In this article, we will first review the current regulations governing transfer pricing, and then examine the proposed changes included in the “Polish Deal” package.
Specific conditions allowing an adjustment of transfer prices under CIT Act Art. 11e:
“The taxpayer may make an adjustment of transfer prices by modifying the amount of revenue generated or revenue-earning costs incurred, if all the following conditions are met:
1) In controlled transactions carried out by the taxpayer during the tax year, terms were established that would have been established by unrelated entities.
2) There was a change in relevant circumstances having an impact on the terms established during the tax year, or the actually incurred costs or revenues that are the basis for calculating the transfer price are known, and ensuring their compliance with the terms that would have been established by unrelated entities requires an adjustment to the transfer prices.
3) At the time the adjustment is made, the taxpayer holds a statement by the related entity that that entity has made an adjustment to the transfer prices in the same amount as the taxpayer (for downward adjustments by the taxpayer).
4) The related entity referred to in point 3 has its residence, registered office or management in the territory of the Republic of Poland or in a state or territory with which the Republic of Poland has concluded an agreement on avoidance of double taxation or there is a legal basis for exchange of tax information with that state.
5) The taxpayer confirms execution of the adjustment of transfer prices in the annual tax return for the tax year which the adjustment concerns.
Tax issues concerning adjustments to transfer prices
On 31 March 2021, the Polish Ministry of Finance published tax clarifications involving transfer prices, concerning adjustments to transfer prices within the meaning of CIT Act Art. 11e (or Art. 23q of the Personal Income Tax Act, as the case may be), under the regulations in force from 1 January 2019.
The clarifications raised the issues of the essence and aim of the adjustment, the frequency and timing of adjustments, the manner of documenting the adjustment, and the conditions that must be met when making adjustments of transfer prices. Examples were presented to illustrate these issues. The clarifications also covered the following additional issues:
- The aim of the adjustment is to adjust the transfer prices for the given settlement period to an amount consistent with the arm’s-length principle. The taxpayer should make an adjustment in a situation where even though it acted fairly and rationally in concluding a transaction, to maintain the arm’s-length principle, the transfer price applied by the taxpayer ex post is not market-based.
- The reason for making an adjustment cannot be an accounting error or other oversight. In that case, the taxpayer should make an adjustment retrospectively, during the period affected by the error.
- An adjustment of transfer prices is not intended to “market-up” the terms of a completed transaction; the terms should already have been market-based.
- Adjustments may also be made with respect to a related entity that is not a party to direct transactions with the taxpayer (an example given is a central entity with extensive functions, assets, and risks in relation to related entities fulfilling manufacturing and distribution functions, for which the central entity uses the adjustment to top up the profitability to an amount consistent with the arms-length principle).
- Adjustments between related entities resulting from a change in the circumstances of a specific transaction, such as returns, volume rebates, or the like, are made on the basis of general rules and do not constitute an adjustment within the meaning of CIT Act Art. 11e.
- The method for verifying transfer prices made by the taxpayer in establishing the terms of the transaction should be identical to the method used for making the potential adjustment.
- A finding that a specific adjustment constitutes an adjustment within the meaning of CIT Act Art. 11e should not be determined by the form of the accounting document on the basis of which it was made (the preferred form is an accounting note or correcting invoice), but rather the economic essence of the adjustment, including the functional profile of the parties to the controlled transaction.
- As a rule, adjustments are made after the end of the tax year, although the possibility of making adjustments during the tax year, e.g. after the end of a month or quarter, cannot be excluded.
- The tax consequences of a controlled transaction are determined for the given tax year. As a rule, the adjustment must be made before filing the tax return for the given year, and should cover a period of no longer than the tax year. It is also possible to make an adjustment after filing of the annual return.
- In assessing the rationale for making an adjustment, it is also taken into consideration whether the contract concluded between related entities includes a clause enabling retroactive correction or amendment of the price, margin, markup, or financial result. But lack of a contractual clause for correction or amendment does not exclude making an adjustment.
