Planning, rather than mere compliance, is the essence of transfer pricing

For most taxpayers, transfer pricing is associated with numerous and complex formal requirements that must be met within a specified deadline, under the threat of escalating and increasingly severe sanctions. But what if we approached the issue of market conformity of transactions differently?

The established pattern

Among the majority of taxpayers, we often observe the following mechanism after the end of the tax year:

• verification of the value of transactions with related entities is conducted,
• a compilation of transactions exceeding statutory thresholds is prepared,
• opportunities for exemptions are reviewed,
• ultimately, for transactions subject to documentation requirements, transfer pricing documentation and analysis are prepared.

In other words, taxpayers frequently do not analyze the course and verify the market conformity of transactions for which they are not formally required to prepare documentation and transfer pricing analysis. For those transactions subject to this obligation, they typically do so after the end of the tax year.

Market conformity applies to all

It is important to note that, in accordance with income tax regulations, related entities are obligated to establish transfer prices on terms that unrelated entities would have agreed upon. If, as a result of existing relationships, conditions are established or imposed that differ from those that unrelated entities would have agreed upon, leading the taxpayer to declare lower income (or higher loss) than would be expected if such relationships did not exist, the tax authority determines the taxpayer’s income (loss) without taking into account the conditions arising from these relationships. In such a situation, when determining income/loss, the authority considers the actual course and circumstances of the conclusion and implementation of the controlled transaction, as well as the behavior of the parties involved in this transaction.

Importantly, the regulations do not differentiate between the application of the most important principle—the arm’s length principle—and the transaction value. The principle applies to all transactions between related entities, even those below statutory thresholds. From our experience, tax authorities scrutinize and question the settlements of individual transactions independently of documentation requirements. Moreover, authorities may also request the preparation of documentation for transactions that they find particularly risky.

Alternatively… starting from the end

The documentation and reporting obligations determined by the annual transaction value are one aspect, while ensuring the market conformity of transactions is another. Therefore, to ensure that each transaction between related entities is conducted in accordance with the arm’s length principle, it is not advisable to wait until the stage of verifying and fulfilling documentation and reporting obligations. The key is early and proper planning of the transaction’s course and the establishment of market conditions. A detailed and comprehensive analysis of functions, assets, and risks appropriately allocated between related entities—the parties to a given transaction—is essential for the accurate determination of the calculation method for compensation and its amount. It also allows for the preparation of documents that form the formal basis of the transaction in line with its actual and market-driven course.

A good, albeit somewhat marginalized, way to plan and control transactions with related entities is to prepare a transfer pricing policy that includes all transactions (not just those exceeding statutory thresholds). Despite the lack of a requirement to have such a policy or specific content requirements, our experience indicates that a brief description justifying the inclusion of a transaction, a description and allocation of functions, assets, and risks, an explanation of the remuneration calculation method, the application of adjustments, and verification of market conformity serve as valuable tools for defense during potential audits. The policy ensures consistent principles for all transaction parties, which is also important from a tax security perspective. Magdalena Dymkowska and Marta Klepacz discussed the reasons why having a transfer pricing policy is valuable in a podcast available at the provided link.

An essential element in ensuring the market conformity of settlements in all transactions between related entities is the use of high-quality benchmarks. The quality is as crucial as the timing of their preparation, and the principle here is simple – the earlier, the better. Compiling a comparative analysis during the transaction planning stage or at the beginning of the year provides a robust basis for determining the market level of remuneration and ensures confidence that the transaction is conducted on market terms from the outset. Possessing an up-to-date and well-prepared ex ante analysis is always a significant advantage in disputes with authorities questioning settlements with related entities. Agnieszka Walska and Adrian Mroziewski also explain this well in their discussion available at the provided link.

First planning, then obligations

We encourage taking a comprehensive and proactive approach to transfer pricing and the market conformity of transactions. Regardless of statutory formal requirements, let’s look at transfer pricing from a different perspective—not just as another set of obligations to fulfill within deadlines but as a means of safeguarding against potential challenges to the market conformity of transactions or even as a foundation for determining/changing transaction terms.

Properly planning the terms and course of a transaction, as well as verifying the market conformity of remuneration at the beginning of the year, also facilitates the fulfillment of transfer pricing documentation and reporting obligations after the end of the year. In a situation where, after the year ends, it turns out that a particular transaction exceeds the statutory threshold and is subject to documentation and reporting obligations, preparing the local file based on the current transfer pricing policy and comparative analysis prepared ex ante will be a straightforward formality!

We understand that the beginning of the year is a time to take a break from transfer pricing after a busy end of the year. But what if we changed the order—put in more work at the beginning of the year to properly plan transactions? Perhaps the end of the year wouldn’t be such a documentation and reporting marathon? For those of you wondering if it’s possible, we assure you it is! We work with clients who have been diligently maintaining an up-to-date transfer pricing policy and comparative analyses prepared during the transaction planning stage or at the beginning of the year. As a result, the end of the year is not a surprise for them, and they submit the TPR-C form confidently and often as one of the first.