Arm’s length price as a method of filling the “gap”, i.e. the budget
Since June 2012 the tax authorities have been particularly active in issues of filling the budget through the tax liabilities assessment using arm’s length prices. Thus, the State Tax Service of Ukraine issued the following documents as for arm’s length prices:
- the Order No. 581 of July 5, 2012 “On approving of the Generalized Tax Consultation on the Procedure of Determination of Income and Expenses under Free-of-Charge Transfer of Goods (works, services) Transactions”.
- the Letter No. 20001/7/15-1217 of 24.07.2012 “On the Direction of the Methodical Recommendations for Algorithm of Calculation of the Arm’s Length Price of Goods (Products) when Carrying out Foreign Economic Transactions”.
As a consequence of such “rule-making” activity, of the State Tax Services, the local tax services have become more active as well. There are cases of receiving the requests by some of the enterprises from the tax authorities with the request to provide for the documents on doing foreign economic activity including the grounds of price making. Therewith the request is not grounded on the necessity of the audit of the arm’s length prices audit , but another ground is mentioned, for instance, the transaction accomplishment check for aim of the calculations in Foreign Economic Activity, checks of transactions with the contractors following the calculation chain.
As a rule, the letters of the tax authorities are not motivated enough (no grounds for the request are indicated but only the references to the general regulations of the Tax Code), therefore it is not obligatory to provide for the documents and information on such request, the reply groundlessness of the request shall be sent.
In order to provide the tax authorities with the possibility to send the notifications-decisions to the taxpayers by the results the tax liabilities determination with the usage of arm’s-length prices, the Supreme Court of Ukraine has issued the Letter No. 1500/12/13-12 of June 14, 2012 prescribing that till 2013 the tax authorities possess the right to send tax notifications-decisions on the basis of the audits due to determination of the tax liabilities determined by using arm’s length prices mechanism. Herewith, these are the taxpayers who have to prove illegitimacy of tax liabilities, i.e. such tax notifications-decisions are not considered to be withdrawn if the taxpayers disagree as it will be since January 1, 2013 (Article 39 of the Tax Code of Ukraine coming into force; if nothing is changed again, the respective draft law already exists).
There are also some cases of extra-charge of tax liabilities using that very mechanism of arm’s length prices for manufacturers due to selling goods to the related persons (for instance, to the distribution companies).
That is why such activity of the tax authorities shall be taken into account and at least check the possibility to provide for grounds of the price volume which is used by the taxpayer. We advice to use the methodical recommendations approved by the STC of Ukraine for the so called “self-test”, for instance:
- the level of purchase prices under comparative circumstances (property characteristics, functional analysis, contract terms, economic circumstances, business strategies);
- extra charge level;
- expenses on related to sale of inventories;
- inventory cost;
It is of special concern when the same product is sold to different purchasers at different prices (for instance, to distributors, trade networks, restaurants). There is no necessity even for tax authorities to collect information on prices because enterprise possesses all the information. Therefore, the precise policy of price assessment for every purchase segment shall be elaborated (if there is no such).
As they say, wish for peace, be prepared for war. Therefore, we must be on alert and be ready to provide grounds of price assessment for the tax authorities.
Letter of the State Tax Service of Ukraine No. 12372/6/15-1216 of July 9, 2012 “On repair expenses and expenses on transactions with related persons” may be used as a ground in favor of a taxpayer (at least as an evidence of vagueness of rule implementation on determination of the expenses on goods production if they are sold to a related person).
The above commentary presents the general statement for information purposes only and as such may not be practically used in specific cases without professional advice.
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