Czech Republic: Transfer pricing issues identified in financial statement reviews

12 February 2020

Tax professionals typically become involved in the examination of financial statements at the start of the new year because of the significant risks posed if transfer pricing issues are ultimately identified.

A typical issue that may be considered is a reduction in operating profit or profit before tax. Experience reveals that a cautious approach may be prudent—a manufacturing company reporting a significant reduction in profit or continuous losses while simultaneously engaged in considerable trading with related parties can be factors that trigger the attention of the tax authority. In such situations, the tax authority tends to claim that these Czech manufacturing companies are in the position of contract manufacturers and that losses need to be attributed to their foreign parent corporations.

The tax authority’s somewhat simplistic approach in this area is not new. However, in 2019, new and rather uncertain situations relating to manufacturers that were part of corporate groups arose. While the manufacturing capacity and the cost of labour of such manufacturers were on the verge of economic viability, the manufacturers were at that time unable to deliver the contracted volumes. The question was then, what party to the transaction—the contractor or the manufacturer—would actually bear any related extra costs.

Another trend that has been seen is that outcomes of transfer pricing inspections of foreign related parties have been systemically mirrored by their Czech counterparties—that is, the accounting implications of such transfer pricing adjustments are reflected in the financial statements of Czech companies being audited. These changes may involve adjustments to pricing agreements and business cooperation models (e.g., the introduction of royalties or payments for functions performed abroad that have thus far not been remunerated). The Czech tax authority is aware of this tendency and repeatedly has stated that it will not automatically tolerate any decreases in the Czech income tax base because of foreign inspection resulting in adjustments.

Other issues concern pricing adjustments and their proper recording to the period to which they relate in terms of substance and timing, as well as the quality of transfer pricing and inter-company services documentation. These issues show that transfer pricing risks need to be identified so that intra-company discussion of relevant remedial measures may begin as soon as possible.

Read a February 2020 report prepared by the KPMG member firm in the Czech Republic

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