Risk of losing PGK status for non-arm’s length transfer prices

Remuneration in transactions between related parties should be determined on an arm’s-length basis: on such terms as third parties would determine between themselves. Otherwise, in the event of an audit, their arm’s length nature is expected to be challenged.

The most common risk is that the authorities will consider that there has been an understatement of income and will then overestimate tax due. However, there are some less obvious consequences. One of them, concerning tax capital groups (PGKs), has been addressed in a recent Supreme Administrative Court ruling.

What was the dispute about

A PGK entered into controlled transactions with related parties not belonging to it. After the end of the fiscal year, the group would verify whether the transfer prices applied were outside the range established in the benchmarking analysis (despite due diligence). If this occurred, it planned to make the adjustment under general rules (i.e. recognize it in the current accounting period, not in the period to which the adjustment applies) and pay the tax arrears plus interest. The taxpayer wanted to know if it would not lose its CIT status in such a case, since according to Article 1a(2)(3)(b) of the CIT Law, if a PGK enters into transactions with related companies outside of PGK on other than market terms, it risks losing its CIT status. The PGK has requested an individual interpretation from the tax authorities.

The authority disagreed with the party’s standpoint. It stated that if the remuneration in transactions with related parties from outside a PGK deviated from arm’s length conditions, the group automatically loses its status as a CIT taxpayer. The fact that PGK has taken corrective measures (both on its own initiative and during the audit) is irrelevant. It should be noted that making adjustments (both under general rules and transfer pricing adjustments under Article 11e of the CIT Law – we explained the differences, among others, in this post) during and after the end of the tax year is a common practice in the market.

The case went to the Voivodeship Administrative Court which agreed with the taxpayer. It concluded that a controlled transaction includes subsequent changes in its terms, including adjustments to transactions and tax settlements. Therefore, the PGK status should not be lost.

The authority filed a cassation appeal and the case went to the Supreme Administrative Court (NSA), which disagreed with the court of first instance and upheld the authority’s position. The NSA stated that if the controlled transaction differs from the terms set by third parties, a PGK loses its status as a CIT taxpayer. The court underlined that entities forming a PGK must expect certain conditions to be met. In addition, none of the participants in the proceedings pointed to the existence of separate provisions governing transfer pricing adjustments (Article 11e of the CIT Law). Reference was made to adjustments under general rules only.

Points to remember

Transfer prices set on non-arm’s length terms trigger a number of risks, including less obvious ones, such as the loss of CIT status for a PGK. Taxpayers should therefore pay special attention to preparing reliable benchmarking analyses that serve as the basis for setting remuneration within the capital group. It is a good idea to have a qualitative analysis even before the transaction is made: verifying arm’s length nature retrospectively can lead to unpleasant surprises.

Before applying remuneration adjustments in transactions with related parties, you should consider whether to do so under general rules or under separate transfer pricing adjustment regulations. The topic is unclear and often raises doubts not only for taxpayers, but also for authorities and courts. Thus, it is worthwhile to thoroughly analyze and consult a given case before making an adjustment.