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Transfer price checks also in personal income tax inspections

Transfer prices between related parties remain a priority of tax administrators’ inspection activities. As much as the general public believes that this only concerns corporate entities and cross-border transactions, the recent Supreme Administrative Court’s judgement clearly shows that the arm’s-length principle also applies to individuals, and to intra-state transactions.

Most of these cases concern rental payments. For instance, in an inspection of personal income tax for 2011, the tax authority for the Vysočina region reviewed the rent charged by a member of a limited liability company to the company in which he owned a 50% share. The tax administrator determined the reference amount of the rent based on rent paid for other (in their opinion comparable) property and on an expert opinion. The taxpayer then had the chance to disprove this by submitting his own evidence, namely to prove that the property had been unsuccessfully offered for rent to third parties; the taxpayer, however, failed to produce any such evidence.

The tax administrator thus assessed additional tax on the part of the taxpayer – the member charging the rent. Logically, this should have been followed by increasing the expenses, and subsequently reducing the tax liability, on the part of the other party to the transaction – the company. However, because of the length of the proceedings and the time limit for filing an additional tax return, the other party was most likely unable to do this. Unfortunately, this situation is not uncommon in the Czech Republic.  

While personal and corporate income tax inspections are not primarily focused on transfer prices, tax administrators may still open this topic in the course of the tax inspection. It is therefore necessary to keep records supporting the arm’s-length character of transfer prices. Quite often, tax administrators do not hesitate to obtain an expert opinion or a specialised study, even where no significant additional tax assessment is expected.

The commented judgement further shows that tax administrators are also looking into intra-state transactions. It is thus recommendable that taxpayers respond actively during the tax proceedings, making sure that the principle of ‘neutrality of additional tax assessment’ is observed, i.e. that the other party to the transaction gets the chance to reduce their tax liability accordingly.