Transfer pricing - Latvia

• As of January 1, 2018, amendments to the Law on Taxes and Duties came into effect, aligning Latvia’s transfer pricing documentation (TPD) requirements with those set out in the Organisation for Economic Co-operation and Development (OECD) standard. These changes introduced the TPD format, comprising a Master File and a Local File. 
• In Latvia related party transactions are regulated by Article 4 of the Latvian Corporate Income Tax Law (CIT Law), Regulation No. 667 on “Application of norms of Corporate Income Tax” (Regulation No. 667), Article 15.2 of the Law on Taxes and Duties, and Regulation No. 802 “Transfer Pricing Documentation and Procedures for the Conclusion of an Advance Ruling for the Determination of the Arm’s Length Price (Value) for a Transaction or Type of Transactions Between a Taxpayer and the Tax Administration” (Regulation No. 802).
• Article 4 of the CIT Law determines cases, when the taxable income should be adjusted, if related party transactions are not arm’s length. Whereas Article 15.2 of the Law on Taxes and Duties defines when full TPD should be prepared in order to justify the prices applied in transactions.
• In accordance with the regulations mentioned, transactions of Latvian companies with the following entities should be arm’s length:
  • Foreign related entities
  • Related natural persons (in accordance with Article 1, Paragraph 18 of the Law on Taxes and Duties)
  • Companies that are located, created, or established in low-tax or tax-free jurisdictions or territories (full list of tax havens is prescribed by the Regulations No. 333)
  • Other related Latvian taxpayers, if the transaction takes place within a single supply chain with another related foreign company, or companies / persons located in offshores.

• Latvia has been a member country of the OECD since 1 July 2016.
• Regulation No. 667 specify that OECD TP Guidelines might be used for the needs of TP analysis as long as it does not contradict the local TP legislative acts. In most cases, the State Revenue Service (the SRS) accepts the principles stipulated in the OECD TP Guidelines regarding the structure of the TPD.
• The principle of supremacy of laws does not provide the application of the OECD TP Guidelines directly. However. The SRS is following the recommendations of the Council of the OECD (C(95)126/Final), which was a base in the drafting of current legislation.

• Regulation No. 667 prescribe five methods for determining an appropriate transfer price between related companies and specify that OECD TP Guidelines might be used for the needs of TP analysis. As such, the following methods can be used:
• Traditional transaction methods
  • Comparable uncontrolled price (CUP) method
  • Resale price (RP) method
  • Cost plus (CP) method.
• Transactional profit methods
  • Transactional net margin method (TNMM)
  • Profit split method (PSM).
• There is no hierarchy between the available TP methods in Latvian legislation and the applicability (for both international and domestic transactions) is present. Domestic legislation indicates that the most appropriate method should be used. However, in practice, traditional transaction methods are favoured by the SRS, with CUP method being the most favoured.
• Notwithstanding to the fact that local legislation directly does not allow to use unspecified methods, in practice valuation techniques/methods, eg discounted cash-flow based methods, may be used in cases when intangibles are transferred.
• Local legislation does not mandate the use of more than one TP method to test the arm’s length nature of a specific controlled transaction.

• There is no specific TP declaration in Latvia. However, the total volume of related party transactions (aggregated volume of services received / provided to related parties and goods sold / bought from related parties) for a given year needs to be disclosed in the CIT return for the specific year (Row 6.5.1. of CIT return for transactions with non-residents and 6.5.2. - for transactions with resident/local related parties). In case the taxpayer has made TP adjustments, the taxpayer must disclose the income it would have received or the expenditure a taxpayer would have not incurred if commercial and financial relationships were created or established under valid conditions between two independent persons. It should also indicate the applied TP method in the annual CIT return of the respective reporting year (row 6.5 of CIT return). In accordance with the Law on the Annual Financial Statements and Consolidated Financial Statements, Section 53, a taxpayer must disclose its parent entity and its legal address, as well as the transaction amounts with related parties if such transactions are significant and do not conform to normal market conditions. This is for companies whose financials on the balance sheet date exceed at least two of the three values indicated below:
  • Balance sheet total: EUR 4 million
  • Net turnover: EUR 8 million
  • Average number of employees during the reporting year: 50.
• Additionally, in case of a TP audit, tax authorities would usually inquire about (i) description and quantification of the transaction cost base for each transaction (including information on full cost (direct costs and overheads) base using actual costs in the specific year); (ii) availability of agreements with related parties; (iii) analysis that determines the arm’s length price for a given transaction.

