7 February 2019

Transfer prices and audits of financial statements

The beginning of each calendar year traditionally entails intensive work on audits of financial statements. Among multinational corporations in particular, accounting issues are very often closely connected to an audited entity’s cooperation with related parties.

Daniel Szmaragowski
Lenka Pól Brožková
  • Are revenues from the sale of products to an affiliate recognised in the amount corresponding to similar revenues carried out by an independent entity under similar conditions?
  • Are expenses recognised in connection with the purchase of services from a parent company inappropriately high?
  • Would an independent entity pay royalties for the provided manufacturing know-how?

Even though a proper audit of the financial statements may not entirely avoid transfer pricing, a detailed analysis of intercompany transactions is definitely not its primary objective. Neither are the auditor’s report or the report on relations intended to represent evidence of the accounting entity’s application of transfer prices in compliance with the arm’s length principle.

Instead, an entity’s transfer pricing documentation should summarise evidence confirming that the methods of setting prices in intercompany transactions as well as the transactions’ conditions and circumstances are in line with the conditions and procedures that would have been applied by independent business partners under similar circumstances.

As obvious from decisions by the Czech courts, requirements on the quality of transfer pricing documentation have been growing. Documents such as concluded contracts and issued invoices are not sufficient to prove that services have actually been rendered at an arm’s length price.

Apart from discussions with auditors and tax authorities on transfer pricing issues, management must also cope with the demanding requirements of the due managerial care concept.  Statutory representatives are expected to show essential knowledge and necessary loyalty and care in all aspects of management. For example, seeking the general meeting’s agreement with transactions under conditions other than at arm’s length does not rid the statutory representatives of their liability.

The Criminal Code imposes even stricter requirements, and not only on company management. An individual holding a position of statutory representative, finance director or chief accountant may face criminal prosecution even for an indirect intent to intervene in accounting records, maintain and keep accounting and tax documentation or communicate with government bodies and business partners in a manner that may result in tax evasion. Such prosecution may result in the prohibition of professional activities, pecuniary punishment, confiscation of a thing or even imprisonment.

The higher the tax evaded, the higher the punishment. Imprisonment can be imposed for acts involving a substantial amount, i.e. exceeding TCZK 500. Taking into account a multinational corporation’s typical value of invoices for goods and services, we cannot but recommend preparing transfer pricing documentation that meets all relevant quality standards.

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