Transfer Prices – The Arm's Length Principle in the Context of Parent Company Influence

In this regard, we would like to bring to your attention the latest ruling of the Supreme Administrative Court (hereinafter referred to as the "SAC") in the area of transfer pricing.

This decision concerns a Czech company operating within a group that has incurred a loss as a result of the influence of its parent company. The key factor to consider here is that the tax administrator identified this influence in relation to transactions carried out with independent companies, not only in relation to intra-group transactions.

During the course of a tax audit, the tax administrator concluded that the Czech company had provided services to its parent company. The scope of the service included the purchase and sale of goods at prices that did not allow the Czech company to achieve the arm´s length level of profitability normally achieved by independent companies. The following findings by the tax administrator were pivotal to this conclusion:

• The parent company was responsible for the negotiation and setting of the purchase prices of goods from independent suppliers.
• The Czech company sold these goods to an independent customer at prices set after consultation with the parent company.
• The parent company provided the Czech company with intra-group loans, thus enabling the Czech company to conduct its business activities.

As the Czech company was not remunerated by the parent company for carrying out this activity, the tax administrator determined that the arm's length principle had been violated, as the profit (loss) achieved by the Czech company did not correspond to the profits of comparable independent companies.

The tax administrator's conclusions were subsequently upheld by both the Regional Court and the SAC, including the related cancellation of the tax loss and the determination of the amount of additional tax assessed.

As outlined above, it is imperative to acknowledge that transactions involving unrelated parties may be classified as controlled transactions. These transactions are subject to the provisions outlined in Section 23(7) of the Income Tax Act, provided that the terms and conditions of these transactions are determined or influenced by the parent company or another company within the group. Therefore,  tax administrator may then conduct a thorough examination of the compliance of the terms of such transactions with the arm's length principle during a tax audit.

Authors:

Kateřina Veselá, Senior Consultant, Tax Department

Ivo Žilka, Tax Department Manager