactions, or would carry out such an activity for itself.

The audited company must be able to properly prove the fulfilment of these conditions with evidence. Therefore, companies are advised to regularly archive evidence and various supporting materials. With such an approach, companies will avoid being unable to present evidence several years after the close of the audited period, whether due to its loss, damage or because of employee turnover.

In today's global economy, transfer pricing is an integral part of international trade. Slovak tax authorities have the right to examine companies' transactions in certain cases up to ten years back, in order to determine whether the prices were set in accordance with market conditions. Tax audits are usually concluded within one year, however, in the case of tax audits focused on transfer pricing it is possible to extend this period up to two years.

In a tax audit, it is up to the companies to prove that their transactions were not only real, but also economically justified. Transfer pricing documentation is the cornerstone of this evidentiary process. However, by itself it is not a guarantee of success. Tax authorities often use the transactional net margin method, which focuses on net profit and is less dependent on the comparability of products. This method, however, can complicate the determination of corresponding adjustments if a discrepancy with the arm's length principle is found. Double taxation is another risk that companies may face if the tax office applies different criteria in assessing individual transactions. Therefore the comparability analysis, although not always mandatory, is key to complete documentation. If the company's profitability is not within the range of market profitability, the tax office may proceed to an adjustment to the median of comparable values.

Good advice in conclusion

Based on our experience from practice, we recommend paying particular attention to the quality and scope of transfer documentation. Proactive steps and careful preparation can significantly influence the course of an audit, with correct documentation serving as a shield against possible sanctions. Maintaining good tax practices and transparency is the foundation for maintaining a positive relationship with the tax authorities and protecting the company's reputation.

If you need advice with transfer documentation, do not hesitate to turn to the team of experienced professionals in the area of tax consultancy from the company VGD SLOVAKIA s.r.o.

Source: APZD