Transfer Pricing (TP) 2018

Price is a crucial component when determining the income taxable base. Non-integrated market participants (counterparties) are at a certain distance from each other (at arm’s length) and make transactions among themselves at prices formed under the influence of the market. This is the essence of the ‘arm’s length’ principle.

The income taxable base for such participants is based on market prices. Unlike non-integrated counterparties, affiliated market participants (interdependent companies) ‘go hand-in-hand’, i.e. are in the position to set up transaction terms, which includes determining favorable for the group of companies prices in terms of minimizing the income taxable base (transfer prices).

Interdependent companies, upon concluding transactions with each other, set up specific (extraordinary) prices and other terms of trade that would have been unacceptable for the independent market participants. Transfer pricing (TP) is the ascertainment of transactions price between interdependent companies conducted for redistribution of incomes (or losses) within the group and minimization of the taxable base. The process includes controlled members of the group in low tax jurisdictions.

The main task for the tax authorities is to determine whether the transfer price corresponds with the objectively formed market (free-of-control) price. If proved that transfer transactions were not concluded on market terms, additional tax assessment will be calculated on the market price basis.

The tax legislation of the Russian Federation does not contain such concepts as 'transfer price', 'transfer pricing' or TP, however, those are practiced on a wide scale. Thus, on the Federal Tax Service website the transfer pricing is described as the simplest and most common scheme for minimizing taxes by redistributing the total profit in favor of those participants of the group residing in countries with lower taxes.

Terms of TP in the Russian Federation

The terms for TP in the Russian Federation became operative on January 1, 2012, when the Tax Code of the Russian Federation was supplemented by the Section v. 1 'Related Persons. General provisions on pricing and taxation. Tax menagement of transactions between related persons. Pricing agreement’ (Federal Law of 18.07.2011227-ФЗ). Since then, this section is constantly being improved. On January 1, 2018, it has been supplemented by new rules on international groups of companies and relevant documentation package — the ' three-tier TP documentation package'.

The FTS transfer prices tax control is only permissible in respect of controlled transactions and those equated with them. The verification of transfer prices for compliance with market prices is an independent type of tax control and cannot be subjected to the field and desk audits (section 1 of the clause 105.17 of the Tax Code of Russian Federation).

The TP rules require prices applied by related parties in controlled transactions are to be consistent with the level of prices applied by independent parties to equitable transactions.

According to section 2 of clause 105.5 of the Tax Code of the Russian Federation, transactions are determined as equitable with the transaction under analyses, if both are closed in the same commercial and (or) financial conditions.

Testing of transfer prices against market prices is conducted in this manner. An analysis of a controlled transaction is performed on its subject, functions, and accepted risks of the parties to the transaction. Then, the grounds for the market price is determined with reference to the identified features of the controlled transaction. Takin on this method of the market price calculation, the income from the transaction is determined on the basis of market prices and is compared with the actual income of the parties to the transaction.

By comparing transfer prices with market prices, the Federal Tax Service checks the completeness of assessment and payment of the following taxes:

  • tax on the profit of organizations, with the exception of part of the organizations profit tax, calculated in relation to the profit of controlled foreign companies;
  • the personal income tax paid by the individual entrepreneurs and other persons obliged to report on the personal income tax in accordance with Art. 227 of the Tax Code of the Russian Federation;
  • MET (Mineral Extraction Tax);
  • VAP, if one of the parties to the transaction is an entity or a VAP nonpayer private entrepreneur.

In the event of an underestimation of the amounts of the above mentioned taxes or an overestimation of the amount of loses determined in accordance with Ch. 25 of the Tax Code of the Russian Federation 'Profit Tax', the FTS makes adjustments to the relevant taxable bases (cl. 5 Art. 105.3 of the Tax Code).

Transfer Prices Calculation Methods

When monitoring transfer prices, The FTS applies the following methods:

  • Comparable Uncontrolled Price Method (a priority when selling goods, works, services);
  • Resale Price Method (a priority if the goods are sold to another person without processing);
  • Cost Plus Method (compared with the gross profit margin of the seller, applied to when it the first two methods are inapplicable);
  • Transactional Net Margin Method (the operational profitability of the party to the transaction is compared with the market level of operating profitability in comparable transactions, used when the first two methods are inapplicable);
  • Profit Split Method (the profit received by the parties to the transaction is redistributed as it is distributed among independent parties; mainly used when the transaction party holds intangible assets, which affects profitability or when the first two methods are inapplicable).

The RF Tax Code allows a combination of two or more transfer pricing methods.

If the methods above do not allow to determine whether the price of a product (work, service) applied in a single transaction is in accordance with the market price, compliance with the price in such a transaction can be determined based on the market value of the transaction subject established by an independent assessment in accordance with the law concerning valuation activities in the Russian Federation or in foreign countries.

The Tax Code of the Russian Federation determines a single transaction as a transaction whose economic essence differs from the main activity of the organization and which is carried out on a one-time basis.

The core principals of the TP rules in Russian legislation are controlled transactions and related persons.

