Comply with the arm’s length rule and fulfill your obligations properly

Failure to fulfil transfer pricing obligations carries serious sanctions, which can be divided into the following categories:

• liability under the Fiscal Penal Code (FPC),

• an increased tax risk regarding the assessment of additional income,

• an additional (penalty) tax liability.

Fiscal Penal Sanctions (FPC)

• Liability under the FPC applies to persons responsible for the entity’s business affairs, i.e., in principle, members of the management board.

• Transfer pricing documentation:

  - failing to prepare local documentation (including a transfer pricing analysis), preparing it inconsistently with the actual facts, or failing to attach the group documentation, carries a fine of up to 720 daily rates;
  

  - failing to fulfil the above obligations on time carries a fine of up to 240 daily rates.
  

• Transfer pricing information:

  - failing to file the TPR information to the competent authority, or including data in it that is inconsistent with the local documentation or the actual facts, carries a fine of up to 720 daily rates;
  

  - filing the TPR information after the deadline carries a fine of up to 240 daily rates.
  

• In minor cases, the offender is liable to a fine for a fiscal offence.

Increased tax risk

• If the tax authorities conclude that a taxpayer should have declared higher income than actually reported, they will have discretion in determining the amount of that income. The absence of transfer pricing documentation, including an analysis confirming the arm’s length nature of the transaction terms, means the taxpayer lacks supporting arguments and comparable data that the authority would otherwise have had to verify.

• An assessment of additional income means determining CIT tax arrears, i.e., taxing the assessed additional income at the standard rate of 19% (or 9%), together with charging the taxpayer late-payment interest.

Tax sanctions

• Regardless of the penalties and risks described above, if an audit results in the correctness of the price applied by the taxpayer in a given transaction being challenged, the authority will, by way of a decision, determine an additional tax liability. The standard rate of this penalty liability is 10% of the value of the assessed additional income.

• If the taxpayer failed to submit the mandatory transfer pricing documentation, the rate increases to 20% - which is why fulfilling these obligations is so important.

To understand what constitutes a relationship between entities, it is necessary to understand the definition of “exercising significant influence”. This is:

• holding, directly or indirectly, at least 25% of:

  - shares in the capital,
  

  - voting rights in controlling, decision-making or managing bodies,
  

  - rights to a share in profits, losses or assets;
  

• an individual’s actual ability to influence key business decisions of a given entity;

• being married to, or being related by blood or affinity up to the second degree with (grandchildren and grandparents, siblings, parents and children, parents-in-law, brother-in-law/sister-in-law).

Entities are considered related if:

• one entity exercises significant influence over at least one other entity (e.g., a parent company and a subsidiary),

• they remain under the significant influence of the same other entity (e.g., companies with the same management board member, sister companies),

• one entity is under significant influence of a person related by blood or affinity to a person who exerts significant influence on the other entity (e.g. companies related by spouses who are members of the management boards of these companies),

• the relationship concerns a company that is not a legal person and its partner,

• the relationship concerns a general partner and a limited partnership or a limited joint-stock partnership,

• the relationship concerns a taxpayer and its foreign permanent establishment,

• relations exist between entities that are not established or maintained for justified economic reasons.

A transfer pricing analysis is, as a rule, a mandatory element of local transfer pricing documentation. There are, however, situations in which a taxpayer is exempt from the obligation to prepare it and attach it to the documentation.

Local transfer pricing documentation may not include a benchmarking analysis or a compliance analysis in the following cases:

• transactions carried out by micro-entrepreneurs and small entrepreneurs (within the meaning of the Business Law Act) – provided the thresholds defining that status are met in the year for which the documentation is prepared;

• tax haven transactions other than controlled transactions (with an unrelated party) – in which case, instead of a transfer pricing analysis, the documentation should include the economic justification for the transaction.

Polish regulations provide for a broad range of situations in which taxpayers are exempt from the obligation to prepare local transfer pricing documentation:

• Domestic transactions – this is one of the most commonly applied exemptions. To benefit from it, the following conditions must be met cumulatively:

  - all entities participating in the transaction have their place of residence, registered office or management on the territory of Poland,
  

  - none of the entities benefits from the subjective CIT exemption or from exemptions relating to Special Economic Zones (SEE) or the Polish Investment Zone (PSI),
  

  - none of the entities incurred a tax loss in the year to which the documentation relates.
  

• Transactions covered by the so-called safe harbour mechanism – taxpayers may be exempt from documentation for specific types of transactions:

  - low value-added services – provided an appropriate level of mark-up on the costs of those services is maintained and the formal conditions are met,
  

  - financial transactions (a loan, credit facility or bond issue) – provided, above all, that the interest rate is set based on the announcement of the Minister of Finance, and the loan term does not exceed 5 years.
  

• so-called pure re-invoicing transactions,

• other types of transactions provided for under Article 11n of the CIT Act.

Transfer pricing regulations do not apply, among other things, to transactions in which the price, or the method of determining it, results directly from statutory provisions or from implementing regulations issued on their basis.

Furthermore, where certain statutory conditions are met, the tax authority will refrain from determining the taxpayer’s income (loss) for transfer pricing purposes. This applies where safe harbour mechanisms are used, in which case treated as arm’s length, for:

• low value-added services,

• financial transactions (a loan, credit facility or bond issue).

A tax haven, formally referred to as a country or territory engaging in harmful tax competition, is a jurisdiction characterised by significantly lower tax rates, or an absence of taxation, compared to other countries.

The list of countries and territories engaging in harmful tax competition is set out in the Regulation of the Minister of Finance on the list of countries and territories engaging in harmful tax competition for corporate income tax purposes.

