Poland issues binding interpretation of the concept of `controlled transaction’ for transfer pricing purposes

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

From December 2021, associated companies in Poland should consider the Ministry of Finance’s binding interpretation of the notion of “controlled transaction” for transfer pricing purposes. The legal definition of a controlled transaction was introduced into tax law from the beginning of 2019 and it has created a few issues concerning its interpretation since then.

Legal definition

The notion of a controlled transaction was introduced to the chapter glossary for transfer pricing purposes in Polish corporate income tax law (the same in the individual income tax law). According to the legal definition, a controlled transaction is the set of actions of an economic nature that are identified based on the actual behavior of the parties—including the allocation of profit to the permanent establishment, where the conditions were made or imposed as a result of the association.

Some aspects of the definition have been excluded from the interpretation, like allocation of profit to permanent establishment or unpaid services.

The notion of controlled transaction is used as one of the conditions for primary adjustment, documentation purposes, safe harbour transactions, or transaction exemption from documentation requirements.

Relevant areas of interpretation

According to the interpretation, the assessment of whether a set of actions can qualify as a controlled transaction should be made individually by each party of the transaction. Thus, that action can be assessed as a controlled transaction by one party while it might not qualify as such for the other party. Parties do not have to agree with each other whether they enter the controlled transaction or not. Take, for example, the renting of a warehouse by a shareholder to the company. For the company, it will be a controlled transaction; for the shareholder, who is an individual person, it might be a different result if the renting is not of an economic nature.

A controlled transaction is one that is established based on actual behavior of the parties, according to the definition. It remains unclear what will be the result of differences in assessment of actual behavior among the taxpayer and tax authorities, however. For example, it is uncertain whether the taxpayer would have met documentation requirements for controlled transactions if the actual behavior of the parties were successfully challenged by tax authorities in the course of a tax audit. The question remains open as to whether penalties will be charged as a result of documenting the wrong controlled transaction.

The interpretation of the wording of “actual nature” provides that only justified economic reasons should be considered for pursuing the action. Any kind of sham or artificial actions shouldn’t be treated as actual behavior. Substance of action should be identified based on actual behavior of the parties, in particular where a contract is not aligned with the actual course of a controlled transaction.

The difficulties of these aspects of interpretation result from the fact that Polish transfer pricing regulations don’t implement directly the six-step approach into the law. So, a potential departure from the terms of contract is authorized only through the wording of a controlled transaction definition. While the law is silent on the appropriate approach of such a departure, the result might differentiate between taxpayers when setting a controlled transaction and the tax authority when assessing it during a tax audit.

Decomposition of the notion of `made or imposed conditions’

The notion of “conditions made or imposed” used in a domestic legal definition of a controlled transaction is not aligned with the same notion used in arm’s length principle (presented in article 9 of the OECD Model Convention) by adding the term that they must be made or imposed as a result of the associations. The binding interpretation is adding a new meaning to the wording “as a  result of the association” that already existed in the transfer pricing regulations. It is said in the interpretation that the pure existence of association between companies is not determinative of indicating a controlled transaction. It is required that the conditions of the economic activity must be made or imposed because of such an association. The association can be indirect and it may involve other associated companies than those party to the transaction.

If it can be proven that conditions of a transaction between associated companies are not made or imposed as a result of such an association (for example, they can be concluded straight from market conditions), then such a transaction should not be qualified as the controlled transaction. Keeping this in mind, the taxpayer might be interested in proving that the conditions were not made or imposed as a result of any association within the group if this would help exclude the transaction from the notion of being a “controlled transaction.”

Following that interpretation, considering that the transfer pricing documentation requirements are imposed only on controlled transactions, then providing the documentation is like the statement that conditions in this transaction were made or imposed as a result of association. Thus, based on this interpretation—in the author’s opinion—deciding whether transfer pricing documentation should be prepared requires a proper decision-making process regarding how the transaction will be presented.

According to the wording of the provision, while the tax auditor must consider a controlled transaction when adjusting the income of associated companies, the further conclusion would be that if there is no controlled transaction then no primary adjustment is possible. This also would mean that if a taxpayer does not provide transfer pricing documentation, then the tax auditor wanting to make the adjustment should—in the first step—prove that conditions in the transaction are the result of association and not, for example, market conditions. Thus, considering this binding interpretation, taxpayers should be very careful when making decisions on whether they should prepare the documentation for some transactions.

Obviously, it is a grey area regarding distinguishing when conditions were made or imposed as a result of direct or indirect association or in result of other factors, such as purely market conditions. The interpretation does not touch this loophole created by itself, leaving a broad area of diversified possible interpretation in practice.

Conclusions

The discussed binding interpretation provides helpful explanation in transfer pricing practice, cutting off many unnecessary discussions. For example, simple and straightforward conclusions—such as paying the dividend between associated companies is not the controlled transaction as it is not of an economic nature—bring visible improvement to the practice. Similarly, the payment of profits to the shareholders of partnerships shouldn’t be treated as a controlled transaction.

However, it also proves that Poland’s Ministry of Finance does not have a holistic view and understanding of diversified difficulties that appear in the practice. Thus, while frequently explaining one area of controversy, it creates other grey areas of uncertainty by using unexpected wording or broadening the meaning of a provision. This creates the situation of cherry-picking both from the side of tax auditors and taxpayers arguing which part of an interpretation is consistent with the provision.