By Ricardo Sergio Schmitz Filho, Assistant Lecturer and Ph.D. Candidate, Mykolas Romeris University, Vilnius
On December 23, 2021, Estonia published amendments to the Ministry of Finance’s regulation No. 53 from November 10, 2006 on the methods for determining the value of transactions between related persons. The changes, in force since January 1, represent an approximation to current practice in OECD countries, although it leaves some open questions.
The main aspects included in the amendments are discussed below.
Comparability analysis
Adjustments to the wording describing the comparability analysis now include specific requirements to compare risks and assets, in line with the OECD guidelines. This provides for clarity; although, in practice, functional analysis based on the OECD “standard” was already common in Estonian practice.
The previous version of the Estonian transfer pricing rules explicitly disallowed taxpayers to correct data regarding analyzed transactions (perform transfer pricing adjustments). This particular provision was excluded from the new version by the amendments and no other provisions in this sense were placed instead. Although it would have been preferable to have a clearer indication of how data regarding analyzed transactions could be amended, it seems that it is now a possibility and that further parameters might be delineated by the practice.
Financial transactions and intangibles
New requirements were introduced for the comparability analysis in terms of financial transactions and transactions involving intangibles. In terms of the first, the apparent aim seems to be the implementation of the OECD transfer pricing guidance on financial transactions, although the Estonian rules do not mention the latter document.
The amended rules also increase provisions regarding the benchmarking requirements when comparing transactions that involve intangibles. New elements to be considered when performing benchmark studies for these transactions include the expected return on assets, the development stage of the intangible, the rights over the property and the uniqueness and value of the intangible.
Taxpayers can now expect Estonian tax authorities to pay closer attention to these sets of transactions, as there is a tendency of strengthened rules on both financial and intangible-related transactions, in line with contemporary international movement.
Services (low value-added services)
Another important addition to the rules was the introduction of the low value-added services concept. The application of a 5% mark-up for the purpose of pricing low value-added services-related transactions is also foreseen by the amended transfer pricing rules, following the guideline’s provisions. On the other hand, it is not clear from the wording of the new regulations whether the application of such a concept would be optional or obligatory (once the requirements would be met).
Because of the lack of an explicit notice regarding any obligation to apply this concept (and the underlying 5% mark-up)—combined with the fact that the Estonian rules recommend the auxiliary application of the guidelines—it can be said that the optional approach, such as that contained in the OECD document, should be considered in line with the amended rules.
In any case, it would have been preferable to have expressly mentioned the guidelines in the provisions dealing with such transactions regarding the amended rules. It also would have been more suitable to have a clearer delineation of the evidence needed for taxpayers to substantiate the application of the low value-added services simplified approach and the underlying 5% mark-up.
Transfer pricing methods
According to the Estonian transfer pricing rules, tax authorities can adjust the prices of related-party transactions if they fall outside the “price range.” The introduced amendments, nevertheless, change the wording of the definition of such an expression (price range), which now clearly states that the interquartile range standard should be adopted.
Although the interquartile range is broadly accepted across the international community, the guidelines do not rule out the possibility of the adoption of other methods for determining the arm’s length range. Still, based on the wording the rules adopt, taxpayers can expect a stricter approach from Estonian tax authorities and should avoid the use of price ranges other than the interquartile range (even the minimum-maximum range).
On a side note, no changes were introduced in terms of the specific transfer pricing methods.
Consequently, no changes were made to the provisions’ wording on the application of the profit split method in the new version of the Estonian rules. That makes them inconsistent with the new amendments introduced to the provisions on comparability analysis—under which risks and assets should be taken into account—and with the OECD’s revised guidance on the application of the transactional profit split method. Besides, as detailed below, it makes them inconsistent with the updated provisions on cost-sharing agreements, as the Estonian rules only mention the splitting of profits based on “tasks” performed (and do not explicitly include risk considerations).
Naturally, a systematic interpretation can (and should) be made, and risks and assets considerations could be interpreted as intrinsic parts of these tasks when applying the profit split method in Estonia.
Cost-sharing agreement
In terms of the cost-sharing agreement provisions, the importance of risk considerations can also be found. Following the amendments, taxpayers can now be a party to a contract not only if income is to be received from the object of the contract, but also if the taxpayer exercises control over risks. Furthermore, the Estonian rules also state that allocation of these risks among the parties to the cost-sharing agreement must be determined and properly documented.
Documentation
Last, but not least, important changes were also introduced in terms of the transfer pricing documentation requirements.
The amended rules mainly refer to the provisions of the Estonian Tax Information Exchange Act, as included in 2017, on the obligation for in-scope taxpayers to prepare country-by-country reports, referring as well to revised (and expanded) guidance on the requirements for both master and local files, in line with the contemporary OECD three-tiered approach.
Another change was the inclusion of the (vague) requirement for taxpayers to provide “up-to-date” information, which was available to the taxpayer at the time of the transaction. Although it indicates stricter compliance rules, it did not clarify issues such as whether there would be a need to provide yearly updates, what the extensions would be, and what the limits would be of these updating requirements.
Still, no provisions were included in terms of transaction amount thresholds, limiting analysis, or documentation requirements for small related-party transactions. This omission does not contribute to tax certainty and tends to increase either compliance costs or risk exposure for taxpayers.
Finally, the new amendments introduced a series of changes in terms of the wording used to detail transfer pricing documentation requirements. In this sense, the update of terms has brought enhanced convergence with current international/OECD practice. An example is the replacement of the expression “low tax territory” with the concept of “non-cooperative tax jurisdiction.”
Conclusion
While the enacted changes represent an important move towards current international/OECD practice, the Estonian government missed its opportunity to provide the expected clarification of relevant issues. Nevertheless, taxpayers should expect to face stricter transfer pricing requirements in Estonia and, quite possibly, increased scrutiny from its tax authorities.
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Ricardo Sergio Schmitz Filho is an assistant lecturer and Ph.D. candidate at Mykolas Romeris University in Vilnius.
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