Tax Control and the Most Frequent Deficiencies in Transfer Pricing

Purpose and Course of Tax Control

The general course of tax control is regulated in Sections 44 to 47 of Act No. 563/2009 Coll. on Tax Administration (Tax Procedure Code) and amending and supplementing certain acts (hereinafter \"Tax Procedure Code\"). The purpose of tax control is to examine the taxpayer's procedures in determining transfer prices, i.e., whether they have chosen an appropriate transfer method, whether they have sufficient documentation for the transactions under review, whether they can transparently provide explanations for individual cases, whether they have chosen the correct basis for comparability analysis, and thus whether they can sufficiently demonstrate the application of the arm's length principle for dependent transactions conducted in the given taxable period.

Commencement and Notification of Tax Control

According to Section 44 of the Tax Procedure Code, tax control begins on the day determined by the tax administrator, of which the taxpayer is informed via notification. The notification must further contain the place of control performance, the type of tax that will be the subject of control, the period under review, and the deadline for submitting requested documentation along with instruction on the consequences of non-compliance. The tax administrator may also start tax control without notification if they suspect that the taxpayer will alter or destroy documents necessary for assessing the case.

If the tax administrator identifies irregularities in periods other than those specified in the notification during an ongoing tax control, they are entitled to extend the control to these periods as well.

Taxpayer's Obligations During Control

The taxpayer is obliged to enable the tax administrator to perform the control, allow access to premises and their software, provide cooperation, and lend materials even outside their premises if the tax administrator so requests.

During control, the tax administrator examines submitted documents in terms of their correctness, completeness, and truthfulness, while if they identify any irregularities, they notify the taxpayer and invite them to comment on them. The taxpayer may submit all documents and provide evidence and explanations for the case, which the tax administrator then assesses; if the document or explanation is insufficient, the tax administrator invites the taxpayer for supplementation.

Most Frequently Controlled Areas

In terms of controlled areas, the most frequent subjects of controls are particularly the area of services, goods, and intangible assets. Furthermore, it is the area of cost reallocation between dependent enterprises and group financing.

The control itself takes place through samples selected by the tax administrator, who then invites the taxpayer to submit them. The reason for choosing a certain controlled transaction sample may be its frequency within the taxpayer's overall activity. Sample selection may also be influenced by the tax administrator's suspicions, for example, if the taxpayer changes their business model or if they flip from profit to loss year-on-year. The tax administrator also usually opens tax controls for problematic taxpayers, for example, those who were reassessed in the past or those who conduct risky transactions.

What Tax Administrators Control

During tax control, tax administrators particularly control:

• whether the subject of performance was actually delivered or services provided,
• whether the company actually needed the given subject of performance or provided services, i.e., the tax administrator will ask whether the controlled entity would have provided such service to an independent person,
• whether prices were set in accordance with the arm's length principle.

Most Frequently Identified Problems

The most frequently identified problems during tax controls include:

• inability of the enterprise to sufficiently explain services provided between dependent persons; the taxpayer must undoubtedly demonstrate that the service provided was justified, i.e., related to the recipient's needs and in accordance with the arm's length principle,
• insufficient or non-existent transfer documentation,
• poor quality of transfer documentation,
• inconsistency between the content of documentation and the taxpayer's subject of activity and their explanations,
• insufficient substantiation of comparability factors, i.e., insufficient functional and risk analysis, e.g., too small or inappropriately chosen comparison base,
• insufficient explanation of the enterprise's lower profit level compared to other enterprises in the group,
• non-existence of contracts and other documents that would support the taxpayer's chosen procedure,
• inability to provide requested information about dependent persons to the tax administrator,
• slowness, problematic nature, or inability of the taxpayer to respond to diverse requests from the tax administrator.

The approach of the controlled taxpayer to the transfer pricing issue undoubtedly influences the course and result of the tax control itself. If the tax administrator sees that the taxpayer has made maximum effort within the documentation process and this effort is reflected in the high quality of submitted documentation, they may speed up the course of tax control, for example by approving the method used, accepting corporate explanations without the need for further examination, which ultimately does not result in a tax reassessment.