Ministry of Finance published 29 March 2023 tax explanations on transfer prices from 24 March 2023 on the price method of the disposal. It was stressed that the explanations apply to controlled transactions after 31 December 2018 As pointed out at the beginning of the document, they aim to clarify practical aspects related to the application of the reselling method and to increase tax security for taxpayers. What exactly is in the explanation? That's in a minute.
At the outset, however, it is worth mentioning what the method of disposal is. For the record, according to Article 11d(1) Corporate Income Tax Act[1], Transfer prices shall be verified using one of the following methods:
- the method of comparable uncontrolled price,
- the method of selling price (referred to in this Article and in the above-mentioned explanations),
- cost plus method,
- the net transaction margin method,
- the method of profit sharing.
The clarification of each of the above methods can be found in the Regulation of the Minister of Finance dated 21 December 2018 on corporate tax transfer pricing[2], in Chapter 3 entitled ‘Transfer pricing verification methods’.
According to section 11 Regulations, the sales price method consists of calculating the purchase price of the goods or services from the related entity by reducing the sales price of the goods or services to an unrelated entity by a margin of the sales price.
Under section 2 The above provision can be read as to the fact that the margin on the resale price should provide the seller to cover its direct and indirect costs related to the sale of the subject of the controlled transaction and to provide a profit corresponding to its functions, assets and risks.
Finally, according to section 3: the market value of the resale margin shall be determined by reference to the level of the margin that the related party uses in comparable transactions with unrelated parties or the margin used in comparable transactions by unrelated parties.
According to the explanations, the resale margin should cover direct and indirect costs and provide profit. Direct and indirect costs related to the sale of the subject matter of the controlled transaction shall not include the value of the goods or services sold (in particular goods)
According to published explanations, direct costs include costs which may be directly linked to a particular product, product or service. Indirect costs (i.e. costs which cannot be assigned directly to the transaction) should be calculated using the allocation keys.
The allocation key is a measure indicating to what extent the cost should be assigned to the transaction. In line with the recommendations of the explanations, the allocation key should be easy to use and verify and fixed over time. As one example, the share of transaction revenue in total revenue is given.
According to Article 11d(3) Corporate income tax laws shall, when selecting the most appropriate method in the circumstances in question, take into account in particular the conditions which have been established or imposed between related parties, the availability of the information necessary for the correct application of the method and the specific criteria for its application.
As explained above, the reselling method concerns transactions in the acquisition of goods and services from related parties and their disposal to unrelated parties.
As is also noted in the further part of the explanations, it is primarily used in the trade in goods between related parties, of which one is a producer and second a distributor (possibly both entities are distributors); sellers, including distributors or intermediaries.
The method may also be used for the sale of routine services with low added value. As the explanations rightly state, the above does not mean that it can only be used in the above examples, each transaction needs to be examined individually if the appropriate method is chosen.
In the methodology, the prices of sales margins should be comparable to transactions of a similar nature, i.e. transactions carried out by comparable entities in similar economic circumstances and taking into account the similarity of goods and services. It has been indicated that the most reliable use of this method is achieved when:
- there is functional comparability of entities,
- the subject of the controlled transaction has been sold to an unrelated entity in a short period of time,
- the subject matter of the uncontrolled transaction (reselling transaction) has not changed significantly, e.g. through its processing, causing it to increase its value,
- the seller does not involve unique and valuable assets in transactions (e.g. intangible assets such as patents, licences, trademarks).
The explanations also show the different stages of the application of the reselling method. First of all, this method should be preceded by the functional analysis referred to in section 3[3] Regulations of the Minister of Finance dated 21 December 2018 on corporate tax transfer pricing.
Determination of sales price and margin of sales price.
Calculation of the purchase price.
Choice of the financial indicator.
Calculation (calculation) of the selected financial indicator.
Comparison of the financial indicator and verification of whether the purchase price was set at market price level.
According to the explanations, the resale margin should cover direct and indirect costs and provide profit. The direct and indirect costs associated with the sale of the subject matter of the controlled transaction do not include the value of the goods or services sold (in particular goods).
According to the further part of the explanations, the notion of direct and indirect costs should be understood as transaction-related sales and general management costs[4].
According to the explanations, direct and indirect costs should not be understood as not necessarily related to the transaction or financial costs, as not related to the entity's operating activities and as part of its financial activities.
