Tax Control and Common Deficiencies in Transfer Pricing

Purpose and Course of Tax Control

The general course of tax control is regulated in § 44 to § 47 of Act No. 563/2009 Coll. on Tax Administration (Tax Code) and on amendments to certain laws (hereinafter "Tax Code"). The purpose of tax control is to examine taxpayer procedures in setting transfer prices, i.e., whether they chose an appropriate transfer method, have sufficient documentation for verified transactions, can transparently provide explanations for individual cases, chose the correct basis for comparability analysis, and can adequately demonstrate the application of the arm's length principle in related party transactions carried out in the given tax period.

Start and Notification of Tax Control

According to § 44 of the Tax Code, tax control begins on the day determined by the tax administrator and about which they inform the taxpayer through notification. The notification must also contain the place of control, type of tax subject to control, controlled period, and deadline for submission of required documentation along with instructions on consequences of non-compliance. The tax administrator may start tax control without notification if they suspect the taxpayer will alter or destroy documents necessary for case assessment.

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

Taxpayer Obligations During Control

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

During control, the tax administrator examines submitted documents for correctness, completeness, and truthfulness. If any discrepancies are identified, they notify the taxpayer and request explanation. The taxpayer may submit all documents and provide evidence and explanations for the case, which the tax administrator then evaluates. If documents or explanations are insufficient, they request supplementation.

Most Frequently Controlled Areas

From the perspective of controlled areas, the most frequent subject of controls is the area of services, goods, and intangible assets. Additionally, cost allocation between related enterprises and group financing are commonly examined.

The control itself is conducted through samples selected by the tax administrator, who then requests their submission from the taxpayer. The reason for selecting a particular controlled transaction sample may be its frequency within the taxpayer's overall activity. Sample selection may also be influenced by tax administrator suspicions, for example, if the taxpayer changes business model or switches from profit to loss year-over-year. Tax administrators also typically open tax controls for problematic taxpayers, such as those previously assessed or those conducting risky transactions.

What Tax Administrators Control

During tax control, tax administrators examine primarily:

• 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 questions whether the controlled entity would provide such service to an independent party,
• 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 adequately explain services provided between related parties; the taxpayer must undoubtedly prove that the provided service was justified, i.e., relates to the recipient's needs and complies with the arm's length principle,
• insufficient or non-existent transfer documentation,
• poor quality of transfer documentation,
• inconsistency between documentation content and the taxpayer's business activity and explanations,
• insufficient substantiation of comparability factors, i.e., inadequate functional and risk analysis, for example, too small or inappropriately chosen comparative base,
• insufficient explanation of lower profit compared to other enterprises in the group,
• non-existence of contracts and other documents that would support the chosen taxpayer approach,
• inability to provide requested information about related parties to the tax administrator,
• slowness, problematic nature, or inability of the taxpayer to respond to various tax administrator requests,

The course and outcome of tax control is undoubtedly influenced by the controlled taxpayer's approach to transfer pricing issues. If the tax administrator sees that the taxpayer made maximum effort in the documentation process and this effort was reflected in high quality submitted documentation, it may accelerate the tax control process, for example by approving the used method, accepting business explanations without need for further examination, ultimately not assessing additional tax.