Since the last global financial crisis, transfer pricing has become an increasingly common term in the business press, sometimes associated with sensationalist approaches to the strategies used by large multinational groups to divert profits to low or no tax territories or tax havens. Today we will focus on explaining everything related to transfer pricing. All you have to do is read on.
What is transfer pricing?
In open market conditions and free competition, when two independent individuals or companies carry out an economic transaction of any kind (purchase of goods, loan, …), the very opposition of their own interests is reflected in the price they finally agree on, which is called market value.
However, when these two parties or companies are linked or related, or subject to a common control, this opposition of particular interests may not exist or may yield to the interest of the common shareholder. Transfer pricing is the prices agreed in transactions between related parties or entities.
What does transfer pricing analyze?
In related party transactions, the Tax Authorities may have the suspicion that the absence of a particular interest opposition may lead the related parties to agree on prices different from the market values in order to take advantage of a tax advantage, such as a more favorable tax treatment in one of the parties (more generous tax deductions, a lower tax rate, tax opacity…).
For this reason, the tax laws of various countries and tax treaties have gradually incorporated specific rules on transfer pricing since the beginning of the 20th century.
Currently, almost all countries in the world have established tax rules that follow an international standard called the Arm’s Length Principle, which determines that transfer pricing is determined in accordance with certain valuation methods and tax criteria, which aim to ensure that such prices reflect the conditions that would be agreed upon by independent parties in the open market and the value creation of each of them.
When is transfer pricing applied?
As we have indicated, transfer pricing is the prices agreed in any type of transaction carried out between related or related individuals or entities. Unfortunately, there is no universal definition of what is meant by relatedness and depending on the country we will find narrower definitions (e.g., only companies belonging to a group) or broader ones (e.g., a certain participation in the capital of the company).
In Greece, the Income Tax Code (L.4172/2013, Article 2, Section g and POL 1142/2015) contains the Greek definition of related parties:
‘Associated person’: any person who participates directly or indirectly in the management, control, or capital of another person with whom they are related or associated. In particular, the following persons are regarded as associated persons:
- any person who owns directly or indirectly stocks, shares, or shareholding of thirty-three (33) percent or more, by value or by number, or profit rights or voting rights,
- two or more persons if one person owns directly or indirectly stocks, shares, voting rights or participation in the capital of at least thirty-three (33) percent, by value or by number, or profit rights or voting rights,
- any person with whom there is a direct or indirect relationship of substantial management dependency or control, or who has or could potentially have a decisive influence on another person, or where both persons have direct or indirect relationship of substantial management dependency or control with a third person or are potentially influenced by such third person.
The above definition applies only for Greek direct tax purposes (personal income tax, corporate income tax and non-resident income tax) and may be different for accounting or VAT purposes.
Permitted Methods for determining Transfer Pricing
The valuation methods permitted by the tax regulations in Greece are the five methods recognized by the OECD Transfer Pricing Guidelines, as follows:
Traditional transaction-based methods
Comparable uncontrolled price method (CUP)
The CUP method is what we all intuitively consider as taking the market value of a good or service.
It consists of valuing the related transaction at the price that would have been agreed upon by independent parties exchanging an identical or very similar good or service under identical or very similar conditions.
Resale price method (RPM)
This method is particularly useful when we are dealing with marketing or distribution activities of goods in which the marketing related party does not make substantial contributions of value.
This method starts from the price at which the related party marketer resells the merchandise to the final customers. The value (the price at which the reseller buys the products from its related party supplier) is determined by subtracting a market resale gross margin from the resale price.
Cost-plus method (C+)
This method is particularly useful for valuing manufacturing operations of semi-finished goods or services.
The value is obtained by adding the direct and indirect costs associated with the production of the goods or the provision of a service, and a market mark-up, which compensates the producer for the performance of its functions, use of assets and assumption of risks in this activity.
