“Our experience in the area of transfer pricing shows that taxpayers make a number of mistakes when they prepare reports on controlled transactions”, Yaroslav Romanchuk, the managing partner of International Legal Center EUCON, says. He argues that such mistakes are generally a consequence of the complexity of legislation, lack of clear regulations, and their lack of experience. However, there were many situations where mistakes were made due to poor control of the price level or the total lack of such control. In such cases, controlled transactions are identified too late and the methods of pricing are chosen and applied incorrectly. “To avoid tax risks and to justify the contractual prices in controlled transactions, we always recommend our clients to set an efficient system of compliance with legal requirements”, Mr. Romanchuk says. Practices evidence that the first steps should include development of internal transfer pricing rules and upgrading of software.
The aim of the internal rules includes:
Systemization of the methodology implies a detailed description of the step-by-step procedures for the tracking and analysis of controlled transactions. The main stages of control of transfer pricing transactions can include the following:
Internal rules should include a detailed description of each stage of such control.
The rules should clearly define algorithms for actions at every stage of control over transfer transactions pricing.
The IT department is responsible for the automation of detection of controlled transactions.
The legal department is responsible for drewing up the list of persons, transactions with which may be recognized controlled ones. It is at the stage of signing a contract that an evaluation may be made as to whether an agreement (transaction) is potentially controlled. For that purpose, the interdependence of the parties and the tax status of the resident are examined. If a contracting party is a non-resident it is necessary to check whether its country is a low tax jurisdiction. It is also necessary to found out the corporate tax rate of the non-resident in its country. “It is very important because the non-resident’s country may be in a list of low tax jurisdictions, but the resident may pay the tax at a higher rate, and the transaction would not be deemed controlled. The resident would need to provide a certificate from the competent authority of its country to confirm its tax rate”, Mr. Romanchuk says.
Besides, some changes need to be made in the contractual work. For transfer pricing, it is important to set out the commercial and financial terms of the transaction in the agreements. A search for comparable transactions needs to be carried out. They are considered comparable if they are carried out in similar commercial and financial conditions. And the setting of commercial and financial terms of transactions occurs solely on the basis of agreements.
All of these tasks rest with the legal department, which works closely with the accounting department.
Involvement of commercial services includes measures to track comparable transactions and to analyze the terms of a transaction.
Of course, the division of responsibilities between departments within a company depends on the latter’s organizational structure but, in any case, the accounting department would hardly be able to perform all measures of control independently without the involvement of additional specialists.
The internal rules of transfer pricing may also contain standardized documents to summarize information that is reported on controlled transactions, and documented results of functional and economic analysis. Often, such documents are called templates. The templates are filled out for each controlled transaction and can be used as part of the documentation to justify the contract price.
In general, this a set of basic steps that we recommend to taxpayers with a controlled transaction. “Over the last year, our experts prepared internal rules for many business clients and the rules enable them to promptly identify controlled transactions and track the relevant prices”, Mr. Romanchuk says.