Draft new transfer pricing rules – comment

Mid-July 2018 for public consultation, a draft law amending the Income Tax Act on Transfer pricing was submitted[1]. This project is an attempt to redefine the rules for the application of transfer pricing, which envisages repealing the existing rules on tax documentation, as well as the rules for the estimation of revenue and introducing new rules, in a more coherent and transparent way.

Introduction

The draft provides that in each income tax bill 2 a new chapter on transfer pricing will be included in its entirety. To develop a new regulation, which is cited by the authors in the justification of the project 3 , there is simplification of tax rules and reduction of bureaucratic and administrative burdens. In this article, we present what changes are foreseen in the new draft, taking into account the results of the public consultation, as at the beginning of September 2018.

Definition of transfer price, determination of links

Time and Time first It is proposed to introduce a transfer price definition to be understood as a financial result of the conditions applied as a result of existing links. A new way of defining related entities was also proposed by the concept of having a significant impact on another entity.

Under this concept of significant impact, both the existing capital and management-control links have been identified, the family relationship has been clearly identified, and the existence of the link will be determined by the actual ability of a natural person to have an influence on the entity's key decisions.

In the margins, it is worth mentioning that the draft changes to the capital link indicate that such links are also generated by units and investment certificates, which means that new regulations will include, inter alia, closed investment funds.

The project also addressed the issue of indirect link, indicating that such link would be created through one or more entities, which in practice would imply examining indirect links at multiple levels/levels in the structure of a group of related entities (including a ‘sum of indirect shareholdings or rights’)[4].

This obligation may be particularly burdensome from the perspective of local companies/entities operating in large groups which do not have such information.

In terms of terminology, it has also been proposed to introduce the concept of "controlled transaction", replacing the currently existing and causing numerous differences in interpretation of "transaction or other events".

New way of identifying transactions subject to a documentation obligation

one of the key proposed changes is a new way of identifying transactions subject to the documentation obligation. The project proposes moving away from the recently introduced (only applicable 1.5 (year) a system based on a two-step survey, in which the size of the entities was first determined and the value of the transaction was subsequently examined.

According to the new project, the determination of the transactions for which the local documentation is to be drawn up will be based on an examination of the value of the transaction between related parties, which should be eligible for one of 10 the categories of transactions defined by the legislator.

Proposed two the materiality thresholds:

• - 2,000,000 PLN – for transactions in the following categories: intangible assets, services, fixed assets (including leases, leases), assignment of income to a foreign establishment and other transactions,
• - 10,000,000 PLN – for transactions in categories: tangible assets, fixed assets, debt financing, guarantee and guarantee[5].

The thresholds above should be set individually for sales and purchases.

As reported in the justification for the project, the thresholds are set separately for each transaction controlled within each category, meaning that within the one the categories will be allowed to group into types of transactions. Consequently, the values of the various transactions controlled under the one the categories should refer separately to the threshold indicated for the category of transaction.

For the purposes of setting the threshold for financial transactions, it is clear that the threshold 2,000,000 PLN reference should be made to the value of the financing (i.e. the value of the capital provided in the case of loans) or the value of the guarantee sum in the case of guarantees/guarantee transactions.

It was pointed out that the net value of transactions should be referred to all new thresholds, i.e. without including tax on goods and services.

It is provided that, when determining the value of transactions, account should be taken together of the value of all homogeneous transactions, regardless of the number of accounting documents, payments made and the number of connected entities with which the transaction is carried out.

The examination should be carried out in succession on the basis of invoices, and where invoices are not available on the basis of contracts or other documents, and lastly on the basis of payments made.

The requirement to have group documentation is intended to apply only to taxable persons who operate in groups that produce consolidated financial statements in which consolidated revenues have exceeded 200,000,000 PLN.

Elements of local and group documentation

The general list of elements to be included in the tax documentation is to be substantially reduced, each of which is to consist essentially of four Main parts 6 : In the case of local documentation, the following shall be considered:

• 1) a description of the related entity;
• 2) a description of the transaction;
• 3) a transfer pricing analysis, including: a benchmarking analysis or an analysis demonstrating the conformity of the conditions under which the controlled transaction was concluded, with the conditions that would be determined by unrelated parties;
• 4) financial information.

For group documentation:

• 1) a description of the group of related parties;
• 2) a description of the material intangible assets of the related party group;
• 3) a description of the material financial transactions of the group of connected entities;
• 4) financial and tax information of a group of related entities.

The detailed scope of the elements of both types of documentation is to be laid down in the Regulation of the Minister for Public Finance. It is therefore still unclear to what extent the assumption of simplifying the content of tax records will become realistic in practice.

Under the new rules, group documentation may be drawn up in a foreign language, according to the proposed provision, if the group documentation is drawn up in English, the obligation to translate it into Polish may be imposed on the taxable person by the authority in compliance with the deadline. 30 days from the date of service of the call.