Related Persons

For taxation, persons are recognized as related if the specifics of the relationship between them can influence the results of their transactions and accordingly affect the economic results of their activities, including the amount of taxes.

What is a controlled transaction?

Controlled transactions are those carried out between related parties, taking into account specific parameters of these transactions (including the sum limits) specified in art. 105.14 of the Tax Code, as well as transactions between persons who are non-related, but can be equated to controlled transactions. Moreover, a controlled transaction can be recognized by judicial process.

Transactions equated with to the controlled transactions:

  • Transactions with the participation of intermediaries (third parties not recognized as related), who do not perform special functions in transactions, except for organizing the resale of goods (works, services) between the two related parties. In the meanwhile, intermediaries do not assume any risks in the chain of such transactions and do not hold any assets, i.e. serve only for the formal document control process organization. Any transaction of this nature is subjected to be controlled, regardless of the amount of income.
  • Cross-frontier trade with global exchange business goods.
    This group includes goods with the FEACN codes, a list of codes approved by the Order of the Ministry of Industry and Trade of the Russian Federation of 30.10.2012 N 1598. The limit on the income amount for a calendar year with one person for recognition of such transactions as controlled is 60 million rubles.
  • Transactions with persons registered in the offshore zone.
    The Order of the Ministry of Industry and Trade of the Russian Federation of 13.11.2007 N 108n stated the list of territories considered offshore zones. For transactions in these areas, the limit of income with one person is also 60 million rubles per a calendar year.
Transactions between related parties, one of which is not a tax resident of the Russian Federation, are considered to be controlled, regardless of the income amount received. For example, a transaction of a subsidiary Russian organization with a foreign parent company is subject to tax control regardless of the amount of this transaction, including gratuitous.

Even if the transactions meet the above criteria they cannot be recognized as controlled ones in the following cases:

  • The parties to the transaction belong to one and the same consolidated group of taxpayers, with the exception of transactions that are related to mined materials, the MET tax unit at the rate established in percentage.
    At the same time, there other conditions that has to be met in this cases:
    • the participants are to be registered in one and the same subject of the Russian Federation, while not having separate subdivisions in other subjects of the Russian Federation or outside the borders of the country;
    • they are not subjected to income tax in other subjects of the Russian Federation, have no losses at the moment of tax calculation being carried out for the organizations in the absence of other exceptions for recognition of these transactions as controlled.
  • Transactions between taxpayers entering into an engagement of carrying out activities related to the production of hydrocarbons in a new subsea hydrocarbon field, in relation to the same field.
  • Interbank loans (deposits) for a period of up to seven calendar days.
  • Transactions in regard to the military-technical co-operation of the Russian Federation with foreign partners.
  • Transactions in regard to the provision of guarantees (surety) only in the a situation when all parties to such a transaction are Russian organizations conducting nonbanking activities.
  • Transactions in regard to the provision of noninterest earning loans between related persons, provided that the place of registration or place of residence of all the parties involved as well as their beneficiaries is in the Russian Federation.

Controlled Transaction Notice and the Transfer Pricing Documentation Package

For subjected to the monitoring transactions conducted in the course of current calendar year, the income tax payer is obliged to submit to the tax authorities a notice on the controlled transactions no later than May 20 of the year following the current calendar year in which the transactions controlled took place. Controlled Transaction Notice has to be filed by both parties, regardless of whether the party to the transaction received income or held the expenses.

As supplementary to the Controlled Transaction Notice, the tax office authorized agent has the right to call up from the taxpayer a documentation package on controlled transactions. Such documentation formats are arbitrary, The Russian Tax Code only covers specific content requirements, including furnishing of the information on all the taxpayer’s activities related to the transaction under control, analysis of all the functions of all the parties to the transaction, justification of the method for commercial prices calculation, a description of the sources of information for the pricing calculation and such other information.

If the taxpayers happen to be participates of an international multicorporate enterprise and at the same time meets certain conditions, in addition to the above given information on controlled transactions, additional data on the international multicorporate enterprise has to be included in the provided documentation package.

A detailed procedure for the provision of the three-tier documentation for international multicorporate enterprises (global documentation, national-level documentation, country report) is ascertained in Chapter 14.4–1 of the Tax Code of the Russian Federation.

There are certain conditions under which the taxpayer is considered having an extra responsibility when submitting the TP accounting, as a member of the international multicorporate enterprise:

  • The current annual revenue from 50 billion rubles, if the parent company of the multicorporate enterprise is a tax resident of the Russian Federation;
  • The current annual revenue in the amount established by a foreign state for filing a country report, if the parent company of the multicorporate enterprise is a tax resident of a foreign state.

In case if the organization failed to submit a report on the controlled transactions, it will face severe taxation consequences. At the same time, the penalty for failure of submitting a timely notice or inaccurate information provided in the notice is relatively small — 5,000 rubles. For participants in the multicorporate enterprises, responsibility for the failure to submit a country report (or submittance of an inaccurate one), national, global documentation amounts up to 100,000 rubles for each and every event. If the tax authority determines that due to the application of non-market prices, the taxpayer underpaid taxes to the budget, the penalty will be 40 percent of the unpaid amount.