Transfer pricing study, or how to avoid astronomically high tax fines

Transfer pricing study, or how to avoid astronomically high tax fines

The global business environment of today is marked by an ever-increasing number of companies which, due to the lower tax rates, open their subsidiaries in countries with lower tax rates, or use networking to make hidden profit payments by resorting to preferential prices or non-market prices. Such financial operation of related companies favoring each other is not limited to multinationals: it can also include related firms registered in Croatia – at least until the Tax Administration comes knocking at your door and requests your transfer pricing study.

What is a Transfer Pricing Study?

To sum it up, a transfer pricing study is a document used to regulate prices used in transactions between related companies (both relationships between residents and non-residents, as well as relationships between residents) correspond to the prices that would be used between independent, mutually unrelated companies for those same transactions (i.e. market price) by following the arm’s length transaction (arm’s length principle) adopted by EU member states. The transfer price rules are based on methodology developed by OECD and are prescribed by Article 13 of the Corporate Income Tax Act as well as Article 40 of the Corporate Income Tax RegulationsandRegulations on Procedure of Contracting an Advance Pricing Arrangement on Transfer Prices between the Taxpayer and the Tax Authority.

Croatian Corporate Income Tax Act prescribes the following mandatory elements of a transfer pricing study:

  • Information on the taxpayer’s business group and its status within the group with an added description of all related transactions
  • Description of the method chosen to determine the transfer pricing, comparative analyses (benchmarking), explanations and reasons supporting the chosen method,
  • Assumptions and assessments which were used to determine the transfer pricing,
  • Calculations made by using the method chosen and with regards to the taxpayer, as well as taxpayers being compared to,
  • Sources of analyses of the transfer pricing.

The transfer pricing study has to be written in or translated into Croatian. Documents from previous years should be updated with regard to any material changes.

Who can be treated as a related person?

According to tax regulations, related persons are:

  • Persons specified or immediate family members
  • Companies which are a part of the same group
  • Companies which are either affiliated companies, or joint ventures
  • Companies which are joint ventures or affiliated companies with the same owner
  • Companies which are jointly-controlled by persons specified and immediate family members
  • Companies significantly influenced by persons specified or immediate family members and
  • State-affiliated companies.

With that being said, if you are an owner of two or more legal entities engaged in mutual transactions; or your spouse owns one company, and you own the other, or vice versa, while these companies engage in mutual transactions; or you, as a natural person (owner) have given a loan to the company, things are crystal clear – any and all of it denotes you as a related person, making the transfer pricing agreement a highly desirable investment, especially if your company enjoys a tax-favored position.

Fines for the absence of Transfer Pricing Study

Because of ample opportunities for manipulation and frequent examples of business practice misuse, transfer pricing is in the special focus of the Tax Administration of the Republic of Croatia, with the following fines, none of them insignificant, prescribed:

  • A monetary fine ranging from 2,000.00 to 200,000.00 HRK for the taxpayer
  • A monetary fine ranging from 2,000.00 to 200,000.00 HRK for the responsible person
  • A default interest calculated under the rate of 8%
  • The possibility of criminal prosecution under the provisions of the Criminal Code concerning the responsibility of the members of the management board in the case of tax evasion or other tax reductions

Do we need to mention that the tax auditors nowadays have more ways than ever to find and establish the mutual connections between companies and discover other offences in the area of transfer pricing? You are therefore encouraged to revisit your documents as soon as possible and order your own Transfer Pricing Study, because this is the only way you will avoid the astronomically high tax fines and sleep peacefully!