Time limits and declarations

As regards reporting obligations, it was proposed to replace the obligation for taxpayers to report CIT /TP or PIT /TP by reporting transfer prices in electronic form (TP-R). This would be the information provided by taxpayers obliged to draw up local documentation to the Head of KAS on the actual transfer prices applied.

The draft law adopted that it would continue to be compulsory to make a declaration of the drawing up of documents (signed by the persons authorised to represent the entity), with the extension of the deadline applied this year on an exceptional basis from 3 months to 9 months after the end of the financial year will become the basic rule – the time limit for submission of a declaration confirming the drawing up of the local documentation is to be 9 months after the end of the financial year.

Current deadline 7 days to submit local documentation from the date of receipt of the request from the tax authority; and 30-the day-to-day time limit for documents to be drawn up at the request of the authority to the transactions identified by the authority.

As far as group documentation is concerned, the project requires the document to be attached to the local documentation by the end of time 12. one month after the end of the financial year. It is also a new obligation to submit group documentation to the Head of KA S, which is to concern taxpayers covered by CBC-R procedures under the Tax Information Exchange Act with other countries.

The proposed amendment also includes the introduction of a list of transactions which will be exempted from the obligation to prepare local transfer pricing documentation. Such transactions shall include:

• - transactions between entities whose relationship arises solely from links with the State Treasury or local government units;
• - transactions the value of which, in its entirety and permanently, does not constitute income or the cost of obtaining income;
• - transactions in which the price has been fixed by open tender[8].

How will the authority control the transaction price, what rules should the taxpayer apply when setting the price with the related entity?

The basic rule authorising the tax authority to determine the taxpayer's income or loss is to remain in a similar formula, but it is clear that when examining market conditions, the tax authority can determine whether the related entities have not carried out the transaction at all or would have carried out another transaction under certain circumstances.

As far as the methodology of the tax authorities is concerned, the proposed novelty is the opening of a directory of methods, because in addition to five so-far known in the Polish legislation, the so-called ‘tax method’ has shown that the transfer price is determined by another method, if this method results in the transfer price being determined by related parties. This other method would only be used if the application of five tax methods would not be possible[9].

The way in which the new rules are formulated has far-reaching implications not only for the methodology of the tax authorities to verify transactions with taxpayers, but also for taxpayers themselves at the price setting stage in transactions with related parties.

The basis of the solution to date is that the so-called "tax methods" are mandatory for tax authorities, for the purpose of setting the price at the control stage.

A taxpayer cooperating with associated entities may set prices in its transactions by any method which it uses in its business practice, and the so-called ‘tax methodologies’ serve verification purposes; the application of tax methods by the taxpayer also obliges the tax authority to apply the same method during the verification of transactions.

However, the new provisions used by the legislator in the draft legislation, ‘The related entities are obliged to set transfer prices (...)’ and then ‘The transfer prices shall be determined using the following methods: (...)’ means that the provision is also addressed to taxpayers.

The consequence of leaving the provisions in the proposed form would be to require taxpayers to set prices by tax methods already at the stage of the calculation of the transaction at the time of its conclusion, in any case of transactions between related parties.

This is not only a very difficult solution for their operation, but in many cases even impossible to apply in practice.

It was indicated that the most appropriate method should be used in the circumstances in question, including a different method or valuation technique, but the grounds for determining these circumstances are defined fairly broadly.

On the other hand, the use of another valuation method or technique would be allowed only if the application of any of the five tax methods are not possible.

It is therefore not sufficient for this "other method" to be more appropriate than tax methods, it is necessary to comply with the condition that it is not possible to apply other methods, which means the risk of long-term and complex disputes with the tax authority as to the rightness/inadequacy of applying a given method, which is very large with such a solution.

The obligation of the tax authority to apply in principle First, the method adopted by the related party.

Transfer price adjustments

Another novelty is the regulation on the adjustment of transfer prices, which can be applied by the taxpayer when, during the tax year, significant circumstances affecting pre-established conditions would change.

The possibility of correction is provided for taxable persons conducting transactions with both national related entities and entities from countries with which Poland has concluded agreements on the exchange of tax information, with adjustments to be made before the deadline for the submission of the annual tax return and subject to a statement from the related entity to apply the correction of the same amount[10].

The timing of the adjustment of transfer price adjustment was also clarified, providing that such adjustment should be recorded during the reference period concerned and not during the period when the correction invoice was issued.

Simplified solutions

The draft amending law also includes proposals for simplified solutions in which the taxpayer, after complying with the proposed remuneration framework, will be sure that the tax authority will not assess the market value. Safe Harbour solutions apply to two, the following types of transactions.

After first, in the case of loan transactions, it is provided that the Minister responsible for public finance will publish a notice containing the types of base rate and margins. If, in a loan transaction with a related entity, the taxpayer applies this level of interest, with the sole form of remuneration, the loan will be granted for a maximum period of time 5 years, the total loan liabilities will be no more than 20,000,000 PLN and the loan does not come from a tax haven, the taxpayer will be able to ensure that the tax authority does not verify its loan contracts[11].