• As stated above, as of 1 January 2018 came into force amendments to the Law On Taxes and Duties. With said amendments, Latvia has introduced the OECD format of the TPD, consisting of a Master File and a Local File (see graph below).
• Compulsory annual preparation of Master File and Local File within 12 months after the end of the specific fiscal year, and submission within 1 month upon a request from the Latvian tax authority, if:
  • Master File, where the total value of related party transactions in the specific year exceeds EUR 5 million
  • Local File, where the total value of related party transactions in the specific year exceeds EUR 250 thousand.
• Obligatory annual submission of Master File and Local File to the Latvian tax authority within 12 months after the end of the specific fiscal year, if:
  • Master File, where (i) annual turnover in the specific year exceeds EUR 50 million and the total value of related party transactions exceeds EUR 5 million or (ii) the total value of related party transactions in the specific year exceeds EUR 15 million
  • Local File, where related party transactions exceed EUR 5 million.

• Article 8, Paragraph 4 of the Official Language Law states that statistical summaries, annual accounts, accounting documents and other documents which are to be submitted to State or local government institutions on the basis of laws or other regulatory enactments, shall be drawn up in the official language. Pursuant to regulatory requirements, in most cases all TP documentation must be submitted to the SRS in Latvian language. However, it is permitted to prepare the Master file either in English or Latvian.
• Notwithstanding to the above, in practice, all TP related documents can be submitted to the tax authority in English language, and tax authorities tend to review TPD in English. However, if the SRS has reason to speculate that the taxpayer will challenge its findings in court, the tax authority reserves the right to require a full or partial translation of the documentation to Latvian language, as courts would only look at documents in local/state language. In most situations, a 30-day time period is granted for translation of all relevant TP documents into the Latvian language. Failure to provide the tax authority with TP documentation translated in Latvian once the 30-day time period has expired will be considered as non-compliance, therefore, subjecting the taxpayer to be penalised.

• Following the activities carried out by the OECD within the base erosion and profit shifting (BEPS) project, and the updated OECD TP Guidelines, there have been major changes with respect to the TP documentation preparation / content in Latvian legislation, the most significant of which is the introduction of the three-tier approach for TP documentation, which consists of the following:
  • Country-by-country report (CbCr) provides tax authorities with a high-level overview of a multinational enterprise's global income allocation, taxes paid, and economic activities across respective jurisdictions (turnover threshold applies, i.e. EUR 750 million turnover for the previous financial year required for CbCr to be mandatory)
  • Master File contains information on the entire groups global operations, including the nature of business activities, overall TP policy, revenue placement and more. The information to be included in the Master File may be categorised as follows - group organisational structure, description of lines of business, intangible assets, financial arrangements, financial and tax liabilities
  • Local File contains detailed information on the transactions controlled by the local company. The information included in the document supplements the Master File and is presented to support the assumption that the price in the controlled transaction corresponds to the market price. The Local File contains TP analysis for the transactions controlled by the local company, the underlying financial information, justified reasoning behind the selected TP method, a benchmarking analysis etc.
• As per the content of TPD, Latvia follows the standard Master File and Local File content requirements set by the OECD, with a noteworthy addition that taxpayers are demanded to provide screenshots with fixed dates and downloads from databases with fixed dates for acceptation or rejection reasons of comparable entities.
• Regulation No. 802 prescribes the information to be included in both the Master File and Local File, note situations in which a simplified documentation can be prepared, and prescribe what information should be included in said simplified documentation, as well as prescribe the procedure for concluding an APA with the tax administration.
• Regulation No. 677 prescribes five methods for determining an appropriate transfer price between related companies and provides guidelines for preparing a functional analysis and benchmarking study. Furthermore, Regulation No. 677 specifies that OECD TP Guidelines might be used for the needs of TP analysis, provided that it is not in conflict with the rights and obligations of a taxpayer and tax administration laid down in laws and regulations

• Small taxpayers in Latvia have usually a medium risk that they will be subject to general tax audit, while medium-sized and large multi-national taxpayers have a high risk of audit. Based on the tax audit practice, there is a medium risk for all taxpayers that if TPD is reviewed as a part of the audit, the TP methodology will be challenged. Additionally, there is a medium to high risk for all taxpayers of an adjustment if the TP methodology is challenged.
• Other aspects which could be of the SRS interest:
  • Persistent losses for local entity
  • Licensing (also other/any type) payments to low tax jurisdictions
  • Business restructurings, or changes in TP model, can also trigger a challenge.
• According to Article 23, Paragraph 1.1 of the Law on Taxes and Duties, the SRS has the right to assess whether controlled transaction pricing was arm’s length within five years after the tax becomes due. As such, the relevant records need to be kept for at least the 5 years following the submission deadline of the CIT return for the specific period.
• Additionally, tax control may be commenced by sending a notice with which the taxpayer is informed of the non-conformities detected by the tax administration. The abovementioned notice shall contain an invitation for the taxpayer to eliminate the non-conformities detected by the tax administration within 30 days from the day of receipt of the notice or to submit a justified explanation thereof or additional information.

