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What to expect in a transfer pricing inspection?

Not too long ago, transfer pricing was an issue tax administrators preferred to avoid, as their knowledge was limited in this respect. These times are over.

In 2016 and 2017, more than 14 billion Czech crowns were additionally assessed (including the reduction of losses) based on tax inspections focusing on transfer prices. From 2012 to 2014, only a little over 1 billion had been additionally assessed. Tax administrators have now turned their focus on corporations that generate losses or incur significant expenses for intra-group services. Tax inspections usually begin with a request to submit transfer pricing documentation or to fill in an extensive questionnaire (approx. 60 questions) focusing on a corporation’ functional and risk profile and on documentation supporting received services. Regardless of the extent of information provided by the corporation in response to the questionnaire and the quality of provided supporting documentation, the corporation may almost be certain that the tax administrator will subsequently and repeatedly request additional and more detailed information as well as other supporting materials.

Purposive selection
In many cases, the tax authority’s reasonable arguments seem to have disappeared. In addition to the oversimplified interpretation of a corporation’s functional and risk profile and a subsequent reclassification of a corporation to a contract manufacturer/contract distributor, the tax administrators increasingly often select and assess evidence with the single purpose of assessing additional tax.

In cases when no significant transactions have actually taken place within a group of companies, it is quite astonishing to see tax administrators treating a parent company as being responsible for poor results and incorrect business decisions of a local company, which is, in the tax authority’s opinion, actually a contract manufacturer, and as such must generate at least a minimum profit. The tax authority subsequently will not hesitate to devise a fictitious transaction, assess additional tax and request that damage in form of losses incurred by a Czech company be settled by its parent company. No wonder that the company subject to inspection often and soon becomes convinced that the inspection’s outcomes had been decided long before the inspection actually commenced.

Affected companies usually try to avoid any further interactions with the tax authority during appellate and subsequent court proceedings and decide to “sacrifice” one year, i.e. they pay the additionally assessed tax without any appeal. This, however, may be viewed by the tax authority as an invitation to inspect all other open years.  

Attack is the best defence
All the above shows that attack remains the best form of defence as the nearly unlawful tax administrators’ procedures and their simplified conclusions often meet with disagreement before the court. An alternative to defence before Czech courts is the involvement of a foreign tax administration via proceedings for mutual agreement upon a request filed by the company subject to inspection. It is up to each company to select the right strategy, but our experience has shown that if real economic arguments exist for a particular situation, it is better to defend and prove one’s rights at court. The more judicial decisions on transfer pricing, the clearer the limits within which tax authorities and taxpayers operate will become.