Poland clarifies its unique definition of “controlled transaction” for transfer pricing purposes

By Dr. Monika Laskowska, Center of Tax Analyses and Studies, Warsaw School of Economics

Poland’s Ministry of Finance in early April launched a public consultation on new transfer pricing guidance defining controlled transactions. The ministry requested comments by 30 April.

The interpretation of provisions given in the explanatory note will be legally binding; however, it appears to depart from the OECD’s transfer pricing guidelines. 

Poland’s definition of controlled transaction

Poland created its definition of a controlled transaction in a 2019 domestic transfer pricing law. Since then, the definition has created controversies and difficulties in practical implementation.

The Polish definition says that the controlled transaction, including the attribution of income to a permanent establishment, should be determined based on the actual behaviour of the parties of the economic nature and the conditions of the actions that were made or imposed as a result of the association.

The identification of a transaction as a controlled transaction involves further consequences. For example, tax authorities should assess income considering the actual course and circumstances of a controlled transaction. Additionally, if tax authorities recognize that nonassociated companies would not enter into the indicated controlled transaction or would enter into a different one or would undertake other activities, they may disregard the transaction or recharacterize it. Moreover, transfer pricing adjustments can be made with respect to a controlled transaction.

Controlled transactions also create an obligation for transfer pricing documentation if specific thresholds are met. However, documentation requirements might also appear in situations of uncontrolled transactions where an independent party to the transaction is alleged to have a relationship with an entity in a tax haven.

Actual behaviour of parties

The explanatory note confirms the unfortunate actual behaviour rule for identification of controlled transactions. The Polish rule provides that what is not based on “actual behaviour” can’t be considered as a controlled transaction.

The poor wording used in the definition means that the 6-step approach of risk analysis described in section 1.60 of the OECD transfer pricing guidelines is no longer an element of delineation of the actual transaction in the controlled transaction but the criterion for including or excluding a transaction from the notion of controlled transaction, with further consequences.

The uncertainty is increased because the notion of “actual behaviour” includes an assessment element.

This means that the taxpayer should do an initial assessment of a controlled transaction to meet documentation requirements. However, a second assessment of “actual behaviour” might be performed during a tax audit, and this assessment might differ from what the taxpayer put in place. This is especially so because, according to the explanatory note, it is necessary to justify the economic reasons for the specific actions the taxpayer took.

And, as practice reveals, this opens a real Pandora’s Box of interpretations. Different assessments of “actual behaviour” will create different controlled transactions with further consequences. In case of a different result from an assessment, based on the wording of the provisions, it would create possibilities for the tax authorities to improperly insist upon documentation. Unfortunately, the explanatory note does not solve this dilemma.

Conditions made or imposed

As was highlighted in the explanatory note, the existence of associations between entities does not create a controlled transaction per se.  It is necessary that actions were made or imposed as a result of associations.

It is confirmed that there might be actions between associated companies that do not establish a controlled transaction. This explains why the Ministry of Finance excludes actions such as payment of dividends, contribution in kind, etc., where the conditions are imposed by law rather than by associated companies.

However, the explanation goes too far in expanding upon this distinction. This might be good news for taxpayers, as establishing that a condition is imposed by the associated company is required for tax authorities to make transfer pricing adjustments.

Conclusions

The Ministry of Finance’s explanatory note was highly anticipated. It’s positive in that it solves some taxpayer uncertainties. However, it also leaves some unanswered questions, especially in regard to the attribution of profit to permanent establishments.

The 2019 provisions drastically changed long-standing Polish practice from the use of the authorised OECD approach to formulary attribution of profits to permanent establishments. This diversion is already used and confirmed in tax rulings. An immediate change in the law is required, not an explanatory note.