Transfer pricing - basic information

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Transfer pricing is a concept that occurs when transactions are concluded by related entities, i.e. those that have a specific impact on other domestic or foreign entities. What are transfer pricing? Who uses them? Who are affiliates? We answer below!

What are transfer prices?

Pursuant to Art. 23m of paragraph 1 point 1 of the PIT Act and Art. 11a paragraph. 1 point 1 of the CIT Act, the transfer price is "the financial result of the conditions established or imposed as a result of the existing relations, including the price, remuneration, financial result or financial ratio". Based on this definition, it can therefore be concluded that transfer prices are prices of goods and services and intangible assets sold by related entities, which consequently have an impact on the final financial result of the enterprise and financial indicators. Transfer prices usually deviate from market prices, i.e. general prices applied by unrelated entities. As follows from the Organization for Economic Co-operation and Development (OECD) Guidelines, transfer prices are an important factor in determining tax liabilities, taking into account the division into countries where multinational enterprises operate.

Related parties and unrelated parties

Transfer pricing is determined at the time of transactions between related parties. It is therefore worth taking a look at what they are. According to the provisions of the PIT and CIT Act, these are natural persons, legal persons or organizational units without legal personality as well as foreign establishments that take part in the management or control of another enterprise or have a share in the capital and profit of that enterprise.

Thus, there are:

  • domestic entity - an entity that participates directly or indirectly in the management or control of another enterprise located abroad or has a share in the capital of this enterprise,
  • foreign entity - an entity that participates directly or indirectly in the management of a domestic entity or holds shares in its capital,
  • the same natural or legal persons - who take part in the management and control of a foreign entity and a domestic entity or hold shares in their capital, and as a result of these connections conditions have been established that would not apply if these entities operated independently. The result of relationships between the entities is that they do not show any income or show lower income than that which would be achieved if the entities were not related. Undoubtedly, related entities are most often mother companies and their foreign or domestic daughter companies or sister companies.

Example 1.

Company X is the main company operating and headquartered in Germany. It holds shares in the Polish company Y and directly participates in the management of the enterprise. Thus, entities form related entities.

Transfer pricing - the most important functions

Transfer pricing has specific functions. The most important of them are:

  • income sharing function - related entities, when setting transfer prices, have a certain margin of freedom that affects tax planning, which in turn affects the amount of taxable income,
  • control function - this is the performance of control, planning and coordination activities that affect the functioning of the company. The use of transfer prices by related entities leads to a correct assessment of the functioning of related enterprises.

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The risk of applying transfer pricing

Transfer pricing is considered to be a tool for transferring income between related parties. This can be done by increasing the cost of purchasing goods or services or by lowering the revenue. As a consequence, the transfer of income contributes to the reduction of the interest rate in a given capital group or to the improvement of the financial result in the dominant enterprise in a given capital group.

If, in transactions between related entities, the income is understated, the tax authority may determine the income on the basis of the principles that would have been applied if the links between the entities did not exist. Art. 23o sec. 2 of the PIT Act:
"If, as a result of the existing relationships, conditions are established or imposed that differ from those that would be established between unrelated entities, and as a result the taxpayer shows an income lower (higher loss) than that which would be expected if the said relationships did not exist, the tax authority determines the taxpayer's income (loss) without taking into account the conditions resulting from these connections. "

The arm's length principle is applied to limit the use of transfer pricing to carry over income. Thanks to it, the tax authorities of the country in which related entities operate have the opportunity to verify the correctness of the prices established. The verification is made by comparing the conditions set by related parties to the conditions set by entities independent of each other. Art. 23o sec. 1 of the PIT Act:
"Related entities are obliged to set transfer prices on terms that would be agreed between unrelated entities." According to the above article, in order to correctly determine transfer prices, related entities should compare the agreed terms with those set by unrelated entities.

In summary, transfer prices are applied by related entities. However, it is worth remembering that when setting prices, one should take into account the conditions that would be taken into account if there were no links between the entities concerned. Thanks to this, they will not be exposed to the understatement of income, and thus to negative consequences caused by the determination of the level of income or loss by the tax authority.