THE IMPORTANCE OF TRANSFER PRICING DOCUMENTATION AND THE IMPACT OF THE COVID19 ON DOCUMENTATION

Transfer pricing documentation and corporate tax return

In the current period, issues related to transfer pricing documentation are likely to arise for all companies concerned, as the deadline for preparing the documentation is the same as the deadline for submitting the corporate tax return. For taxpayers with normal financial year this date is no later than 31 May 2021 for the 2020 financial year.

When preparing the corporate tax return, all taxpayers, including small companies, must check whether the transfer prices they applied in their transactions with affiliated parties can be considered arm's length, as required by law. The arm's length principle must be met irrespective of the transfer pricing documentation requirement, so it is also important for small companies to examine this.

At this point  we would like to draw attention to the determination of the size of the company, which is also a task included in the context of preparing the report. The provisions of the SME Act also apply to corporate tax, and thus to the related transfer pricing documentation, according to which during determination of company size not only the company's own data must be taken into account, but the data must also be add together at the level of the group of companies (including foreign members of the group) with the data of the affiliated companies and their affiliated and partner companies, as well as the proportional data of the partner companies, where the data of the partners must be supplemented by the data of their related companies. Please note that if a company enters a new group or leaves the group due to a new ownership structure, its size may change immediately with the date of the change.

In the case of transactions with affiliated parties, if it is established that the individual transactions were not settled at arm's length, i.e. not at a price that independent parties prevail or would prevail between themselves in comparable circumstances, the corporate tax base shall be adjusted as follows:

1. In any case, there is an obligation to make an adjustment if the price settled between affiliated parties results in a lower profit before taxation for the company concerned than would have been in the case if an arm's length price had been applied.
2. If, on the other hand, the price settled results in a higher profit before taxation, the adjustment can be made if the affiliated party contracting with the company is a resident taxpayer or a foreign person subject to corporate income tax in its own country of residence and declares the amount of the difference.

Taking the adjustment into account not only affects corporate tax, it can also change the basis of assessment for business tax and innovation tax, and may also have an impact on VAT.

Documentation requirements

As of the 2018 financial year, transfer pricing documentation consists of a Master File about introducing the company group, and a Local File about the taxpayer, if there is a documentation obligation, in accordance with the NGM Decree 32/2017 (X. 18.).

The Master File provides an overview of transfer pricing relevant data for the whole group. The Local File describes the data for the company, the presentation and analysis of transactions between related parties, the related contracts, the relation between the financial data used in the arm's length pricing method and the data in the financial statements.

Hungarian legislation does not set a specific limit for the preparation of the Master File. If the Local File is required, the Master File must be available, so with that the transfer pricing documentation can be considered complete.

Impacts of the Coronavirus pandemic

In December 2020, the Organisation for Economic Co-operation and Development (OECD) published a guidance on the implications of COVID-19 for transfer pricing. The National Tax and Customs Administration (NAV) has already provided guidance to taxpayers on how to deal with the issues arising from this topic in September 2020. The guidance issued by the tax authority is in line with the OECD guidelines.

The OECD Guidance highlights four main areas, the area of comparative analysis, the area of allocation of losses and specific costs incurred as a result of COVID-19, government action and the area of advance pricing agreements. In this newsletter, we address the most important and common issues.

The coronavirus pandemic has different impacts on different sectors of the economy, industries and entities. Different operational decisions and strategies adopted by companies can result in significantly different profitability, even for firms in the same industry. In the light of this, a conclusion can only be drawn by looking closely at the circumstances of the transaction.

Adjustments may need to be made to the determination of comparable figures, but these should be consistent with the transfer pricing policy previously followed by the taxpayer. It is necessary to assess whether economic circumstances have changed in a way that would have affected the agreement of unrelated parties. Macroeconomic data, statistical data and methods, differences between planned and actual data, even partial data on the behaviour of independent market participants, may be taken into account in determining comparable data.

However, the questions mainly arise in connection with the comparable data when examining the profits made by companies, during the transactional net margin method. While, in general, comparable data are historical data, since at the time of preparation of the documentation data for the comparable companies are not yet available for the year under review, and therefore, in accordance with international and national practice, the data for the previous three years are taken into account, these data are unlikely to be comparable without adjustment. This raises the question of whether the data from the previous major economic crisis can be used as a basis. According to the guidance published by the NAV, the two situations are different, as the 2008-2009 crisis was a gradual one, while the pandemic brought rapid changes. The opinion published by the OECD is in line with this. The exact impact of the coronavirus is not yet known, as the situation is still ongoing. The data from the previous economic crisis should therefore not be taken as a basis, nor should they be used because they are quite old.

The OECD Guidelines and the guidance of NAV also address the question of whether data from companies that have made losses can be taken into account for the comparison. According to the guidance published by the NAV, if a large proportion of independent companies in the industry have incurred losses due to the negative effects of COVID-19, it is acceptable to include loss-making companies, but reliable data may not be available at the time of preparing the 2020 transfer pricing documentation. However, for companies with limited risk, the NAV guidance continues to expect low but stable profitability. The OECD Guidelines call for an assessment of whether COVID-19 has changed the risk appetite of a previously limited risk company.

In order to ensure comparability, according to the NGM Decree 32/2017 (X. 18.), the adjustment is possible not only for the comparable data, but also for the tested party, i.e. the taxpayer under investigation. According to the OECD Guidance, it is important to examine which party would have borne the additional costs incurred as a result of COVID-19 if the independent parties had agreed, and whether it is justified for the tested company to bear the additional costs.

Whether the adjustment is made to the taxpayer or to comparable data, it is essential to have precise documentation with figures. Any possible inspection  by the tax authorities will take place at a later stage, and although the OECD Guidelines state that an inspection should avoid making findings based on hindsight, information on the full range of industry participants is available at the time of the inspection. We consider it important to draw attention to the importance of keeping adequate and detailed records of the additional costs associated with the effects of COVID-19, the decisions to bear them, and all decisions and changes made in connection with the event that affect transfer prices, the activity, the function performed by the company in the related party, the risk assumed.