TAX NEWS - DECEMber 2009

Slovakia Tax: Recent transfer pricing developments in Slovakia

Transfer pricing enforcement is gaining traction in Slovakia now that a specialized transfer pricing audit department has been established and formal transfer pricing documentation guidelines and advance pricing agreement (APA) procedures are in place.

Transfer pricing compliance has been part of Slovakian tax rules for some time; the arm's length principle was introduced in 1992, and taxpayers were required to document their related-party transactions. Taxpayers were left in a quandary, however, because no specific regulations, guidance, or case law existed on how to comply with these rules – and taxpayers did not know what to expect in a transfer pricing audit. Documentation preparation was left largely to the discretion and professional judgment of taxpayers.

The introduction of formal transfer pricing documentation became more essential following the current developments in Central and Eastern European countries, as well as increasing interest of the Slovakian tax authorities toward transfer pricing.

New documentation provisions for transfer pricing in Slovakia became effective as of January 1, 2009. In general terms, the provisions require taxpayers to now have upfront documentation related to the methodology for the determination of the transfer prices used in the transactions with the related party.

The Ministry of Finance of the Slovak Republic published guidelines on January 22, 2009, specifying the content of documentation required for the transfer pricing methods used by a taxpayer in cross-border related-party transactions.


General principles

The purpose of documentation is to record the pricing methodology of the taxpayer's non-arm's-length transactions, including its relationship with the related parties, the prices for services, loans, and credit granted. The documentation should demonstrate that the pricing of the Controlled Transactions1 is in compliance with the arm's length principle. The documentation content depends on the circumstances and conditions applicable to individual Controlled Transactions of the taxpayer and the transfer pricing method employed.

Documentation should be prepared separately for each Controlled Transaction or jointly for a group of Controlled Transactions, that is, several Controlled Transactions that are closely related, are of the same kind, have been made under identical conditions, or are comparable from a function and risk perspective.


Documentation requirements

There are two types of reporting requirements in Slovakia, depending on the taxpayer's financial reporting. The Full Documentation requirement is applicable only to IFRS reporters, and the Simplified Documentation requirement is applicable to non-IFRS reporters. The content of documentation is described below.

Full documentation: IFRS reporters – A taxpayer reporting its accounting results in individual financial statements according to IFRS is obliged to maintain the following documentation:

- General Documentation – Information relating to the whole group of related parties;
- Specific Documentation – Information regarding a related party.


General Documentation should contain the following information:

- Identification and legal description of individual group members, a description of the global organization and ownership structure of the group;
- Description of the group's business activity and strategy, industry identification, business relations and activities of the group within the industry;
- Planned business strategy, anticipated future activities, projects and goals of the group;
- General description of the functions performed by individual group members, as well as anticipated risks borne by the group members;
- Other related information that will help to prove compliance with the arm's length principle.


Specific Documentation is directly linked to General Documentation and contains specific information relating to the taxpayer. The Specific Documentation should contain the following information:

- Identification and legal form of the taxpayer, a description of its organizational and ownership structure;
- A description of the business activity and strategy of the taxpayer, industry identification, business relations and activities of the taxpayer within the industry;
- A planned business strategy and business plan of the taxpayer, its anticipated future activities, projects and goals;
- A list of Controlled Transactions, and a description of individual Controlled Transactions of the taxpayer (business terms and conditions and other matters having impact on the Controlled Transactions);
- An overview of the intangibles owned or used by the taxpayer (patents, trade-marks, business names, know-how, etc.), and the method and extent of their use;
- A list of measures preceding the evaluation, e.g. ratification of the valuation method, which has been approved for the taxpayer;
- A list of cost contribution agreements, on which the taxpayer has participated and any other decisions having impact on transfer pricing;
- A general description of the functions performed by the taxpayer as well as anticipated risks borne by the taxpayer;
- Internal or external comparable data from independent parties, comparability analyses (information on factors determining comparability of Controlled Transactions with uncontrolled transactions, asset or service characteristics, functional analysis, contractual terms and conditions, economic environment, specific business strategies);
- A description of the taxpayer's transfer pricing system and information regarding selection and application of transfer pricing method(s) and price determination for Controlled Transactions;
- Other information that supports and demonstrates compliance with the arm's length principle.

