Transfer pricing audits – even tax authorities make mistakes

With increasing determination, tax authorities continue with their inspections of transfer pricing policies. Nevertheless, even they sometimes take unlawful steps we should all know about, either when preparing or later defending our transfer pricing rules. In one of its recent judgments, the Czech Supreme Administrative Court (“SAC”) stood up for a taxpayer and ruled that a tax administrator had acted incorrectly when it reassessed tax on the grounds of an incorrect application of transfer pricing rules.

Misconduct of the tax administrator in assessing the application of transfer pricing rules

In its judgment in case no. 1 Afs 143/2017, the SAC has held that the tax administrator committed a gross misconduct when assessing the application of transfer pricing rules by an individual who had sold all its inventory to a related legal entity (the individual was an executive director and a shareholder in the company). The individual sold the inventory at an 80 per cent discount on the selling price (purchase price plus margin), i.e. approx. for 40 per cent of the purchase price, which the tax administrator considered unreasonable low. As a result, the tax administrator made its own comparison which identified a similar case when an individual sold all of its goods to a related party (legal entity) for the purchase price. The tax administrator relied on the purchase price and has additionally assessed the difference (60 per cent of the purchase price) to the individual as undeclared income. The SAC contested the procedure as inadmissible and ruled and upheld the following facts relevant to us in its judgment:

1. In tax proceedings, the principle applies that a taxpayer bears the primary burden of proof and pleading in respect of its tax obligation. Nevertheless, transfer pricing is an exception to this rule, i.e. it is the tax administrator that bears the primary burden of proof.
2. If the tax administration refers to prices of comparable transactions, these must be transactions between independent entities.
3. To determine a comparable (reference) price, the tax administration should rely on a specific price range, i.e. compare the original transaction with more than one transaction between independent parties.
4. If the tax administration ascertains a difference between the transfer price charged and the reference price, it must give the taxpayer an opportunity to satisfactorily explain and substantiate the difference.

We will be glad to assist you in defining your transfer pricing rules and to represent you before the tax administration. Please do not hesitate to contact us.