Transfer pricing methods: selection and application from 2018 (1)

Read in Latvian
Read in Russian

15.12.2017

While the lawmaker is in the process of revising the Taxes and Duties Act, adding new terminology to describe related parties and their mutual transactions, and contemplating the materiality threshold for a single controlled transaction or a category of controlled transactions that will determine whether related parties will have to file the master file and/or the local file of their transfer pricing (TP) documentation, it is already clear what TP methods taxpayers will be allowed to select for deciding whether the terms of their related-party transactions meet the arm’s length standard. This article explores the TP methods described by the Cabinet of Ministers’ Regulation No. 677 of 14 November 2017, Application of Provisions of the Corporate Income Tax Act (effective from 1 January 2018) as well as their selection and application.
 
TP methods
 
Paragraphs 13–17 of the Cabinet Regulation define methods a taxpayer will be allowed to use in applying the arm’s length principle. There are still five TP methods, of which –
  • four (the comparable uncontrolled price method, the resale price method, the cost plus method, and the transactional net margin method) are considered unilateral because the financial indicator is examined only in one of the parties to the transaction; and
  • one (the profit split method) is regarded as combined because the combined profit is split between two or more parties according to the analysis of their contributions.
It is important to note that the TP method selection process is always aimed at finding the most appropriate method for a particular case, and the choice of method depends on the facts and circumstances of that case.
 
The comparable uncontrolled price method
 
Under paragraph 13 of the Cabinet Regulation, this method is applied to transactions involving goods and services with comparable prices.
 
Under generally accepted principles, this method involves comparing the price applied in a transaction between related parties –
  • with the price of a related party’s comparable transaction with an unrelated party (an internal price); or
  • the price of a comparable transaction between other unrelated parties (an external price); or, where this is sufficiently comparable,
  • with aggregated publicly available information about the prices of comparable transactions between unrelated parties (aggregated external price information).
Paragraph 1 of Annex 2 to the Cabinet Regulation offers an example of how the comparable uncontrolled price method is applied.
 
The resale price method
 
Under paragraph 14 of the Cabinet Regulation, this method is applied to a reseller’s purchases from a related party if the reseller sells on to an unrelated party.
 
The price of resale to an unrelated party is reduced by a gross profit out of which the reseller should cover his selling and administration costs to arrive at a suitable margin, considering the functions performed, the associated risks, and the assets used for the conduct of the transaction, as well as other factors affecting its price.
 
Under generally accepted principles, this method involves comparing the resale price difference (gross margin) a reseller earns in a transaction between related parties –
  • with the resale price difference (gross margin) the reseller earns on goods he buys and sells in comparable uncontrolled transactions (an internal comparable); or
  • with the resale price difference (gross margin) earned by unrelated parties in comparable uncontrolled transactions (an external comparable).
The resale price difference (gross margin) is calculated as follows:
 
 
Paragraph 2 of Annex 2 to the Cabinet Regulation offers an example of how the resale price method is applied.
 
The cost plus method
 
Under paragraph 15 of the Cabinet Regulation, this method is applied to a seller’s (manufacturer’s) or service provider’s transactions where goods or services are supplied to a related party.
 
An appropriate markup is added to the supplier’s direct and indirect costs related to the controlled transaction, considering the functions performed, the associated risks, and the assets used for the conduct of the transaction, as well as other factors affecting its price.
 
Under generally accepted principles, this method involves comparing the markup a seller adds in a transaction between related parties –
  • with a markup he applies in a comparable uncontrolled transaction (an internal comparable); or
  • with markups applied by unrelated parties in comparable uncontrolled transactions (an external comparable).
The markup is calculated as follows:
 
 
Paragraph 3 of Annex 2 to the Cabinet Regulation offers an example of how the cost plus method is applied.
 
(to be completed)

 

 
Contacts
Zane Smutova
zane.smutova@pwc.com
Tel: +371 67094400
© 2019 PwC. All rights reserved. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details.  | Last updated: 14.01.2019