The tax administration uses several sources of internal and external information to assess transfer pricing risk. How do you find out whether you are a hot candidate for a transfer pricing audit? Based on publicly available sources and our department’s own practical experience, we have come up with this little test.
1. Have you reported losses in recent tax periods? Is your total before tax mark-up or profit margin relatively low or has declining tendency?
Long-term losses reported by a company with no change in its commercial policy may indicate that the company’s business activities do not reflect reality.
2. Does Part N of the notes to the financial statements only partially disclose related party transactions?
Incomplete information indicates either you want to conceal information or you are not paying enough attention to your transfer pricing policy.
3. Do you have significant related party transactions with an entity established in a low-tax country?
The more transactions and significant transactions you have with jurisdictions with a low or no tax rate, the greater the risk of profit shifting.
4. Do the aggregate royalties you paid to other members of the transnational group in the tax period exceed 5% of your turnover or 30% of your operating profit before subtracting them?
Royalties are a risk area because determining their amounts according to an independent principle is far more complicated than transactions involving goods or merchandise. It is also important to judge whether individual group members are receiving any economic gains from these royalties.
5. Do aggregate service charges you paid to other members of the transnational group in the tax period exceed 5% of your turnover or 10% of your operating profit?
Services are a significant cost item. If the amount paid for them is high, the taxpayer is at risk of allocated costs with no real economic benefit for the sole purpose of reducing taxable income.
6. Does aggregate interest paid in the tax period on borrowings from other members of the transnational group exceed 25% of your operating profit or is long-term debt more than 70% of your total financing?
The higher the percentage of long-term financing from intra-group lending, the more financially dependent you become on the group and the higher the probability of intervention in your transfer pricing policy
7. Do you have substantially lower profitability compared with industry averages or other members of the group?
Any deviation from sector averages can often mean transfer pricing has been adjusted and such a situation often times requires closer examination.
8. Has there been significant restructuring of your business during the tax period?
The impact of corporate restructuring can be extensive because profit potential is shifted between countries and this affects the amount of tax paid even in subsequent tax periods.
If you answered “yes” to at least two questions, transfer pricing documentation should be a priority in your business . Our international taxation specialists will be happy to advise you on preparing such documents.
