Transfer pricing adjustment – what is worth knowing about it?
Transfer pricing is one of the most difficult areas of tax law. The regulation of transactions between related parties aims to ensure that the prices determined reflect market conditions and do not lead to tax avoidance. In this context, the transfer pricing adjustment becomes an important tool to align tax settlements with actual economic conditions. It is worthwhile to understand what exactly a transfer pricing adjustment is, under what circumstances it can be applied and what risks are associated with it.
What is a transfer pricing adjustment?
A transfer pricing adjustment is a mechanism to bring financial results from related party transactions into line with market values. In practice, this means adjusting income or expenses to ensure compliance with the arm’s length principle. This avoids disputes with the tax authorities and also ensures that transactions are in line with actual economic conditions. The introduction of an adjustment may result from differences between the conditions envisaged at the beginning of the transaction and what actually happened during the execution of the transaction.
When can an adjustment be applied?
Transfer pricing adjustments may be necessary in situations where the original arrangements do not correspond to market conditions. Changes in economic conditions, such as sudden fluctuations in exchange rates or increases in raw material prices, may require transfer prices to be adjusted to reflect the current economic situation. Also, unforeseen events such as disruptions in supply chains that change the realities of doing business may lead to the need for an adjustment. Sometimes the differences between the expected and actual results of a transaction are significant enough to require an adjustment of the financial results to be in line with the arm’s length principle.
Conditions for the application of the adjustment
For a transfer pricing adjustment to be effective and recognised by the tax authorities, several key conditions must be met. First and foremost, the company must have adequate documentation that explains the reasons for the adjustment and its relation to actual economic conditions. All adjustments should be consistent with the company’s transfer pricing policy and the documentation prepared for tax purposes. It is also important that the adjustment is agreed between all parties to the transaction, meaning that related parties must accept the changes made. It is also crucial that the adjustment is made in a timely manner so that it can be recognised in the tax accounts for the year.
Risks associated with the adjustment
Although transfer pricing adjustments are an important tool for bringing financial results in line with economic realities, they carry certain risks. Lack of adequate justification or insufficient documentation may lead to the adjustment being challenged by the tax authorities. In the event of a dispute, the taxpayer may be exposed to additional tax liabilities, interest and fiscal penalties. A particular risk in international transactions is the non-acceptance of the adjustment by foreign tax authorities, which may lead to double taxation of income.
How to prepare for an adjustment?
Companies should regularly monitor the performance of related-party transactions and analyse whether they meet the conditions of marketability. Preparing ongoing documentation that justifies adjustments and takes into account changing economic conditions is key. It is also advisable to consult transfer pricing experts who can assist in the preparation of appropriate policies and documentation. Preparing and updating documentation in line with current legislation and OECD guidelines avoids many potential problems.
Summary
The transfer pricing adjustment is an important element in ensuring that transactions between related parties are in line with actual economic conditions. Its application avoids disputes with tax authorities and brings financial results into line with market principles. However, proper preparation is key, including documenting the reasons for the adjustment, its compliance with the transfer pricing policy and agreeing the changes with related parties. A proper approach to adjustment can be beneficial both in terms of compliance and in building a transparent relationship with the tax administration.