Czech republic: General Financial Directorate published a new decree pertaining transfer pricing

Czech General Financial Directorate has published the Decree D – 34, which replaces the Decree D – 332 on international standards application in taxation of transactions between associated enterprises from 2011.

Decree D – 34 (hereinafter as “the Decree”) was issued following the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations published by the OECD in 2017, while reflecting a consolidation of the changes resulting from the Base Erosion and Profit Shifting (BEPS) Project. Together with the Decree, also an official Czech version of the OECD Transfer Pricing Guidelines 2017 was made public. The Decree is not a legally binding document, it is not a part of tax legislation, it merely serves as an interpretation in the field of transfer pricing.

Contrary to the previous Decree D – 332, the new Decree D- 34 focuses, among other things, on the practical importance of functional and risk analysis and processing steps of comparative analysis.

Functional and risk analysis

The Decree focuses on the correct determination of the functional and risk profile of parties participating in the controlled transactions, which, among other things, is of great importance for the determination of choosing the tested party in the comparative analysis. A crucial step in the analysis is to determine the so-called value drivers, i.e. driving functions affecting pricing, and assign them a weight based on the value chain. According to the Decree, it is necessary to assess, if risk allocation is in accordance with economic characteristics of the transaction and if contractual risks and the actual conduct of parties reflect the ability to control the risks and at the same time having financial capacity to assume these risks.

The Decree provides a description of basic differences between entities with routine or fully-fledged profile and states that some entities might simultaneously have several different profiles for different transactions. Company with a routine functional profile is a company performing functions based on instructions of another company, bearing adequate risks and therefore should - in this context - achieve a lower but stable profit. However, in practice, there may be exceptions to this rule where a company with a relatively limited functional and risk profile may have certain functions (decision-making powers) that can cause loss, so each case must be assessed on a case-by-case basis.

Although the Decree provides a description of several different types of functional profiles, i.e. from routined ones to fully-fledged ones, it also claims that in practice, it is often impossible to define precise boundaries between given profiles. Therefore, it is important that a resulting remuneration reflects the performed functions, assumed risks, assets, human and financial resources used by each type of entity.

Comparability analysis

In order to find external comparable entities and their profitability for the purpose of processing a comparative analysis, it is recommended to use commercial databases. However, in order to increase the reliability of the analysis, the use of additional resources is recommended by the Decree - e.g. websites or accounting statements may be used.

To implement the quantitative part of the comparative analysis, the Decree recommends the main types of selection criteria. The Decree also recommends to annually examine the correctness of the selected criteria and to examine possible fluctuation of profitability in the particular business sector. The profit margins of comparable companies selected in the framework of comparative analysis and should be updated annually.

The Decree emphasizes that it is not possible to automatically exclude all loss-making firms (as it is usually done by the tax authority) from a sample of comparable companies, but it is always necessary to properly justify such a step.

When it comes to defining the arm’s length range, the Decree suggests to use multi-year data, i.e. 3 – 5 years, and to calculate arithmetic or weighed average in order to increase the reliability of range. Since data from commercial databases usually do not provide a high degree of comparability and contains extreme values, an interquartile range can be used, however, reasons for its use should be provided.