Blog

Ivan Shynkarenko

Partner, Ph.D. in Economics

Transfer pricing (TP) rules have been introduced into Ukrainian legislations since 2013. Yet, most taxpayers are still associating TP control with risks of penalties for formal breaches during regular TP reporting rather than with effective control over tax-driven pricing. Penalties for formal violations are indeed material and the regular TP reporting was quite expectedly the area of first conflicts at the phase of TP rules introduction.

However, there are clear signs that the system of TP control slowly but inevitably moves towards more mature stage of its existence. Namely, to more meaningful control of pricing as such rather than of reporting about the pricing.

There are several recent evidences of this.

The first one is recently adopted decision to establish within the central tax office the department of TP control and international taxation. This means serious increase of the status of TP control within the tax control function and is expected to improve capabilities of tax officers in this area.

Joining of the TP and international taxation within one department was also a step in the right direction. Efficient procedures of international tax information exchange are an important pre-condition for meaningful TP control as well as for creation of strong evidences supporting TP adjustment in case of court dispute.

The second evidence is the recent change of tax office’s luck in court disputes related to TP adjustments. Thus, in March and April the tax office won two important TP disputes at the stage of appeal.

It is an alarm signal for taxpayers. Tax assessments may be material. Yet, even more important risk lies in potential discrediting of approach to pricing with wrongdoing confirmed by court. This may have serious long-term business consequences. It is not the ordinary methodological mistake in calculation of the profit tax.

For more detail about recent court decisions in favor of tax office please see our materials “Unexpected victory of the State Fiscal Service at the appeal stage in the important dispute on the TP rules: important court positions” and “The tendency, however… The State Fiscal Service again wins in the dispute on the TP rules at the level of appeal”.

What has driven improvement in the tax offices’ capability of sustaining TP adjustments in the court?

In my opinion, several factors came into play here. It is experience of TP audits accumulated by tax office, rather superficial approach to TP documentation of the taxpayers who often prepare TP documentation in the formalistic way with weak economical substantiation and not to miss drastic change in TP court practice in neighboring countries (Russia, in particular) where tax officers routinely defeat taxpayers in court. While the available court decisions in such cases provide tax officers with algorithms how to make TP adjustment successful.

Hence, the times are changing. And this is the new reality not only for Ukraine but for rest of the world as well. Some countries are on the initial stage of introducing TP rules and other instruments of control over profits shifting, while others have already developed efficient control mechanisms. Experience of the latter countries illustrates that efficient TP control mechanisms is one of the best investments a state may do. During the last year’s ITR International TP and Tax Forum in Munich the figures where mentioned that each Euro invested in combating tax base erosion provides 10 Euro of additional taxes paid.

So, according to Market Law we may easily expect that control in these spheres will only be intensified. Nothing personal, just business.

Against the above, an obvious advice to taxpayers falling under TP control would be to stop moving inertially and adopt more conscious approach to pricing. Don’t perceive TP analysis and drafting TP documentation as a formal procedure. Such levity may turn out to be very costly.

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