On 12 September 2023, the European Commission has published its legislative proposal regarding the harmonization of the transfer pricing rules at EU level. The aim of the proposal is to harmonize the transfer pricing rules at EU level and to make them more transparent, thus preventing potential tax optimisation opportunities arising from diverging rules and ensuring that the risk of double taxation is reduced.
The proposal would introduce significant changes to the currently applicable Hungarian transfer pricing rules on important points, such as the definition of related parties (the currently applicable “50% rule” would be changed to 25%), as well as the methods of the tax base adjustments. In addition, the mandatory application of the OECD Transfer Pricing Guidelines would require the Hungarian companies to comply with much more detailed rules.
The OECD Transfer Pricing Guidelines provide a framework to assist with the methods and principles used to determine the arm’s length price. Member States currently enjoy considerable flexibility in the interpretation and application of the Transfer Pricing Guidelines.
As a result of the initiative, the Transfer Pricing Guidelines (and any amendments to them) would become binding, as the proposal would have to be applied in accordance with the Transfer Pricing Guidelines.
Although the proposal is based on the established transfer pricing practices, as well as the Transfer Pricing Guidelines, it has some important cornerstones for Hungarian transfer pricing regulation, which will certainly have an impact on the operation of Hungarian companies. The most important of these are the following.
Unified definition for related parties
The proposal defines a “related party”, as a person that is related to another person in any of the following ways: (i) may exercise significant influence over it; (ii) holds more than 25% of the voting rights; (iii) owns directly or indirectly more than 25% of its capital; or (iv) is entitled to more than 25% of the profits of the other person.
The proposal will basically be relevant for cross-border transactions, therefore it is questionable whether the legislator will make the application of the new definition of related parties mandatory for domestic tax purposes in the course of local implementation. Obviously, this would require preliminary preparation and the revision of the current group structures from a taxpayer’s perspective.
Transfer pricing adjustments
The EU initiative would also significantly amend the scope of the applicable transfer pricing adjustments. Under the current Hungarian rules, taxpayers enjoy a relatively large degree of freedom regarding the ex-post price adjustments.
In contrast, the proposal would introduce a system of three types of adjustments, as follows:
- “Primary adjustment”: an upward adjustment made to a company’s taxable profits by a tax authority in the first jurisdiction;
- “Corresponding adjustment”: a downward adjustment to a company’s taxable profits made by the tax authority in the second jurisdiction as a result of the primary adjustment made by the tax authority in the first jurisdiction;
- “Compensation adjustment”: a taxpayer applies a transfer price which it considers to be the arm’s length price for a controlled transaction.
The compensation adjustment initiated by the taxpayer could only be acceptable if the given taxpayer:
- has made reasonable efforts to achieve an arm’s length result;
- makes the adjustments symmetrically in all affected Member States;
- consistently applies the same approach over the years;
- makes the adjustment before filing the tax return;
- justifies why the result is not in line with the arm’s length price.
The proposal would facilitate the adjustments (primary and corresponding) to be made by the tax authorities by allowing a so-called “fast track procedure” where there is no doubt that the primary adjustment is justified or it is the result of a joint tax audit. Such a “fast track” procedure should be completed within 180 days.
In our view, while harmonization of the transfer pricing rules is a welcome objective, if the 180-day shortened procedures do not lead to a result, then a Mutual Agreement Procedure (MAP) may be initiated between the competent authorities of the respective Member States, which according to our experiences are lengthy, resource-intensive and costly procedures for all parties involved.
Furthermore, it is not clarified in the proposal what options do taxpayers have, if they wish to decrease their tax base after filing the tax returns (for example, because the deadline for closing the tax year in another Member State is later).
Arm’s length range
As regards the determination of the arm’s length range, the proposal adopts a stricter approach in line with the rules already introduced in Hungary by requiring the use of the interquartile range as a reference. It also stipulates that, as a general rule, when an adjustment is made, the price should be adjusted to the median.
Expected implementation of the new Directive
If the draft proposal is adopted in its current form, Member States will have to transpose the new rules into national law by 31 December 2025 and the application will be mandatory from 1 January 2026 at the latest.
The question is whether transfer pricing and reporting deadlines will also be harmonised once the Directive is implemented. If this is not the case, as we currently experience, there may be timing differences in the preparation of financial statements, tax returns and transfer pricing documents of the individual group members, which may prevent them from applying the compensation adjustment rules in their own accounts.