Caution should be exercised when selecting the comparators and analysing the entities concerned. As written Under point 16 Explanations, gross margin on sales can be calculated on the basis of the benchmarking option of the profit and loss account, but taking into account further costs (i.e. the costs of sales and general management costs) may be impeded by the availability of data or by their different treatment.
According to the further part of the Explanations, the margin on sales is the amount from which the entity covers its sales and other operating costs and in the light of its functions (taking into account the assets used and the risks incurred) achieves an appropriate profit.
As a rule, sales costs are not excluded for the purpose of calculating the margin. This rule does not apply to margin calculated on the basis of formulae for the calculation of gross margin on sales and gross margin on sales[5], because the formulas are based on data not taking into account the selling costs.
In turn, when calculating these indicators in accordance with the Accounting Act, sales costs are not included in the calculation of indicators.
In order to apply the sales price method, it is necessary to determine the selling price to an unrelated party and then deduct the margin of the sales price which reflects the sales costs and the profit to the entity. The result of this calculation is the purchase price from the related party.
Comparison of the margin of the sales price can be made by internal comparison (i.e. internal data for comparable transactions with unrelated parties) or external comparison (i.e. external data for comparable transactions by unrelated parties).
Under point 19 The explanations were also provided with useful information on the calculated gross margin ratios. Profitability should be compared at the level of the controlled transaction. However, it is also acceptable to test the profitability indicators calculated for the entire activity of the entity. This applies to situations where:
(a) the entity has a homogeneous activity, e.g. as an intermediary with simple functions, assets and risks, dealing with the sale of goods,
(b) the entity operates several activities, whereas one of which it is a leading activity, while the others (together and separately) are complementary (supporting) to the main transaction and are not significant in value – for example as an intermediary with simple functions, assets and risks, ensuring the transport of the goods they sell[6].
The following explanation also refers to the criteria for comparability of transactions and entities, comparison of the price method of selling to other transfer price verification methods, practical application of the method and difficulties and errors in applying the method. It is worth to lean on this last issue.
Under points 30 and 31 Examples of difficulties and errors associated with the use of the reselling method have been presented. The difficulties were presented among others:
- obtaining reliable comparative data, i.e. on entity information
- comparable to their risks, assets and functions,
- performance of correct comparability adjustments,
- obtaining information on changes to the subject of the distributor
- transactions,
- accounting differences (e.g. different options for the calculation of the profit and loss account) that
- they have a problematic impact on obtaining data on price indices on sales of other entities.
As examples of errors in the application of the reselling method, the following are listed:
- omitting factors affecting the margin realised, i.e. the assets involved, the risks incurred, the functions performed,
- the absence of adjustments to the comparability eliminating the differences affecting the margin,
- the comparison of transactions which are carried out by entities with a different functional or other market or other geographical scope.
The whole explanation can be found on the website of the Ministry of Finance below: https://www.gov.pl/web/finanse/objasnienia-podatkowe-w-zakresie-cen-transferowych-z-24-marca-2023r---nr-5-metoda-ceny-odprzedazy
At the same time, if you have any doubts about transfer pricing or deal with related parties, please contact us.
[1] Act dated 15 February 1992 on corporate income tax (i.e. Journal of Laws of 2022, item 2587, ).
[2] Regulation of the Minister of Finance of 21 December 2018 on corporate tax transfer pricing documentation (i.e. Journal of Laws of 2021, item 1195).
[3] section 3 section 1.
The comparability test shall take into account in particular the following comparability criteria:
- 1) characteristics of goods, services or other benefits,
- 2) the course of the transaction, including the functions of the entities in the transactions compared, the assets involved and the risks incurred, taking into account the ability of the parties to the transaction to perform the function and to bear the risk,
- 3) the transaction conditions set out in the contract, agreement or other proof documenting those terms,
- 4) economic conditions occurring at the time and place of the transaction,
- 5) economic strategy
- - to the extent that those criteria have or may have a significant impact on the conditions established or imposed between related parties.
[4] Under point 16 It is noted that the OECD Guidelines use the concept of selling and other operating expenses in this case, and the UN Handbook uses the concept of sales, general and administrative (SG&A) expenses. The categories listed in both documents concern the functional cost arrangement – presented in the calculation option of the profit and loss account.
[5] Models for calculating financial indicators data have been presented Under point 19 Explain.
[6] Compare: Tax explanations for transfer prices with 24 March 2023, No 5: The price method of the sales, point 19.