Valuation techniques, or the so-called “sixth method”

The methods used to verify the transfer price are indicated in Article 11d of the CIT Act, i.e.:

1. the comparable uncontrolled price method,
2. resale prices,
3. cost-plus,
4. net transaction margin,
5. profit sharing.

However, taxpayers are not obliged to use only the above-mentioned methods when verifying transfer pricing. If it is not possible to apply any of the above five methods, another method (including valuation techniques), which is most appropriate under the circumstances, may be applied. That is, the so-called “sixth method”.

If a valuation technique has been used as another method, it should be borne in mind that the Transfer Pricing Ordinance, which entered into force on 1 January 2019, explicitly indicates how the valuation technique is to be applied. Thus:

• where the application of a valuation technique requires the analysis to be based on forecasts, forecasts prepared for financial planning purposes shall be used first;
• the volumes or ratios used in the valuation technique should correspond to market value;
• where the correct application of the valuation technique requires the use of a discount factor:

1. 1. the choice of discount factor takes into account how the valued object of the controlled transaction generates cash flows,
   2. the amount of the discount factor takes into account the level of business risk of the related party and the level of volatility of the future cash flows generated by the controlled transaction being valued;

• the analysis takes into account the level of value expected by each party to the controlled transaction.

Often, the valuation technique is applied to transactions involving the sale of shares, share capital increases, the sale of intangible assets or real estate. For such transactions, taxpayers often turn to valuations done by an expert. But is this sufficient for transfer pricing purposes? In this case, the valuation made by an independent valuer should be subject to appropriate verification by the taxpayer.

Bearing in mind that valuation techniques are commonly used to value different types of assets, the legislator in the Regulation on corporate income tax transfer pricing documentation has indicated what information must be included in the description of the analysis based on this method, viz:

• the rationale for the choice of valuation technique used,
• description of the data sources used for the valuation,
• a description and justification of the assumptions made in the valuation, in particular the assumptions made about the ratios used in the valuation and a description of how these ratios were calculated,
• a description and justification of the assumptions made for the forecasts, a description of the source of the data used and an indication of the purpose of the forecast – if the use of a valuation technique requires the use of a forecast,
• a sensitivity analysis indicating the impact of changes in individual assumptions on the valuation result,
• justification of the point adopted from the range of the value of the subject of the controlled transaction.

Taking into account the obligatory elements indicated by the cited legislation, the taxpayer should always verify the valuation in his possession, prepared by an expert, against the transfer pricing requirements.

Independent valuation and potential tax audit

Counter-intuitively, simply having a valuation prepared by an independent valuer may not be sufficient to comply with transfer pricing obligations. Thus, situations may arise in which the tax authority may challenge the application of the independent valuation held. A correct valuation should indeed prove that the value of the transaction carried out between related parties is arm’s length, i.e. in accordance with the arm’s length principle.

In order to prepare for a potential tax audit, the taxpayer should pay attention to whether the prepared valuation contains, inter alia, adequate argumentation proving the marketability of the transaction.

Conclusions

The possibility of applying the so-called “sixth method” provides some simplification for taxpayers, but one must bear in mind the issues related to the provisions defining the manner of application of the method in question. The taxpayer should remember to verify any valuations held against the mandatory information that must be included in the description of the analysis for transfer pricing purposes.

Having a valuation prepared by an independent valuer, it should be checked whether it meets the formal conditions set out by the transfer pricing regulations and can constitute a transfer pricing analysis on its own, which (with few exceptions) is a mandatory element of transfer pricing documentation. It is the taxpayer’s obligation to present arguments confirming the marketability of the transaction in the transfer pricing analysis. The same principle applies when applying the so-called “sixth method”.