Transactional net margin method (TNMM)
This method is the most widely used in practice because it overcomes most of the practical difficulties in accessing publicly available information on gross profit margins and detailed information on the activities of the independent companies present when trying to rigorously apply the resale price or cost-plus methods.
In this method, transfer pricing is valuated (or tested) by comparing the net margin (operating profit) derived from the related transaction with that obtained from comparable transactions between independent parties.
The practical application of this method requires choosing one of the related parties as the tested party, from which the net margin of the transaction will be evaluated in relation to another economic parameter (sales, costs, assets) in the form of a profit level indicator (PLI).
Profit split method (PSM)
This method is based on determining the value with a finalist result, so as to distribute the common result (profit or loss) derived from the performance of the related transactions among the individuals or entities that carry them out according to a criterion that adequately reflects the conditions that would have been subscribed by independent individuals or entities in similar circumstances.
It is a method of great technical complexity in its application, but one that the OECD Guidelines increasingly recommend for valuing transactions in which the activities of both related parties are so integrated that it is impossible to find comparable market situations, or in which both related parties make unique and valuable value contributions, generally using relevant intangible assets.
Method selection criteria
The choice of valuation method should take into account, among other circumstances, the nature of the related party transaction, the availability of reliable information and the degree of comparability between related and unrelated transactions.
Use of other methods
When it is not possible to apply the above methods, other generally accepted valuation methods and techniques may be used, but always respecting the arm’s length principle.
Formal transfer pricing obligations and deadlines
For the purpose of ensuring that companies comply with the obligations to correctly value linked transactions and to facilitate the verification of transfer pricing, the tax authorities of various countries have introduced the obligation to prepare written transfer pricing documentation.
The transfer pricing documentation required by Greek regulations is in line with OECD recommendations, and is structured in two blocks:
a) Master file or specific documentation related to the group; and
b) Local file or taxpayer-specific documentation.
The content of this documentation is detailed in POL. 1097/2014, as amended by POL. 1144/2014, which closely follow that detailed in the OECD Transfer Pricing Guidelines.
This documentation must be prepared (or at least updated) on an annual basis by the companies until the deadline for filing the Annual Corporate Income Tax Return (generally, June 30 for companies with fiscal year coinciding with the calendar year). However, it should be made available to the Greek Tax Authorities upon 30 days from the related request.
In addition, companies must file a Summary Information Table with information on the transfer pricing applied in their related-party transactions. This informative declaration must include all the related transactions that must be included in the transfer pricing documentation. The Summary Information Table must be filed until the deadline for filing the Annual Corporate Income Tax Return.
Examples of Transfer Pricing
Transfer pricing is a common circumstance in the operations of groups of companies. Let us illustrate it with some examples:
- Generally, groups seek to save costs or take advantage of synergies by concentrating the resources of a given activity in the parent company or in a shared service center. For example, marketing and advertising campaign design resources for all group companies can be concentrated in a central group marketing department. This will give rise to invoicing for management support services (colloquially known as management fees) between the parent company where these common resources are concentrated and the subsidiaries that benefit from them, which should be valued in accordance with transfer pricing rules.
- Groups often take advantage of their size to obtain better financial conditions when borrowing from banks or issuing debt on the markets. For this reason, external financing is obtained by the parent company itself or by an ad hoc entity with its guarantee. Subsequently, this bank financing is transferred to the subsidiaries that need it for their activity in the form of an intra-group loan, the interest rate and conditions are subject to transfer pricing rules.
- A Greek group wishing to market its products in other countries may establish subsidiaries to purchase its products for resale to local customers. If the destination countries have a different corporate income tax rate than the Greek one, the way in which the transfer pricing is established will influence the part of the profit that is taxed in Greece or in the destination country and, consequently, the average level of tax paid by the group of companies.
TPS has a team of professionals specialized in Transfer Pricing who can assist you in the mandatory tax documentation on the valuation of related-party transactions in line with the OECD Transfer Pricing Guidelines and the Corporate Tax Regulations.