• When conducting a TP audit, the SRS may impose a penalty on transactions executed during the last 5 years (except if the SRS has entered into an APA with a taxpayer). A penalty may be applied in situations when the taxpayer does not comply with either the submission deadline or the content requirements due to which it becomes impossible to make sure that the arm’s length principle is followed.
• On September 11, 2023 an order by the SRS introduced guidelines on the principles of applying fines for breaches of the deadline for submission or adequate preparation of TP documentation. The new provisions clearly justify the scheme whereby the SRS applies a penalty amount to taxpayers depending on the nature of the breach.
• The SRS determines that the taxpayer will be sentenced to a penalty rate according to the classification of the breach, based on an individual assessment. The relevant breach levels are:
  • Minor - 0.05% of the total amount of controlled transactions, but not more than EUR 15k.
  • Less significant - 0.1% to 0.5% of the total amount of controlled transactions, up to a maximum of EUR 50k.
  • Significant breach- from 0.5% to 1% of the total amount of controlled transactions, up to a maximum of EUR 100k.
• TP adjustments are also subject to an effective CIT rate of 25%. Additionally, according to (i) Article 32, Paragraphs 4 and 5 of the Law on Taxes and Duties, if a TP adjustment is made that results in additional payable tax, then a penalty of 20% or 30% (with the possibility to reduce said penalty by 50%, if the taxpayer cooperates with the tax administration) on the additional payable CIT would apply; (ii) Article 29, Paragraph 2 of the Law on Taxes and Duties, if a TP adjustment is made, a late-payment penalty of 0.05% per each day would also apply to the additionally payable CIT.

Local government has announced and shows intentions to implement digital service tax (DST) as Latvian government commissioned a study to determine the increase of tax revenue based on the assumption that the country levies a 3% DST.

• Latvian tax authorities have elevated the importance of carrying out TP related audits, with companies
  • (i) with losses in previous years,
  • (ii) extensive dealings with related foreign companies,
  • (iii) carrying out non-standard transactions (e.g. sale / transfer of intellectual property) facing increased scrutiny from the tax authorities.
• Additionally, during the last years the concept of “Consult Before” has been introduced by the Latvian tax authorities. This concept entails that in case that tax authorities have identified particular risks related to controlled transaction pricing for a specific taxpayer, instead of initiating a formal audit procedure, they will reach out to said taxpayer with questions on the applied pricing, and provide their guidance / recommendations on how to bring the pricing of controlled transactions in line with the arm’s length principle. If following this process (dialog) the tax authorities and taxpayer can come to an agreement, no audit is initiated, and the taxpayer is not fined. However, if during this procedure an agreement is not reached, a formal audit shall be initiated.
• As stated in an OECD publication, Latvian tax authorities have become more interested in controlled financing transactions carried out between a Latvian company and a foreign related company. Especially if the volume of said transactions is rather high or if certain taxpayers have concluded historical transactions where a possibility of applying fines for non-compliance is prevalent.
• As mentioned before, the SRS has the right to assess compliance with the arm’s length principle for five years after the submission of the annual financial statement for the respective financial year, which differs from a standard tax audit.

• The economic fallout of COVID-19 is likely to have widespread impact and an increase in TP and CIT enquiries globally is expected. All MNEs should be reviewing their potential exposure to TP enquiries and updating documentation accordingly.
• Entities should
  • (i) identify where the key business impacts affect their TP policy;
  • (ii) think strategically how crisis responses can be supported by the TP function; and
  • (iii) start with internal document by adjusting agreements, and include robust and contemporaneous audit files to support TP policy amendments.
• The TP concept assesses the business as a whole rather than individual figures, and also takes into account market conditions, macroeconomic developments and their impact on the company's financial performance. Therefore, for companies for which the issue of TP is relevant, it is recommended to gather and document the objective evidence that affected their performance and that could help to justify the compliance of the prices of controlled transactions with the market level.