- If a related entity issues an accounting document constituting the grounds for making an adjustment and delivers it to the taxpayer, receipt of such document will fulfil condition 3, i.e. the condition of holding a statement of the related entity on making an adjustment of transfer prices, if it also meets the requirements for accounting evidence pursuant to the adopted accounting rules.
- If a downward adjustment is made on the basis of an accounting document issued by the taxpayer itself (without receiving an accounting document from the related entity), the taxpayer may obtain a statement from the related entity on making the adjustment.
- If at the time of filing the annual tax return the taxpayer does not hold a statement of the related entity that it had made an adjustment of transfer prices in the same amount as the taxpayer, then, in the annual return for the period which the adjustment concerns, the taxpayer shall not reflect that adjustment. After receipt of the relevant statement from the related entity, the taxpayer should amend the annual return for the tax year which the adjustment concerns.
- If there is a need for two balancing KCT11e adjustments (upwards and downwards) between the same two related entities, in light of the more extensive set of conditions for downward adjustments, for tax purposes the taxpayer should make such adjustments separately.
- An adjustment of transfer prices that does not result from a material change in circumstances or the adopted method of establishing the transfer price based on the budget (plans or cost estimates) should not be examined in terms of the conditions set forth in CIT Act Art. 11e (an adjustment not constituting KCT11e), but should be conducted under general rules.
What does “relevant circumstances” mean?
Circumstances relevant from the point of view of transfer prices which could not be foreseen as of the time of planning the level of transfer prices for the given year may include, for example, material changes in market prices of basic commodities or materials, fluctuations in exchange rates, changes in interest rates, or significant fluctuations in supply or demand for a given product caused by factors independent of the taxpayer and the related entity.
Differences between the projected profitability and the actual profitability may also result from a model in which transfer prices were established during the course of the year based on historic costs, and during the course of the year the taxpayer could not adjust to the actual costs, where there was a change in relevant circumstances that could affect the level of the transfer price. Then a difference could arise at the end of the year, resulting from a comparison of the historic and actual costs.
Statement on making adjustment of transfer prices
A taxpayer making a KCT11e adjustment downward must hold a statement that the related entity has made an adjustment of the transfer prices in the same amount as the taxpayer. A taxpayer taking an upward adjustment is not required to hold such a statement, in accordance with the wording of the CIT Act.
It is important to remember the current exemption (introduced under the anti-COVID act) from the taxpayer’s obligation to hold a statement as a condition for making a downward KCT11e adjustment when determining the amount of revenue and revenue-earning costs. However, this exemption covers only adjustments made within a specific period, i.e. during the crisis caused by COVID-19, in connection with which the repeal of a state of epidemic threat and state of epidemic announced in connection with the COVID-19 pandemic covering the entire territory of Poland is cited in the regulation. These changes are effective from the start of the COVID-19 pandemic.
Adjustments to transfer prices made before 1 January 2019
It should be stressed that the regulations presented above concerning recognition of adjustments apply only to transactions executed on or after 1 January 2019.
In this respect, it is hard to say that there is a clearly developed line of case law concerning earlier years, which demonstrates the complexity of this subject matter and encourages taxpayers to pursue their rights through the courts.
The problem of recognition of adjustments to transfer prices for the period of 2016–2018 will continue to be a pressing issue for some time yet, and thus it would be desirable for the Minister of Finance to issue tax clarifications in that regard.
The Polish Deal and adjustments of transfer prices
The proposal in the “Polish Deal” package includes a clarification that it is possible to make an adjustment of transfer prices downward also in a situation where the taxpayer has received accounting evidence from a related entity confirming that the related entity has made an adjustment of transfer prices in that amount. This change confirms the possibility already existing under the current law of making an adjustment on the basis of an accounting document received from the related entity which meets the condition for holding a statement of the related entity on making an adjustment of transfer prices, so long as it also meets the requirements for accounting evidence in accordance with the adopted accounting rules. It is also proposed to abandon the obligation to report on making an adjustment of transfer prices in the annual tax return. Thus one of the formal conditions for effectively making such an adjustment would be eliminated.
