Proposed changes to the Income Tax Act and the Tax Code
Transfer pricing revolution?
The Ministry of Finance of the Slovak Republic recently submitted a draft law to amend some provisions of the Income Tax Act and the Tax Administration Act (Tax Code) with effect from January 1, 2023, and in the case of certain clauses from January 1, 2024.
The draft law focuses mainly on supplementing and clarifying the rules of transfer pricing, but it also concerns the introduction of a new rule on the limitation of interest costs for legal entities, the legislative adjustment of the write-off of receivables, the determination of the tax base of a permanent establishment, the possibility of applying the entire right to a tax bonus for a dependent child (children) in cases where the tax base of the taxpayer is not sufficient to apply the full amount of the tax bonus after meeting certain conditions, changes in the method of registration for income tax for selected types of taxpayers and other specific adjustments.
The focus of the draft law is primarily the area of transfer pricing, as it is in this area that the legislator, as well as the general professional public and taxpayers, saw an insufficient and vague legal arrangement, which often led to disputes between the taxpayer and the tax administrator.
The proposed changes in the area of transfer pricing should cover the definition of a significant controlled transaction, which consists in limiting the value of (in)significant transactions. According to the proposal of the Slovak Ministry of Finance, those transactions whose value exceeds EUR 10.000 should be considered significant, with the exception of loans. In our opinion, such a definition of significant transactions can place a disproportionate administrative burden, especially on large multinational companies that annually carry out a large volume of controlled transactions with a value significantly exceeding EUR 10 000.
In the interest of legal certainty, another significant change is proposed - the reference to the Transfer Pricing Directive for Multinational Companies and Tax Administration issued by the Publications Service of the Organization for Economic Co-operation and Development (OECD) directly in the law. The OECD guideline is mainly used as an interpretation aid in the field of transfer pricing in Slovakia, but nevertheless the tax administrator usually bases his decisions on it. The provisions and recommendations of the Directive are often questioned by taxpayers during tax audits, as the administrator often chooses a selective interpretation of the provisions of this Directive that suits him. Adding a reference to the Directive to the law would probably eliminate this discrepancy between the taxpayers' and the tax administrator's point of view, but from a legal point of view it is necessary to assess the feasibility of such a change.
The amendment should also add to the law the procedure of the tax administrator in cases where the prices used by the taxpayer in controlled transactions do not correspond to the principle of an independent relationship and the prices applied by the taxpayer, or the results obtained are not in the interval of independent values. In such cases, according to the bill, the difference by which the taxpayer's tax base is to be adjusted should be determined according to the median of independent comparable values. From our point of view, an interesting situation could arise if the company's result was not in the interval of independent values, but would be even more profitable. Would the tax authority be amenable to the median value in such case?
One of the welcome proposed changes is a change in the way transfer pricing documentation is submitted. Based on the proposed amendment, it would be possible to submit documentation in a language other than the state language without prior request from the taxpayer. If the administrator were to request transfer pricing documentation in the national language based on a call, the taxpayer would be required to submit this documentation within 15 days.
Other changes proposed by the Ministry of Finance of the Slovak Republic in the area of transfer pricing relate to:
- Calculation of the shares of close persons for the purpose of determining the economic connection;
- Clarifications of the definition of a foreign dependent and the definition of a controlled transaction;
- Harmonization of the provisions of the Income Tax Act with the current methodology of the OECD Guidelines for determining the tax base of a permanent establishment, including the addition of the obligation of a permanent establishment to keep documentation on the used method of adjusting the tax base in relation to the founder and other dependents;
- Possibilities of issuing decisions on bilateral and multilateral approval of the use of the valuation method, if the competent authorities have agreed on the use of the valuation method for tax periods prior to the application and for more than five tax periods.
In our opinion, the changes proposed in the transfer pricing law mainly focus on areas that appear to be controversial in tax audits. Tax subjects in these areas had the opportunity to use their argumentation against the tax administrator (e.g. questioning the provisions of the OECD directive as a legally binding document, tax collection at the median level or duplicate exclusion of costs by the tax administrator).
However, the legislative process is only in the initial phase, and individual proposals may still be changed or deleted before the law is approved. We will continue to monitor the development of the situation and will inform about the approval of changes on our website and social networks.