The arm’s length principle is the basic principle which obligates related parties to execute transactions at fair market value. Appropriate transfer pricing documentation should solve all obscurities between the tax payer and the tax authorities. However, preparing transfer pricing documentation under formal requirements is not enough. Latest law practice shows that appropriate criteria used in transfer pricing documentation are the main keys.
Tax authority able and willing to make complicated arm’s length investigations
The tax authorities have not paid enough attention to transfer pricing documentation investigations, especially as to their content. Why? Possible reasons are many: perhaps because of the wide scope and complexity or because of practical difficulties implementing the arm’s length principle. In most cases, it was enough to submit a report that transfer pricing documentation was prepared according to all the requirements. That was the case until now. The situation changed on 26August 2013, when the Lithuanian Supreme Administrative Court ruled in a tax dispute on the composition of appropriate transfer pricing documentation.
The tax authorities and other juridical authorities took a deep look into sensitive and delicate aspects of the content of transfer pricing documentation. This included analyzing such criteria as the method of appropriate transfer pricing documentation, comparability criteria, and intervals. The tax authorities adjusted the quartiles method on existing transfer pricing documentation and, according to the arm’s length principle, narrowed a list of comparable uncontrolled transactions, thus correcting the price of goods between related parties. The amendments resulted in particular numbers – the company’s annual gain increased so that the debt to the state budget also increased by nearly 4 million LTL (app. 1.1 million EUR). According to unofficial data, the company does not accept the decision and is still trying to renew the tax dispute process.
Principle of clarity of taxation: is everything really clear?
Tax legislation contains numberless definitions such as: the arm’s length principle, controlled lender, fixed capital, economic benefit, fair market value, representation, marketing, and the like. Clearly, different definitions can be understood differently, so that it is vital to know (i) who is using these definitions and (ii) in what contest (e.g. law, economics, politics). Every specialist interprets and understands the same definition differently, according to the logic and understanding of their own profession or discipline. And in this way they are right. But trying to compare these definitions between others (e.g., lawyers/economists) we would be quite surprised at their totally different understandings.
This tax dispute once again reaffirms that interpreting tax definitions is a matter for the tax authorities. The principle of clarity of taxation (especially in such complicated cases as transactions at fair market value between related parties) can be achieved only when the tax payer and the tax authorities conclude an agreement on taxes and related amounts. Is this possible? Yes. How to achieve it? The tax payer and the tax authorities can sign an agreement on a binding ruling.
A binding ruling, implemented through the Law on Tax administration, is a remarkable instrument, unnecessarily forgotten and unused. We can clarify taxation only when where there is no space for interpretation for both tax authorities and tax payer. What happens if we leave some obscurity? The answer to that, we already know.
Yvonne Goldammer (Partner) / Simonas Aleksandravičius (Tax Counsel)
bnt attorneys-at-law Vilnius
Embassy House
Kalinausko 24, 4th floor
LT-03107 Vilnius
+370 5 212 16 27