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Introduction to Czech Republic transfer pricing
Transfer pricing rules
- The Czech transfer pricing (TP) legislation is based on Act No. 586/1992 of Coll., on income tax, as amended (ITA) which is the fundamental national law regulating the application of transfer prices between related parties. Article 23 (7) of the ITA stipulates that if the prices negotiated between related parties differ from those negotiated between independent entities in regular business relations under the same or similar conditions and the difference is not satisfactorily substantiated, the tax administrator shall adjust the taxpayer’s tax base for this difference.
- The ITA also specifies which entities are considered as related parties, ie generally direct or indirect ownership greater than 25 percent based on voting rights, share capital, common control. As related parties are considered as well as other related persons (such as person participating in the management or control; being close person etc.). Further, Czech transfer pricing guidelines have a character of the instructions issued by the Ministry of Finance and follow OECD principles.
- The decrees issued by the Ministry of Finance (Decree D-332, D-333 and D-334) are generally considered as instructions issued to the tax administration units as to how they should apply transfer pricing principles.
- For the transfer pricing documentation purpose, the OECD Transfer Pricing Guidelines apply. The OECD TP methods are accepted.
Transfer pricing methods
- There is no specific guidance on the available transfer pricing methods in the ITA or other primary law.
- The description of available transfer pricing methods can, however, be found in Decree D-34, which replaced the previous Decree D-332. The decree provides for the traditional transaction methods, namely:
- The CUP method.
- The resale price method.
- The cost-plus method.
- The decree also provides for profit-based transaction methods, namely:
- The profit split method
- The transactional net margin method (TNMM).
- The ITA provides in section 23(7) that, should it not be possible to determine the arm’s length price, the price will be determined in accordance with the Property Valuation Act. Thus, there is one more method, namely determining the fair market value based on expert valuation.
- Decree D-34 provides that, in the process of determining the arm’s length price, all the five basic methods foreseen in the OECD Guidelines may be used, and the appropriate method should be selected based on a comparability analysis and subsequent determination of which method is the most suitable.
- The Czech Republic has a self-assessment regime, where the onus is on the taxpayer to ensure that transfer pricing regulations are adhered to.
Transfer pricing documentation
Preparation of transfer pricing documentation
- Czech tax legislation does not prescribe any obligation to maintain any TP documentation (including preparation of a benchmarking study, or a functional and risk analysis). Nevertheless, documentation proving that the arm’s-length principle was followed in related-party transactions is typically required by the Czech tax authorities during a potential tax audit. It is a common practice of Czech tax auditors to require transfer pricing documentation from a taxpayer, since a taxpayer bears the burden of proof.
- It is therefore highly recommended that such documentation be prepared in advance and that the TP methodology applied in transactions with related parties be properly documented.
- Common practice nowadays is the requirement of Czech tax auditors to dispose of the documentation in Czech language, if it is used as evidence in tax proceedings.
Master and Czech local file
- As a member of the EU, the Czech Republic has adopted the EU TP documentation Code (master file approach). However, it is at the taxpayer’s discretion to follow the Code.
- The Czech guidance contains the concept of the Local File and Master File based on the EU JTPF recommendation.
- There is no threshold that applies for the obligation to prepare transfer pricing documentation or for the obligation to prepare documentation in the Master File / Local File format.
Some risk factors for challenge
- Generally, long term loss-making positions of the contract manufacturing companies (especially toll manufacturers), situations where a company’s functional profile does not correspond to its profitability, provision of the various intragroup services royalties and financing are focus areas for transfer pricing audits.
- Standard penalties are applicable in the case of additional tax assessment from the tax authority. It means a penalty amounting to 20% of the additionally assessed tax plus interest from the late payment of the tax.
Economic analysis and how to demonstrate an arm’s length result
- When determining an arm’s length price, transfer pricing methods primarily depend on the determination of comparable information (comparable price or comparable gross or net margin). It is, therefore, necessary to perform the comparability analysis to identify comparable data based on transactions carried out between independent entities.
- Decree D-34 emphasizes that prior to carrying out the comparability analysis, it needs to be established that the transaction actually took place (substance test) and also the transaction provided a benefit for the taxpayer (benefit test) as foreseen in article 24(1) of the ITA.
- Both global and regional comparable companies are accepted. However, in practice, a search is generally undertaken to find local comparables first but if the sample is insufficient it could be extended to the EU region. This approach is acceptable by Czech tax authorities.
Advance Pricing Agreements (APAs), dispute avoidance and resolution
- The Advance Pricing Agreements (APA) are in the form of binding ruling valid for up to three years (if conditions and the law remain unchanged), which set out the method for determining transfer prices in related party transactions.
- This concept of 'binding ruling' is set out by Section 38nc of the ITA. First, the taxpayer files a request and, consequently, the tax administrator decides whether the taxpayer has chosen a relevant Transfer Pricing method which would result in a transfer price determination on an arm’s-length basis. The binding ruling can be issued only for transactions effective in a particular tax period or that will be effective in the future. It is impossible to apply for the binding ruling concerning the business relations that have already influenced the tax liability (tax base or tax loss) for the taxable period.
- Guidance D – 32 describes the process for issuing binding ruling and the details for the application. Generally, the decision on the method of Transfer Pricing between related parties is effective for three tax periods following the day when the decision was issued.
- In the case of a European disputes, the Arbitration Convention shall apply. Non-European disputes are executed based on double tax treaties agreed between countries in question.
- Transfer-pricing documentation is not obligatory in the Czech Republic, however, a special annex to the corporate income tax returns related to intra-group transactions needs to be completed provided that the:
- taxpayer carries out a transaction with a related party seated outside the Czech Republic
- taxpayer shows a tax loss and simultaneously carries out a transaction with a related party seated in the Czech Republic or abroad
- the taxpayer was granted investment incentives in a form of tax relief and simultaneously carries out a transaction with a related party seated in the Czech Republic or abroad.
- However, this obligation relates only to a taxpayer who meets at least one of the following conditions:
- total of assets exceeds MCZK 40
- yearly net turnover exceeds MCZK 80
- an average number of employees is more than 50.
Digital services tax
- Teams of experienced tax administrators were created to perform tax audits focused on transfer pricing. The analysis made is based on the data filled in the special annex to the CITR enables the tax authorities to choose the entity which should be subject to a further procedure.
- There are no official standpoint or recommendations in connection with COVID-19 (the recommendation of Czech tax authorities is expected to be published at the end of 2020).