Poland tax guidance confirms controversial position on year-end transfer pricing adjustments

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

 Poland’s Ministry of Finance has launched a public consultation on an explanatory note addressing taxpayers’ ability to make year-end, self-initiated, transfer pricing adjustments. Comments are sought by 6 November.

Despite the fact that the Polish Ministry’s explanatory note is not legally binding,  this proposal is attracting a lot of public attention as it reveals the Ministry’s continued push for a price-setting approach for transfer pricing.

Poland’s price setting approach for transfer pricing

In 2019 Poland introduced new rules formalizing the price-setting approach for transfer pricing.

This approach obliges taxpayers to make a reasonable effort to comply with the arm’s length principle at the time the controlled transaction is undertaken.

Since 2019, the wording of new provision has created uncertainty and thus required publication of broad guidance by Poland’s Ministry of Finance.

However, the newly issued explanatory note reveals that the Ministry of Finance does not have ready answers to many questions. This is due to the fact that some of required changes must be made by amendments to Poland’s transfer pricing legislation, not through an explanatory note.

Limitations on year-end adjustments

Generally, under the 2019 transfer pricing revisions, associated companies are obliged to determine transfer prices on conditions that would be applied among independent companies.

Thus, under Polish law, year-end adjustments cannot be made to introduce arm’s length conditions to controlled transactions, but to make “minor” adjustments to prices already set in accordance with arm’s length principle.

To make these transfer pricing adjustments, several conditions must be met. 

First, the controlled transaction must be compliant with the arm’s length principle.

Second, there must be a change of relevant circumstances that have an impact on the transactional conditions or a taxpayer must gain new information on actually incurred costs (if the transfer price was set on budgeted costs) or on actually attained revenue in the controlled transaction.

Third, the taxpayer must provide a written statement from the associated companies confirming that the adjustment was mirrored on the other side of the transaction and in the same amount.

Finally, the associated company must have its residency in Poland or in another country or territory that has a double tax treaty with Poland or an agreement for the exchange of information.

Taxpayers should also make a note on their annual tax return about the self-adjustment to transfer prices.   

If the adjustment aims to increase taxable income in Poland, it is sufficient to meet two first conditions. In the case of reducing taxable income, all conditions should be met.

According to 2019 revision, compliance with the provided conditions is sine qua non for the right to deduct the adjusted costs as well as to increase the tax base with additional tax revenue in a fiscal year.

 This provision has created signficiant controversy and requires a change to the law instead of an explanatory note. Nevertheless, Ministry of Finance aims to solve crucial issues stemming from these poorly written provisions.

Limited scope of self-adjustment

According to the 2019 provision, year-end adjustments can only be made if the controlled transaction’s price was determined using conditions that would have been applied among independent companies, and all conditions listed above are met.

All other transfer pricing year-end adjustments do not have an impact on tax liabilities.

The explanatory note clarifies that it is expected that, at the moment of engaging in a controlled transaction, the associated companies will have full knowledge of whether all conditions of the controlled transaction are compliant with those set by independent companies.

The explanatory note states that a transfer pricing adjustment does not have the purpose of aligning a transfer pricing result with the arm’s length principle if the conditions existing at the time the transfer price was determined do not align with what would have been expected from independent companies.

The Ministry of Finance listed examples of changed circumstances that might permit a transfer pricing adjustment. These are a change in the market price for raw materials, exchange course, and volatility in sales or demand due to changes in customer demand.

It is unclear whether a taxpayer’s transfer pricing adjustment that appeared to be inconsistent with the tax authority’s primary adjustment in the following years would be deemed illegitimate, giving rise to additional penalties.

Benchmark study preparation

The explanatory note provides that a benchmark study must be at hand when the price is determined. Otherwise, an adjustment will not affect taxable income and the controlled transaction.

This means that if the transaction is not in accordance with the arm’s length principle at the moment it is executed, there is no ability to make an adjustment except for as provided in the explanatory note.

Adjustments in case of no direct transaction

Another controversial area of interpretation involves the availability of a transfer pricing adjustment in cases where there is no direct transaction to be adjusted. 

For example, according to the explanatory note, an adjustment is permitted between a limited risk distributor and the principal of a company even there is no suitable and direct transaction between these two.

The explanatory note states that a transfer pricing adjustment is permitted to adjust the controlled entity’s profitability, no matter what document is used. When there is no direct transaction, a correcting note is a satisfactory document to adjust the entity’s profitability.

Through this explanation, the Ministry of Finance was aiming to address the ongoing debate on transferring residual profit between limited risk entities and principal entities through inadequate forms of intra-group agreements.

While the Ministry of Finance proposition catches the problem, it is both controversial and confusing because the underying law is not settled.

It is difficult to imagine that such adjustments could take place between third parties as the conditions for making a permissive adjustment are not met.

Gordian knot

The central dilemma for Polish taxpayers concerns whether not meeting the listed conditions would mean that the taxpayer can’t make any adjustment having an impact on tax liabilities.

The wording of the given provision is so unfortunate that, following its literal interpretation, if the taxpayer does not meet the conditions, then the taxpayer can’t use any other legal tool to make an adjustment to transfer prices.

This should also include situations of understated taxable income and potential double non-taxation of adjusted income.

The government seeks the remedy for this poorly drafted provision through non-binding explanatory notes.

This attempt should be considered as ineffective as it was confirmed in later court decisions that explanatory notes do not have the normative nature and can’t reform the law (23 September – I SA/Gd 13/20).

Other issues covered in the note

Transfer pricing adjustments should not be treated as separate economic occurrences but should be respected as part of a transaction, group of transactions, or other intragroup calculation.

Transfer pricing adjustments are of a retrospective nature and should not be executed with regard to future transactions;  they can only be attributed to transactions that are the source of adjustment (for example, through a change of future price list).

Year-end adjustments shouldn’t be confused with corresponding adjustments. Taxpayers can’t make self-adjustments in the case of primary adjustment of a controlled transaction made by foreign tax authorities. Such adjustments are allowed only through the mutual agreement procedure.

If adjustments to the transfer price are not permitted, the only acceptable way to change from an unreasonable method is to change the transactions’ functional profile or other economically relevant conditions.

Adjustments should be made before submitting a tax return and should cover a period that does not exceed the fiscal year.

The lack of an adjustment clause in a contract between associated companies shouldn’t be treated as a negative premise for making transfer pricing adjustment.

Negative adjustments can be made only if the taxpayer received in advance a statement from the associated company confirming that it actually made the opposite adjustment, so there is no possibility for double non-taxation.

Conclusions

The price-setting approach implemented in Poland is yet another area where double taxation may arise, especially where a controlled transaction takes place between two associated enterprises where different approaches have been applied and may lead to different results.

The Polish Competent Authority should be prepared for an increased number of double taxation cases arising from different approach to year-end adjustments.

This is especially the case because Poland’s main trading partners, Germany and France,   use an outcome-testing transfer pricing approach.

Germany’s federal government, in a 19 March statement, made it clear that Germany will not apply the price-setting approach in German transfer pricing law, settling all internal debates on this issue.