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TAX COLUMN

Multinational firms and transfer pricing

Multinational enterprises have never been slow to exploit differences in the tax rates of the countries in which they do business. Giant corporations that have mutual interests or owners have long manipulated flows of capital between them to ensure that their profits appear on the books of firms doing business in countries with low tax rates.
This capital manipulation occurs most typically with 'transfer prices' - the money that branches of a corporation charge themselves for goods and services. But tax authorities have recently developed a very sharp eye for prices used between associated enterprises, and regularly verify that multinationals are not dodging their tax obligations.

Multinational enterprises have never been slow to exploit differences in the tax rates of the countries in which they do business. Giant corporations that have mutual interests or owners have long manipulated flows of capital between them to ensure that their profits appear on the books of firms doing business in countries with low tax rates.

This capital manipulation occurs most typically with 'transfer prices' - the money that branches of a corporation charge themselves for goods and services. But tax authorities have recently developed a very sharp eye for prices used between associated enterprises, and regularly verify that multinationals are not dodging their tax obligations.

Slovakia does not yet have adequate means of controlling transfer prices, as modern accounting and tax systems have been in use for only five years. However, some provisions on transfer pricing are already incorporated in the Slovak Income Tax Act.

In general, Slovak law says that if prices contracted between related entities (people or firms) differ from prices contracted between independent unrelated entities in similar commercial transactions, without a good reason being provided, the tax office may add the difference to the offender's tax base.

The term "related entities" is thus crucial, and refers to a relationship in which:

- firms or people directly or indirectly participate in the management, control or capital of the other
- a third legal entity (or individuals) participates in both of the first two entities
- both entities participate in a third entity

The term also means a close relationship between one individual and another (according to the Civic Code). Participation in the management, control or capital of an entity means an ownership interest of more than 25% of registered capital or voting rights.

Avoiding the rush

Multinational enterprises doing business in Slovakia should carefully plan and apply a transfer pricing policy in order to comply with regulations and control measures that will probably be introduced within several years.

The first step taken towards such measures occured in 1997, when the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration was issued by the Ministry of Finance. The ministry recommended it be used as an aid for taxpayers and tax administrators, implying that Slovakia accepts OECD transfer pricing standards.

One of the most important rules of such international transfer pricing agreements is that related firms act at 'arm's length' in their dealings with each other. The arm's length principle says that price agreements between members of a multinational group must resemble those that would have been obtained between independent enterprises in comparable transactions and comparable circumstances. The principle governs any transaction involving tangible or intangible assets, as well as services, loans and cost-sharing agreements.

In the case of credits or loans provided between associated entities, the 'thin capitalisation' rule applies. Wherever a creditor takes part in the management, control or capital of the company receiving the loan, interest payments on the balance of loans that exceed equity by a 4:1 ratio (6:1 for loans from associated banks) are non tax deductible.

The main rule regarding transactions between a branch and its head office is that the profits to be attributed to the branch are those which that branch would have made if it had been dealing with an entirely separate enterprise under conditions and prices prevailing in the current market. The taxable income of such a branch office may not be less than the sum which would be attained from the same or similar activity by a taxpayer with a registered office or permanent residence in Slovakia.

From January 1, 1999 an amendment to the Income Tax Act relating to transfer pricing will come into force. For purposes of adjustments to the tax base, the new term "dependent persons" will be introduced. This refers to a Slovak legal entity or individual associated with a foreign legal entity or individual. Two Slovak entities will no longer be considered related parties, and transfer pricing legislation will not apply.

The Ministry of Finance will also declare how the difference between a fair market price and the price contracted between dependent persons will be determined: Slovak tax legislation still does not provide for this need.

Multinationals and firms which decide not to plan ahead for transfer pricing regulation in Slovakia should be aware that when the tax authorities increase the tax base of the Slovak taxpayer because of a discrepancy in transfer prices, they also impose a penalty for the delayed income tax payment. The penalty is 5 % of the outstanding amount for each month the payment is overdue.


Anna Frimmelová is a tax consultant with Deloitte & Touche.

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