According to Article 39 of Tax Code of Ukraine (TCU) transfer price formation documentation is a set of documents or a single document, drawn up in any form, which should contain certain information that would justify the level of prices in controlled transactions. As noted by Yaroslav Romanchuk, managing partner of theInternational Legal Center EUCON, the Code establishes a list of essential information, but taxpayers have not received any recommendations as to content and order or sequence of preparation. Having worked on preparing documentation for years, he proposes organizing work in the following stages:
1. Identification and analysis of controlled transactions
The stage includes cost criterion calculation, detection of controlled transactions, assessment of their number and complexity. The stage will give an opportunity to assess amount of work and amount of time required for analysis.
2. Planning on volume of documentation and time for its preparation, distribution of tasks
Ukraine has no established criterion of transaction complexity compliance as for volume of documentation, but I recommend taking into account the fact that the amount of detail, documentation relevancy depend on the transaction’s complexity. But the materiality criteria can be defined by one’s own regulations, for example, cost criteria. If the company carried out one transaction with a counterparty for UAH 200 million and one for UAH 20,000 then, of course, the first one is more material.
3. Determining the main characteristics of the taxpayer’ business scope and goods (works, services) that are subject to a controlled transaction
An analysis of the market, its trends, competition level, and availability of government regulation is carried out.
According to Mr. Romanchuk, the result of the analysis held at this stage should be setting the main comparability criteria according to which the search for comparable transactions or entities (companies) will be carried out.
4. Functional analysis
This is a key stage. We analyze and describe the functions of transaction parties, the risks they bear and the assets they use. The result of a functional analysis will be conclusion/classification of transaction parties. For example: Manufacturer, Distributor with limited set of functions, Commission Agent with limited set of functions.
5. Selection of the examined party
It is held according to the previous analysis. During selection an evaluation is carried out for which party the application of a method will be possible and most well-reasoned, for which party it is possible to find a comparable transaction or comparable entities, which party takes the least complex functions, bears fewer risks and has no intangible assets that significantly affect the level of profitability.
6. Selection of comparable transactions/companies and price formation method taking into account the possibility to use information sources
Usually, starting with capability assessment to use the first method, the availability of a taxpayer’s own transactions with unrelated counterparties or availability of such transactions by the other party of the transaction is analyzed.
7. Economic analysis
Calculation of ranges, comparison also carried out as part of this stage.
8. Documentation
This stage involves systematizing and direct description the entire volume of work that was carried out within the economic analysis of controlled transactions.
In preparing quality documentation on transfer price formation one should consider the following:
— Documentation should include a description of approaches to method selection based on the priority of their application. Grounds for refusal of one or other method shall be provided. For example: you cannot apply the transactional net margin method (which is the fourth) without justifying why we could not apply the previous three.
— It is necessary to justify selection of comparable transactions or persons and provide criteria according to which such a comparison was carried out.
— Calculated price ranges/profitability should be sustainable. For them to be sustainable they shall contain enough values, and it is preferable that there should be small gaps between those values.
— Documentation is issued in the official language. In the event of submission of documents in a foreign language (e.g. group FTP policy), such materials shall be accompanied with a translation.
— If a taxpayer is part of a group of companies during the analysis then account provisions of the inner group regulation and all restrictions provided by it must be taken into account.
“Working on the Ukrainian market of services in the area of transfer pricing for three years, we are certain that only preparation of quality documentation shall protect a taxpayer from claims brought by supervisory authorities. This is evidenced by practice of first inspections, for all additional charges were made as result of insufficient justifications and mistakes that were made by taxpayers, which includes documentation”, Yaroslav Romanchuk says.