A recent decision by the Administrative Court in Košice, concerning the 2012 tax period, again highlighted inconsistent application practice regarding transfer pricing and highlighted the lengthy nature of tax audits and court decisions. Although the court confirmed the tax authority’s right to scrutinize transactions between related parties and use the institute of international information exchange, thereby indirectly approving the lengthy tax audits (in the given case, almost 6 years), it also emphasized the need for comprehensive justification of transaction aggregation and determination of dependency criteria when applying transfer pricing methods.
Since this is the first comprehensive judgment in Slovakia on transfer pricing, it can be seen as a step in the right direction towards building interpretative judicial practice on transfer pricing, in which Slovakia significantly lags behind that of, for example, the neighbouring Czech Republic.
Aggregation of transactions and joint evaluation with independent transactions
The Administrative Court in this case criticized the tax authority’s approach, which involved assessing all transactions of the taxpayer with related parties as one “combined transaction of performing production activities.” The court stated that individual assessment might be more appropriate, as it would provide a more detailed view of each transaction and its compliance with the arm’s length principle.
The court stated that the tax authority did not provide sufficient justification for choosing the combined approach and not assessing each transaction separately. The court emphasized that the tax authority must state in its decision why it preferred the combined approach over the individual one in the specific case. Additionally, it is important to note that, even when using the combined approach, the tax authority must precisely identify and quantify the price differences for each individual transaction that was part of the combined transaction. This is necessary to avoid double taxation and ensure the tax base adjustment is fair and reasonable.
The Administrative Court also criticized the tax authority for including transactions with independent parties in the combined transaction of performing production activities based on the existence of an outwardly dependent relationship founded on joint research and development with an independent party. The court stated that joint research and development does not constitute any of the legal criteria of dependency under the Income Tax Act, and the tax authority did not provide any justification for their interconnection.
Utilization of median value in tax adjustments by Tax Authority
As regards demonstrating the arm’s length principle, the Administrative Court focused on adjusting the profitability of the tax entity to the median value determined by a comparative analysis. According to the court, when adjusting profitability to the median value, the tax authority merely cited individual paragraphs of the OECD Guidelines without additional justification. The court’s decision implies that even if there is a need to adjust profitability, the tax authority cannot automatically adjust an entity’s profitability to the median value based solely on a citation of paragraphs from the OECD Guidelines, and additional justification is required.
Duration of a tax audit
The tax entity in the lawsuit also criticized the overall length of the tax audit, specifically the duration of its interruptions due to the use of the international exchange of information mechanism. The tax audit was interrupted for a total of more than 3 years, while the audit itself lasted almost another 2 years. However, the Administrative Court evaluated this objection as unfounded, as the tax authority requested information directly related to the tax audit using the international exchange of information mechanism. The court argued that the interruption of the tax audit to allow information exchange does not interfere with the private autonomy of the tax entity, since no obligations arise from the law as regards a tax audit for the entity during its interruption.
What does this ruling mean for you?
The Administrative Court stated that the use of non-legal and interpretative OECD documents (OECD Transfer Pricing Guidelines) without a clear connection to national legislation is not sufficient to justify the actions of the tax authority. The tax authority is required to comprehensively justify their conclusion and demonstrate that the transfer prices set between related parties do not comply with the arm’s length principle by reference to legally binding documents for taxpayers (laws, international treaties). Therefore, it remains questionable what change in practice the direct reference to the OECD Transfer Pricing Guidelines in the Income Tax Act from 2023 will bring, as according to a number of legal opinions, this reference does not change the nature of the Guidelines themselves and does not make them a source of law. Therefore, their binding nature for taxpayers remains questionable even after 2023 and following the above ruling.
We often encounter the aggregation of transactions and joint evaluation of profitability and transactions during tax audits, even with independent parties. Therefore, the court’s conclusion is a positive step in this regard, as it places higher demands on the argumentation of the tax authority. However, it also increases the demands on the argumentation of taxpayers, as taxpayers often use the aggregation of transactions themselves. Preparing transfer pricing documentation and preparing for a tax audit without a tax specialist thus becomes high risk for taxpayers given the above conclusions and requirements.
Moreover, the court’s decision confirms that despite the tax authority’s efforts to adhere to the principles of proportionality and speed of proceedings, the risk of lengthy tax audits remains. Taxpayers may be exposed to uncertainty for an unreasonably long time, especially in cases where the tax authority applies the international exchange of information mechanism.
How can PwC Slovakia help you?
At PwC Slovakia, we have the largest team of experienced professionals specializing in transfer pricing in Slovakia, who are ready to assist you with navigating the complexities of transfer pricing and minimising the associated risks.
Our services include:
- Support with setting and verifying transfer prices
- Preparation of transfer pricing documentation in accordance with current legislation and, most importantly, with experience from tax audits
- Representation in tax audits and disputes with the tax authorities
- Providing professional training and workshops
- Support with agreeing the transfer pricing method with the tax authorities
Don’t wait for a tax audit! Contact us today - we will be happy to assist you with your transfer pricing. If require more information on the ruling, get in touch one of our specialists, and we will gladly analyse and discuss its impact on your situation.
Contact us
