Robust Transfer pricing analysis and documentation

Following the first comprehensive ruling on transfer pricing in Slovakia, which we informed you about in October 2024, two additional relevant decisions by Slovak courts were published at the end of 2024. The transfer pricing landscape has been shaped by the interpretation of judges by these rulings, as in neighbouring countries, and has set new standards for transfer pricing assessments and underlines the importance of thorough documentation and demonstrating compliance with the arm’s length principle.

Case No. BA-1S/111/2019

In the first case, the Administrative Court in Bratislava (Decision No. BA-1S/111/2019 issued on August 9, 2024) ruled in favour of the taxpayer, thereby overturning the decision of the Slovak Financial Directorate regarding the levied tax. The Administrative Court identified a number of shortcomings by the tax authority and emphasized the need for a more precise application of the arm’s length principle in transfer pricing. The court’s decision highlights the importance of the completeness and correctness of the comparability analysis (benchmark) as part of an appropriately selected transfer pricing method. It therefore emphasizes the need for a high-quality transfer pricing analysis for taxpayers and the tax authorities, since general and insufficiently substantiated arguments and claims are insufficient in court.

Key findings of this ruling:

• Selection of the appropriate method
  The tax authority objected to the use of the profit split method and applied the transactional net margin method (TNMM) during the tax audit as a more appropriate method for evaluating a contract manufacturing transaction, resulting in an additional tax liability. The taxpayer only kept simplified documentation, which did not include a functional and risk analysis. Therefore, the tax authority conducted its own analysis, which led it to classify the taxpayer’s profile as a manufacturer with limited functions and risks, and selected the TNMM as the more reliable method.
  
  To avoid the risk that the tax authority applies a different transfer pricing method due to insufficient documentation (and the lack of a functional and risk analysis), and thus reach a different conclusion or levy additional tax, we recommend preparing at least basic documentation with a thorough functional and risk analysis.

• Comparability analysis
  The Administrative Court emphasized that the comparability analysis, in addition to the functional and risk analysis, must assess other aspects, i.e. the comparability factors, which include the agreed contractual terms, the economic environment of the market, and the business strategy. Based on this principle, the court objected to the comparability of the companies in the comparability analysis prepared by the tax authority in the following key areas:
  • Independence of comparable companies
    The Administrative Court criticized the fact that the tax authority had not sufficiently examined the independence of the companies and thus included companies that were personally connected.
    
    As a result of this decision, it is necessary to identify all connections between the entities in a comparability analysis, focusing also on the personal connection between the compared entities. Therefore, we recommend independently verifying whether the companies included in a comparability analysis are truly independent and not relying solely on the independence criterion listed in the external database.
  • Exclusion of loss-making companies
    The Administrative Court decided that it is incorrect to automatically exclude loss-making companies from a comparability analysis based solely on their negative financial results and such an approach does not eliminate potential differences between the controlled and independent transactions.
    
    The court made it clear that loss-making companies may be comparable in certain cases, even in the context of contract manufacturing, especially if there are legitimate business or economic reasons for the losses incurred and if there are no differences in functions and risks between the comparable and the tested contract manufacturer.
    
    This allows taxpayers to include loss-making comparable companies, but only provided that there is a high-quality analysis ensuring that such a loss-making company is truly comparable in all respects.

Case No. 2Sfk/36/2023

In the second case, the Supreme Administrative Court of the Slovak Republic (Decision No. 2Sfk/36/2023 issued on September 24, 2024) ruled against the taxpayer and dismissed its cassation appeal. The court’s decision highlights the importance of demonstrability and adequate documentation when claiming tax deductions for management and technical services, emphasizing the burden of proof of the taxpayer.

Key findings of this ruling:

• Benefit test for management and technical services
  The tax authority questioned the tax deductibility of the management and technical services due to lack of proofs of the scope and nature of the services provided. The court ruled that formal documents (invoices, contract) are not sufficient to prove the substance and outputs of the services and their link to the company’s business activities.
• Burden of proof
  The court confirmed that the burden of proof lies with the taxpayer, who must be able to demonstrate the genuine nature of services and justify their tax deductibility. General and unclear evidence can lead to a successful challenge by the tax authority. The case emphasizes that for tax deductibility, proper documentation and a clear link to the business activity is crucial.

What are the potential consequences and risks of these rulings for your company?

The newly published court decisions clearly show that the requirements for a high-quality analysis and arguments when defending transfer pricing are increasing, both for the tax authority during a tax audit and for the taxpayer. A superficial or generic analysis can therefore have serious consequences for taxpayers, including an additional tax liability, penalties, and disputes which will often end in favour of the party that has not neglected the analysis.

Key areas you should focus on regarding transfer pricing and documentation:

• Thorough functional and risk analysis: Identify and document the functions, assets, and risks of individual entities within the group.
• Selection of the appropriate transfer pricing method: Choose a method that best suits the specifics of your transaction and is in line with the arm’s length principle. Remember to provide thorough justification for any aggregation of transactions.
• Careful selection of comparable entities: Thoroughly analyse comparable companies and transactions, paying close attention to comparability criteria and personnel connections.
• High-quality transfer pricing documentation: Prepare comprehensive and comprehensible documentation that transparently justifies your transfer prices and is built on strong supporting arguments.
• Documentation and demonstration of services: Do not rely solely on service contracts and invoices. It is essential to prove the scope, nature, and benefits for the taxpayer. It is also key to demonstrate the outputs of the service purchased by the taxpayer with relevant evidence, such as time reports, project reports, or other outputs.

How can PwC Slovakia help you?

PwC Slovakia is ready to help you adapt to the increased demands and ensure that your transfer pricing is compliant with current regulations and court decisions. We offer the following services:

• Design of transfer pricing methods for new transactions: We will help you identify, analyse, and set-up transfer prices in accordance with applicable legislation and current case law.
• Preparation and review of transfer pricing documentation: We will ensure that your current documentation meets all legal requirements and provides sufficient evidence of compliance with the arm’s length principle, or we can prepare documentation from scratch.
• Representation in tax audits and disputes: We will provide you with expert assistance and our very extensive experience during tax audits and in any disputes with the tax authority.

Be sure not to neglect the potential risks and take the opportunity to optimize your transfer prices that these rulings bring. Don’t hesitate to contact us at any time if you require our assistance. Our extensive team of transfer pricing specialists is ready to help you.