“Bedding Textile Sp. z o.o.” (A) is a producer of bedding textiles which is sold to a related party C.
Following an audit, the tax authorities concluded, inter alia, that the pricing of the controlled transactions between A and C was not at arm’s length. This conclusion was based on a benchmark study which showed that the profit earned by A (1.61% ROTC) was lower than the net profit earned by unrelated comparables. The interquartile range for the transaction in question was determined to be between 4.20% and 9.22%, with a median of 5.23% (after rejecting extreme results), and since the profit reported by A was outside the interquartile range, the tax authorities adjusted to the median of 5.23%, i.e. the value that most closely approximates the market value.
An appeal was filed by A with the Administrative Court.
Judgment
The Administrative Court upheld the decision of the tax authorities in regards of the transfer pricing adjustment.
Excerpts in English
“In order to verify whether the terms and conditions of the transactions concluded by a party with a related party for the sale of products to C. are acceptable as transactions concluded on a free market basis, the authorities carried out a comparative analysis of the pricing methods in transactions between related parties with those carried out by independent parties. Based on external databases, i.e., inter alia, the CEIDG application, the REGON search engine, the D. company website, the National Court Register (online version), the authority identified 8 entities carrying out activities comparable to the party, finally, for the analysis it adopted four entities indicating their characteristics comparable to the party, taking into account the business profile, for the study it adopted the period from 2015-2019. For the verification of transactions it selected the net transaction margin method, considering it the most appropriate, taking into account: the type of transaction documented, functional analysis, as well as the availability of financial data. For the purposes of the financial analysis, he used the ratio of the mark-up to operating expenses – the operating mark-up, calculated according to the formula: operating profit (loss) x 100% / operating expenses (according to the authority’s calculation, Company A. achieved an operating profit ratio of 1.61% in 2020).
As a result of the analysis and the results obtained, the authority found that the interquartile range for the transaction under review is between 4.20% and 9.22% with a median of 5.23% (after rejecting extreme results). The authority – taking into account the assets involved by the company, the risks incurred, the access to capital, the way the company is managed – assumed that the amount of the operating mark-up in transactions to a related party that most closely approximates market value is the value corresponding to the median of 5.23%. Taking into account the arm’s-length principle, as well as the scope of A.’s functions, the assets involved and the amount of risk taken, while comparing the prices resulting from the analysis), he concluded that an operating profit mark-up of 1.61% on a sale by a controlled company to a related party was not market value. Consequently, it found a breach by the party of Article 11c(1) of the A.P.C. and, pursuant to the provision of Article 11c(2) of the A.P.C., determined the party’s income from the transaction with the related party without taking into account the conditions arising from the relationship and calculated its amount by increasing the Company’s tax revenue for 2020 by PLN 1,133,197.73.
In the Court’s opinion, the calculations presented by the tax authorities and the methods applied do not raise any doubts, and the reasoning in this respect, as well as the justification of the groundlessness of the appeal allegations in this respect, deserve approval.
Having regard to the party’s allegations, it should be briefly pointed out that, when selecting the most appropriate method in the given circumstances, particular consideration shall be given to the conditions which have been established or imposed between related parties, the availability of information necessary for the correct application of the method and the specific criteria for its application – as indicated by paragraph 3 of the aforementioned Article 11d of the Act.
In turn, in accordance with § 14(4) of the Ordinance of the Minister of Finance on corporate income tax transfer prices: the selection of an appropriate financial indicator is made taking into account the specifics of the industry (i.e. the subject of the business) and the relevant circumstances of the transaction. In the present case, the authorities reasonably took into account that the functional analysis showed that the applicant Company in the examined transaction performs functions typical of a producer and not of a distributor or agent. Which justifies the omission of the indicator indicated by the party, i.e. the net sales mark-up indicator. In doing so, it should be highlighted that the legislator only indicates that: transactions (accepted for examination) entered into by independent parties are to be comparable to those entered into by related parties, not identical. Similarly, the base: it is to be consistent and comparable, not identical. As regards the indicator cited by the party as correct for the transactions in question: the net sales mark-up, the authority correctly pointed out that this is an indicator to assess the mark-up applied in transactions between related parties for distributors and sales agents in relation to the purchase price (and not producers). The functional analysis showed that the complainant Company in the transaction under examination performs functions typical of a producer and not of a distributor or agent. Different economic indicators will apply to a trader that is a producer, others to a trader that is a distributor, still others to a seller or service provider.
Consequently, the determination under Article 58a § 1(4) of the CIT of an additional corporate income tax liability in connection with the issuance of a transfer pricing decision is justified, as the terms and conditions of the transaction between related parties in the present case were not determined on an arm’s length basis.
It is worth quoting at this point the statement of the Supreme Administrative Court, which, in the judgment of 20 June 2018, ref. no. II FSK 1665/16, emphasised that the purpose of the special legal regulation under Article 11c of the A.l.t.c. is to secure the interests of the State Treasury against such actions of taxpayers which consist in applying prices in mutual transactions that deviate from the market in order to achieve a tax result that is favourable to themselves. The prerequisite for the application of Article 11c of the A.p.d.o.p. is not the mere fact of the occurrence of links, between the parties to the transaction, but the use of these links to change the level of taxation (tax evasion). At the basis of the regulation contained in this provision is the assumption that all transactions should comply with market conditions, i.e. conditions that would be agreed upon by independent entities in the same or similar situation.”
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