Watch out for tax inspections! Companies drawing investment incentives surprised by transfer pricing issues

The scenario is always the same: the tax administrators announce a routine inspection of corporate income tax focusing on compliance with the conditions for drawing investment incentives. Among other things, questions are asked about related-party transactions. However, their real focus is on something else than in cases of companies not drawing investment incentives in form of tax relief. It so happens that the Income Tax Act contains a specific condition for the drawing of this type of investment incentive, namely that the taxpayer’s base for calculating the relief must not be increased by business transactions with parties related through capital or personnel in a manner not compliant with common economic principles.

Should the tax authority identify and prove (often using evidence provided by the taxpayers themselves) a breach of this condition, taxpayers are sanctioned for their excessive profitability. Sanctions are imposed depending on when the unlawful increase in the base was proved, and may come in two forms: either the investment incentives are withdrawn completely, in which case the taxpayer must file additional tax returns for all periods when the incentives had been drawn, or the tax administrator assesses additional income tax on the detected excessive profitability.

In our experience, inspections of this type may take place any time while incentives are being drawn. And, what we found rather startling, the tax authority may see a problem even at companies where previous inspections focusing on investment incentives did not find any fault as regards transfer pricing. This means that not even having the methodology reviewed by the tax authority gives the taxpayer any certainty that the same conclusions will again be drawn in a later inspection. We therefore recommend not underestimating even seemingly routine tax inspections.