In addition to preparing local transfer pricing documentation and filing TPR-C information, entities carrying out controlled transactions are subject to a range of further reporting and documentation obligations, including:

• Preparation of group transfer pricing documentation (Master File), intended to present a consolidated description of the entire group, its strategy, finances, key intangible assets and value chains. This obligation applies to taxpayers:

  - required to prepare local transfer pricing documentation for the given year (Year X),
  

  - belonging to a group of related entities preparing consolidated financial statements,
  

  - where the consolidated financial statements are prepared using the full or proportional consolidation method,
  

  - and where the group’s consolidated revenue exceeded PLN 200 million in Year X-1.
  

• Country-by-Country (CbC) Reporting – comprising the notification submitted by the reporting entity (CbC-P) and the CbC-R report on the group’s global allocation of income, taxes paid, and places of business activity (applicable to groups with consolidated revenue of PLN 3.5 billion or EUR 750 million).

• Public reporting on income tax (so-called Public CbCR) – public statement on the allocation of taxation across jurisdictions, prepared and published, in principle, by the ultimate parent entity of the group or by standalone units with foreign permanent establishments (applicable to groups with consolidated revenue of PLN 3.5 billion or EUR 750 million).

• Filing of ORD-U information – an obligation arising under the Tax Ordinance. Information for a given year must, as a rule, be filed by the end of the 11th month following the end of the tax year. However, where the taxpayer is required, for that year, to file transfer pricing (TPR) information, the obligation to file ORD-U does not arise (except in situations where the taxpayer carried out a controlled transaction with a party from a tax haven). This information concerns agreements/transactions in which:

  - personal or capital relations exist between the parties to the agreement, with a value of at least 5%, and the total amount of receivables or liabilities arising under the agreement exceeds the equivalent of EUR 300,000, or
  

  - the other party to the agreement (a non-resident) has an enterprise, branch or representative office on the territory of Poland (within the meaning of separate provisions) – concerning agreements giving rise to (one-off) liabilities or receivables exceeding the equivalent of EUR 5,000
  

If a given controlled transaction departs from arm’s length terms, steps must be taken to bring its result in line with the level that independent entities would have established between themselves. Failing to act exposes companies to an assessment of additional income by the tax authorities, as well as to severe financial penalties.

However, the legislator has provided for corrective mechanisms enabling taxpayers to adjust a non arm’s length transfer price:

• Transfer pricing adjustment – this is the primary tool allowing for the price to be adjusted independently. Importantly, a transfer pricing adjustment requires a strict condition to be met – the transfer price must originally have been set on arm’s length terms.

• Application of one of the available compensation mechanisms (§ 9 of the Transfer Pricing Regulation) – a taxpayer may defend the arm’s length nature of a transaction by demonstrating that:

  - the less favourable terms of a given transaction are compensated for by more favourable terms in another transaction concluded with the same related party, or
  

  - in one tax year the taxpayer reported income lower than could have been expected, and, over a three-year period covering that tax year, it reported income from the transaction higher than could have been expected.
  

If the taxpayer fails to make an adjustment or defend a non-arm’s length transaction, the tax authority will be able to assess additional taxable income, and also to impose an additional tax liability on the taxpayer.

The transfer, between related parties, of economically significant functions, assets or risks is defined, under transfer pricing regulations, as a restructuring.

An action is treated as a restructuring subject to special regulation if both of the following conditions are met cumulatively:

• there is a material change in the business relationships between related parties, including the termination of an agreement or a change in its terms, in connection with the transfer of functions, assets or risks,

• as a result of the restructuring, the taxpayer’s projected average annual financial result (EBIT) over the three-year period has changed by at least 20% of the projected EBIT that would have applied had the restructuring not been carried out.

In this regard, it is necessary to verify whether it is required to determine remuneration for the transfer of profit-generating potential (an exit fee), and to check whether the transaction exceeds the relevant thresholds triggering the taxpayer’s obligation to prepare local transfer pricing documentation.

If it is anticipated that the transferring entity’s average annual EBIT will decrease by more than 50%, this may indicate that a tax arrangement must be reported (MDR).

An advance pricing agreement (APA) is a mechanism under tax law that allows a taxpayer and the tax administration to agree, in advance, on the method for determining transfer prices for transactions between related parties. Covering a controlled transaction with an APA is a solution that provides taxpayers with measurable benefits and ensures a high level of tax security.

• Transactions covered by an APA benefit from a statutory exemption from the obligation to prepare local transfer pricing documentation.

• For the period covered by the APA, the tax authority will not determine a tax liability (i.e., it will not assess additional income or reduce a loss) with respect to the income or loss established in accordance with that agreement.

W obszarze cen traIn the area of transfer pricing, the obligation to report tax arrangements (MDR) is of particular importance – that is, the obligation to report arrangements that:nsferowych szczególne znaczenie ma obowiązek raportowania schematów podatkowych (MDR), czyli uzgodnień, które:

• display specific hallmarks,
  and/or

• lead to the achievement of a tax benefit.

Not every transaction with a related party constitutes a tax arrangement. The provisions of the Tax Ordinance do not contain a list of specific transfer-pricing-related events, but rather set out specific hallmarks. In practice, these include, in particular:

• restructurings resulting in a projected material decrease in the transferring entity’s average annual EBIT (of more than 50%),

• the transfer of hard-to-value intangibles (HTVI),

• stosowanie niektórych uthe application of certain transfer pricing simplifications, in particular the safe harbour mechanism for financial transactions.proszczeń z zakresu cen transferowych, przede wszystkim mechanizmu safe harbour dla transakcji finansowych.