The taxpayer is required to maintain transfer pricing documentation as specified above regarding material Controlled Transactions;2 however, the taxpayer can, but is not required to, maintain documentation of immaterial Controlled Transactions.


Simplified documentation: non-IFRS reporters – A taxpayer reporting its accounting results under local (Slovak) GAAP is obliged to maintain simplified documentation. Simplified documentation includes information such as a list of transactions with related parties, the type of transaction, a description, volume, information on agreed prices used, transactions to be realized and volume. This information is to support compliance with the arm's length principle in material Controlled Transactions. The taxpayer can, but is not required to, maintain simplified documentation on immaterial Controlled Transactions.

Slovakian tax authorities interpret that the simplified documentation should at least contain simplified functional and risk analysis, selected method and comparable transactions/companies supporting the arm's length price.


Presenting / submitting documentation – Taxpayers must present their transfer pricing documentation upon request by the tax authorities during a tax audit. Then, the taxpayer has 60 days from the date the request is delivered to provide the required documentation.

Taxpayers who carry out a significant number of Controlled Transactions may be under time pressure and should have documentation readily available by the time of a tax audit. The tax authorities can request additional information to supplement the transfer pricing documentation, depending on the circumstances of the case.

The information provided in the transfer pricing documentation must be presented in Slovakian. If documentation is available in a foreign language, the timing and cost of translations should be considered.

The taxpayer may also be required to submit transfer pricing documentation in the following cases:

- As part of a request to obtain an advance pricing agreement (APA)3 from the tax authorities (the APA will approve only the selection of the transfer pricing method, but will not the arm's length price/range identified);
- As part of a request on corresponding adjustment to avoid double taxation; and
- As part of a request to start the mutual agreements procedure to be commenced under:
     . An applicable article of the international treaty on the elimination of double taxation in connection with the elimination of double taxation of the profit of related parties; and
     . Convention 90/436/EEC of July 23, 1990 on the Elimination of Double Taxation in connection with the adjustment of profits of associated enterprises.


Penalties – Failing to present the transfer pricing documentation within 60 days can result in fines up to €33,000 per request. Penalties are not tax deductible. However, truly adverse consequences are expected to come from transfer pricing adjustments. More specifically, if taxpayers fail to present their transfer pricing documentation file or have an incomplete file, the Slovakian tax authorities have the right to estimate their transfer prices. The tax authorities may also adjust the price to the most unfavorable point of the arm's length range. The transfer pricing adjustments likely will trigger additional profit tax liabilities and related penalties and late payment interest.


Audit environment – Until recently, Slovakian affiliates did not face intense transfer pricing scrutiny by the tax authorities, due mainly to the absence of specific regulations, such as the lack of formal documentation requirements, and the insufficient number of trained tax controllers for transfer pricing audits. Both factors are on the verge of being addressed.

Having the latest legislative developments on its side, the tax administration is facilitating professional training for tax inspectors.

Under these circumstances, a substantial increase in the number of transfer pricing audits can be expected. The focus of tax inspectors is likely to be on cross-border related-party transactions. Audits are more likely to be triggered by:

- A sudden drop in the Slovakian affiliate's profitability;
- Provision of management and consulting services;
- Long-term loss-making Slovakian affiliates; and
- Other Controlled Transactions wherein tax inspectors suspect that transfer prices are not at arm's length.

Considering the above, taxpayers should address their transfer pricing compliance strategies in advance to be fully prepared in the event of a tax audit.


Miscellaneous – The transfer pricing documentation requirement applies for the first time to a taxation period commencing after December 31, 2008, and the taxpayers are required to maintain the documentation for the applicable taxable period for 10 years. Should no new matters arise that impact the applicability of the transfer pricing method used in the Controlled Transactions, the transfer pricing documentation prepared by the taxpayer for the applicable taxable period will remain valid for the subsequent taxable periods as well.


Conclusion

Operating in a modern transfer pricing environment, Slovakian taxpayers should treat transfer pricing as both an opportunity and a threat. Opportunities arise in terms of spotting the optimal value chain models that may give the entity an advantage in its markets, while threats arise in terms of compliance obligations and tax risks. Entities that commit themselves to seizing the opportunities through transfer pricing policies are expected to emerge as winners.

Ultimately, identifying the most appropriate transfer pricing strategy is a focus that every Slovakian finance manager or tax manger should keep on his or her agenda.