Complete transfer pricing documentation as a condition for its acceptance by tax authorities

25 June 2018

Taxpayers often wonder what information to include in the transfer pricing documentation so that tax authorities accept it as reliable evidence. It is a very important issue at the time of drafting and updating the documentation because the process of collecting data and information is complex and time-consuming, especially if the information must be retrieved from different sources of different availability. Consequently, the correct identification of the necessary information already at the initial stage of preparation of transfer pricing documentation is key to the successful completion of the entire process.

Which components of the TP documentation can tax authorities check

There is no official transfer pricing documentation template. It would be impossible to devise one anyway due to the tremendous variety of transactions that can be documented. To decide what information is necessary to prepare transfer pricing documentation, taxpayers should consider the types of proceedings under which their transfer pricing documentation may be checked. This may happen as part of a tax inspection (kontrola podatkowa), customs and tax inspection (kontrola celno-skarbowa) and tax proceedings (postępowanie podatkowe). Due to its legal structure, a tax inquiry (czynności sprawdzające) into transfer pricing documentation is basically not possible because transfer pricing documentation is not a tax return. However, if tax authorities decided to check the transfer pricing documentation in that procedure, only the formal elements of the documentation would be verified. The subject matter, reliability and completeness of the transfer pricing documentation are verified under the other procedures.

Mandatory components of the transfer pricing documentation

Like the old laws which were generally in force until the end of 2016, current legislation is also not entirely clear when it comes to the components of the documentation. To put things in order note that the mandatory components of transfer pricing documentation are specified in Article 9a of the Polish CIT Act of 15 February 1992 (consolidated text in Journal of Laws of 2018, item 1036, as amended) and in Article 25a of the Polish PIT Act of 26 July 1991 (consolidated text in Journal of Laws of 2018, item 200, as amended). More detailed requirements concerning the components of the documentation have been set forth in the Regulation of the Ministry of Development and Finance dated 12 September 2017 on corporate income tax information to be disclosed in the transfer pricing documentation (Journal of Laws of 2017, Item 1753) and the Regulation of the Ministry of Development and Finance on personal income tax information to be disclosed in the transfer pricing documentation (Journal of Laws of 2017, item 1752).

As mentioned earlier, those requirements are not clear in every case. For example, it is not entirely clear whether a set-off may be treated as “payment made or received”, or whether the description of the financial data of the taxable person should include only a reconstructive commentary on the financial data or whether it may include also other elements, such as a ratio analysis of the taxpayer's financial standing.

Contemplations of information to be included in the transfer pricing documentation are not purely theoretical – according to the case law, submitting incomplete transfer pricing documentation is treated as if the taxpayer failed to submit it altogether (see the ruling of the Provincial Administrative Court in Wroclaw of 26 July 2012, file no. I SA/ Wr 706/12).

Complete documentation – what does it mean

In this context it is in the taxpayer's interest to submit the documents and arguments to support the arm's length pricing of the transactions between associated enterprises. It is the taxpayer who has the knowledge on the course of the transaction and its economic justification, so his ignorance may encourage tax authorities to adopt a negative attitude towards the inspected entity. Nonetheless, they will still be obliged to prove that there are all grounds for a tax base assessment.

As the “completeness of transfer pricing documentation” has not been defined in the legislation, the “maximum scope” of the information to be provided in the documentation itself and in its appendices is believed to be unlimited. Still, the provided information must be coherent. Furthermore, the course of the transaction(s) described in the documentation must be true and accurate. Due to the principle of objective truth according to which tax authorities should exhaustively gather and evaluate exhaustive evidence relevant to the case, potential inaccuracies in the transfer pricing documentation will be compared against other pieces of evidence, e.g. documents obtained from the other party to the transaction or from third parties.

When it comes to the “minimum scope” of the subject matter content of transfer pricing documentation, it must include the components listed in the tax laws and described in more detail in the implementing regulations. Nonetheless, the practice of tax authorities shows that simple formal references to the individual items (e.g. in the form of appropriately marked subheadings) will not be enough if the content of the documentation does not constitute a convincing whole. This is because tax authorities may conclude that the transfer pricing documentation does not allow the verification of the applied prices because it does not include the necessary market references, price lists applicable to the supplies, examples of price calculations etc. (see the ruling of the Provincial Administrative Court in Bydgoszcz dated 22 August 2017, file no. I SA/Bd 675/17). In this case it is crucial to describe the method and manner of calculating the profit (loss) of the taxpayer and justify the choice. Whenever the arm's length nature of the transaction(s) is not easy to prove (e.g. by internal comparison), it is necessary to carry out an economic analysis of the transaction implications, calculate (forecast) the future financial consequences of the collaboration between the associated enterprises and analyse the pursued strategy (see the ruling of the Provincial Administrative Court in Szczecin dated 23 October 2013, file no. I SA/Sz 481/13).

Non-arm's length transactions

Transactions with both associated and independent enterprises may sometimes be made on non-arm's length conditions. At the same time it is worth mentioning that in such situations the taxpayer is not released from the obligation to prepare full transfer pricing documentation which he should treat as the first and primary line of defence. In such a case the taxable person should accurately describe the method of calculating the transactional price and explain why non-arm's length pricing is reasonable business-wise. That is because tax authorities are allowed to assess extra tax only after they manage to prove that by setting a non-arm's length price the taxpayer tries to reduce the due tax amount.

Therefore, a taxpayer who temporarily makes non-arm's length transactions may argue that he pursues his strategy which requires, e.g. keeping the prices down at the initial stage of the project to reach the consumers (see the ruling of the Provincial Administrative Court in Szczecin of 7 March 2018, file no. I SA/ Sz 1005/17). Although there is currently no obligation to describe the pursued strategy in the local file, taxpayers may still include their comments in this regard in every transfer pricing documentation they prepare. By contrast, too general argumentation and obviously wrong sample selection (e.g. as part of internal comparison) may encourage tax authorities to challenge the terms and conditions of the transaction. The evaluation criterion may in this case be the rationality of conduct, e.g. when tax authorities criticised the applied approach consisting in changing the negotiated terms for less favourable ones, and then concluding the transaction with the associated enterprise on those less favourable terms (see the ruling of the Provincial Administrative Court in Warsaw dated 14 December 2016, file no. III SA/Wa 2900/15).

Transfer pricing documentation to be prepared sufficiently in advance

Despite the lack of established line of judgements regarding the new documentation requirements, we may assume with high probability that the current trends in transaction verification will continue. Thus, taxpayers should start drawing up their transfer pricing documentation well in advance because the amount of information to be gathered and reliably presented is significant and the inspections are very thorough.