In the case of low value added services transactions, the tax authority will not verify the amount of the charge at all if it is not more than 5% costs, provided that the calculation is done by cost plus or MTN, the recipient will have a complete calculation of generic costs and a description of how the allocation keys are used (for all related entities using the service).

Summary

The key question in the face of such far-reaching changes is – when will they start to apply? The entry into force of the amending law is currently foreseen on the day 1 January 2019, with the moment of mandatory application of the new rules determined by the prism of revenue obtained after 31 December 2018 For transactions that started before 31 December 2018 and continue In 2019, in accordance with the transitional provision, new provisions should be applied for that part of the transaction which is executed after 31 December 2018, which means that taxpayers would have to divide continuous transactions for the purposes of adequately describing them in the documentation, as well as the application of the appropriate method according to the principles discussed above.

New implementing rules are also foreseen, which seems necessary for the practical application of the new system, but the existing implementing rules (and therefore regulations of 2009 and 2013) would continue to apply until the new implementing rules enter into force, but not later than the end of March 2019

The project also proposed that taxpayers should be able to apply, on a voluntary basis, in their own discretion, the new rules – in particular for the purpose of establishing the scope of the documentation obligation – already in relation to income obtained after 31 December 2017

On 28 August 2018 a public consultation report has been published on a project that takes into account the comments submitted on some issues and complements the original draft with the newly proposed solutions. The following are important comments selected, according to the authors, and the announced changes to the project, which are the result of the public consultations conducted.

one the principles of application of estimation methods and conformity analysis were designed from widely commented aspects. The consultations concluded that the methods for estimating transfer prices indicated under Article 23p u.p.d.o.f.

and 11d the Corporate Income Tax Act will apply to the verification of compliance of the terms of the transaction with the market price principle rather than as initially proposed, to the determination of transaction prices. Comparative analysis is to remain an essential tool for demonstrating the market nature of the transfer price.

Conformity analysis is to be a tool which can only be used in the absence of a comparative analysis.

The great concern of taxpayers is the possibility of refusing to recognise or re-appropriate the transaction (recognising that unrelated parties would have carried out another transaction under the circumstances in question), especially since the original draft does not indicate the reasons for the use of these tools – according to the current announcement, the relevant criteria are to be clarified in the Implementing Regulation.

As regards the proposed arrangements for adjustments to transfer prices, the taxpayer will be required to have a statement from second parties to the transfer price adjustment transaction at the time of the adjustment, but without limiting the deadline until the date of the submission of the annual statement as originally planned under Article 11e(4) the Corporate Income Tax Act

The proposal to introduce simplified forms of establishing and documenting certain transactions (safe harpours) was met with a positive response from taxpayers, but attention was drawn to the need to clarify how a cost base should be established.

With regard to low value services, the Ministry of Finance announced the clarification of the cost base when applying the reasonable margin method (cost plus) or the net transaction margin method (TNMM). The cost base will be clarified under the proposed regulation. In addition, the newly designed rules on low value added services will allow the provision of services to unrelated parties (for this purpose, an appropriate limit will be set).

With regard to other aspects consulted, it is worth noting:

Possible exclusion of the obligation to document domestic transactions

The Ministry of Finance announced the abolition of the obligation to create tax documentation for transactions between profitable national entities. However, if one of the parties to the transaction would have lost, the exemption would not have been applicable. Furthermore, the comments submitted during the consultation show that the absence of documentary obligations would apply to taxable persons taxed at the same rate of taxation who do not benefit from tax exemptions.

Limits on the recognition of revenue costs

The plans to reduce the threshold of debt financing costs to deduct at the level of 20% EBITDA DA, therefore remains 30%. The Minister of Finance indicated that ‘any possible changes concerning Article 15e the Corporate Income Tax Act will be covered by a separate draft regulation."

Formal obligations for CbCr

Dismissed under Article 11n(5) draft, obligation to transfer to the Head of KA S group documentation by taxpayers obliged to provide information about the group of entities (CbCR).

Dividend, donation, grant

The Minister of Finance indicated that activities such as donations, subsidies, dividends are not, in principle, subject to documentary obligation.

Tax Capital Groups

The entities forming the PGK will be covered by the definition of ‘related entities’ and will therefore also be covered by the obligation to apply market prices. Furthermore , a legal definition of an entity that includes legal persons rather than PGK is being designed . Thus, the transaction thresholds will be calculated for companies forming PGK and not PGK as a whole.

The purpose of the regulation was to oblige PGK entities to enter into all transactions at market conditions, not only those subject to the obligation to draw up transfer pricing documentation. Thus any non-marketable transaction ( even below the documentation threshold) will result in PGK being terminated .

Group documentation in English only

The MF did not take into account the request to implement the obligation to draw up group documentation by making such documentation available in a language other than English. It was considered that English is widely used in international capital groups and group transfer pricing documentation is most often prepared in this language.

Given that the published draft has not yet passed the full legislative path, we can expect that the final shape may differ from the proposed one.

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