12.03.2009
Transfer pricing: opportunity or threat to businesses in Latvia
During the period of economic crisis transfer pricing becomes a vital tool used by tax authorities throughout the Europe to increase tax revenues. In Latvia, however, the authorities are not that active in this area yet, but does it mean the Latvian businesses can sleep well? In this respect the businesses must remember that tax audits normally can go three years back to audit taxes in Latvia. Thus we must already now project what might be the authorities’ approach in 2012. The tax authorities normally tend to challenge transfer prices of taxpayers that have low profitability, Janis Taukacs, Sorainen Riga partner writes in Sorainen Blog.
Transfer pricing regulations focus on transactions between related entities that are located in different jurisdictions. Since overwhelming majority of businesses in Latvia are either subsidiaries of foreign parent companies or have related entities outside Latvia it does not come as a surprise that the Ministry of Finance sees area of transfer pricing enforcement as a vital tool to increase the budget revenue.
This tendency is common in the whole Europe. Recently Poland became very aggressive in transfer pricing enforcement area. Germany, France and the UK are known for being historically aggressive in requiring companies to defend their transactions with foreign related parties. Penalties for not compliance are harsh.
With minor adjustments all countries in the European Union base their transfer pricing regulations on the OECD transfer pricing guidelines. Latvian tax authorities are quickly learning from their colleagues in Europe hence Latvian companies should be prepared to defend their transactions with related foreign parties. Majority of costly problems in the transfer pricing area could be avoided by correct planning and documentation.
The cornerstone question in the transfer pricing area is the following: Would the same prices for goods, services, credits or financial guarantees between companies be changed if they were unrelated?
Transfer pricing analysis is rarely “black and while” one, there are many “grey” areas that could be hard to justify or defend without professional help. To make things more problematic, transfer pricing adjustments to the cost base in one jurisdiction will not automatically result in comparable adjustments or tax credits in another jurisdiction. Let us illustrate it by an example.
A Latvian subsidiary of a German parent buys products from its German parent and distributes these products in Latvia. Due to the latest downturn in the economy Latvian subsidiary was making operating losses on its distribution activities in spite of the low risk profile of its operations. Latvian tax authorities could question if the prices paid by Latvian company to its German parent are at arm’s length or prices should have been decreased, esp. if unrelated distributors were able to re-negotiate terms with the German manufacturer. If Latvian tax authorities make a transfer pricing adjustment decreasing the base price for the products purchased from the German parent to bring it at pair with the prices paid by unrelated distributors, tax authorities in Germany could not automatically make matching adjustment for the parent hence German parent may not issue a credit to its Latvia subsidiary.
Transfer pricing analysis consists of two major parts: legal analysis and economic analysis. Tools used in the economic analysis are similar to those used in valuation analysis. Analysis includes market, profitability and statistical parts. In Latvian law three transactional transfer pricing methods (i.e. comparable uncontrolled price, cost-plus and resale method) prevail. Two profit-based methods (i.e. transactional net margin method and profit split method) are available, if the first three methods are not sufficient for determining the arm's length price.
This information is provided in cooperation with Alexey Khripunov, managing director at a US-based firm that provides economic research, statistical analysis services in the transfer pricing and valuation areas as well as M&A services. Sorainen Tax Practice will present a special seminar focused on transfer pricing issues for Latvian companies. Together with Sorainen tax professionals economic analysis part of the seminar will be presented by Alexey Khripunov who has over 10 years of experience in helping multinational companies with transfer pricing planning and documentation challenges. Please feel free to contact me to request detailed information about upcoming seminar on transfer pricing (janis.taukacs@sorainen.lv).