We have already informed you that transfer pricing is gaining popularity and visible is an increasing trend in the number of tax inspections focused on transfer pricing in recent years through our article Million Findings of Tax Controls on Transfer Pricing.

In order to increase the chances of entrepreneurs in a tax audit focusing on transfer pricing and to minimize the risks arising from the tax administrator's adjustment of the tax base, we recommend you to verified the transfer pricing compliance with the principle of independence through benchmarking. Comparability analysis is a key tool for setting the right transfer price for tax purposes and, last but not least, it is a tool for selecting the most appropriate transfer pricing method.

From the practice we know, that during the tax audit, the tax authority requires proof that the transactions carried out by the taxpayer were in accordance with the principle of an independent relationship. One of the ways a taxpayer can demonstrate this compliance is through this analysis.

Obligatory or voluntary?

In general, comparability analysis is a mandatory requirement for documenting transactions where full transfer documentation is required. According to the Guideline of the Ministry of Finance of the Slovak Republic, taxpayers carrying out the following transactions are obliged to carry out a comparability analysis:

• Significant cross-border audited transactions and the taxpayer report the profit or loss in the separate financial statements in accordance with International Financial Reporting Standards;

• A cross-border controlled transaction or a group of cross-border controlled transactions whose value for the tax period exceeded 10 mil. EUR;

• Significant controlled transactions with dependents from non-contracting states;

• The audited transactions and the taxpayer ask the tax administrator to approve the valuation method;

• Controlled transactions and the taxpayer asks to adjust the tax base (except for adjustments resulting from domestic controlled transactions);

• Controlled transactions for which a tax dispute resolution mechanism was initiated for the relevant tax period;

• Significant cross-border controlled transactions and the taxpayer claim tax relief during the tax period.

Since this Guideline only sets out the minimum content of the dossier, it is appropriate that taxpayers who do not have this obligation should also carry out a comparability analysis and, if it’s necessary, adjust their tax base to comply with the principle of an independent relationship.

Another reason why taxpayers should have a comparability analysis, even though such an obligation does not impose on them, is that the taxpayer will be in a more favorable position if the tax audit is opened. Firstly, the taxpayer will know in advance the market price or profit margin, and secondly, it will demonstrate to the tax administrator that the reported margin in the comparability analysis cannot be considered as market. Otherwise, the tax authority will carry out its own comparability analysis, on the basis of which market prices may differ from those charged by the taxpayer and therefore do not have to be for the taxpayer.

Analysis of comparability in practice

The application of an independent relationship is based on a comparison of conditions and prices in controlled transactions with conditions and prices in uncontrolled transactions.

Guidance on how to perform comparability analysis is described in the OECD Guidelines in Chapter III. The comparability analysis may be carried out by means of internal or external comparable data. Depending on the type of comparable data, the analysis consists of the following steps, which can be interchanged and adapted to the circumstances of the case:

1. Determination of the period to be analyzed.

2. Analysis of the circumstances of the case related to the audited transaction of the taxpayer.

3. Understanding the nature of a controlled transaction based on a functional analysis to select the appropriate comparable independent transaction / entity, the most appropriate transfer pricing method, the financial indicators to be used for testing and the significant comparability factors to be considered.

4. Verify that there is an internal comparable uncontrolled transaction.

5. If there is no internal comparable uncontrolled transaction, the identification of available sources of information about the external comparable uncontrolled transaction / entity and the assessment of the reliability of the sources.

6. Selection of the most appropriate transfer pricing method and selection of appropriate financial indicators where the method chosen requires their use.

7. Identification of a potential comparable uncontrolled transaction / entity, identification of key characteristics that it must meet to be considered potentially comparable taking into account relevant comparability factors and having regard to the method chosen.

8. Identification of adjustments needed to ensure comparability.

9. Interpretation and subsequent use of the collected data and verification of the compliance of the controlled transaction with the principle of independence.

Internal or external comparable data?

The use of comparable data obtained from internal sources - from transactions with an independent person is in most cases more appropriate than the use of external data. In the absence of such internal comparable data, external comparable data should be examined. Several sources can be used to obtain external comparable data.

Usually, commercial databases are used to carry out the analysis, which contain detailed financial information on public and private companies, as well as on various contracts and agreements concluded between independent persons, either within the territory of the European Union or worldwide.

VGD uses globally recognized databases such as TP Catalyst by Bureau van Dijk, the Finstat database of Slovakia and the Royalty Range database for the analysis.

Please do not hesitate to contact us for more detailed information about transfer pricing, sending a quotation for elaboration of transfer documentation or comparability analysis. For more information, visit our website, facebook page or Linked-In.

Authors: Frederika Silesky, Ondrej Tupý, tax department, VGD Slovakia