Tax Regulation (#05 May 2014)

With the support ofTax Regulation

Depending on the type of controlled transactions and the specific business activities of the taxpayer, one should choose a pricing method based on which the compliance of the contract price with the usual price would be examined.

The procedure has a particular pattern. The legislation provides for five traditional pricing methods, and there are special rules for setting prices for export and import transactions with non-residents from low-tax jurisdictions for specific commodity groups that are in effect till 1 January 2018. Yaroslav Romanchuk, managing partner of International Legal Center EUCON, explains that if the special rules do not apply to the controlled transaction, the first method of comparative uncontrolled price has priority. It is supported by a provision of Article 39 of the Tax Code, which states that in a situation where the taxpayer can use several methods, including the method of comparable uncontrolled price, the taxpayer needs to use the comparative uncontrolled price method. This means that the taxpayer should always evaluate whether it can apply the method of comparative uncontrolled price. The expert says that the taxpayer needs to check out if he can find comparable transactions.

Based on the provisions of the Tax Code, according to which authorities monitor compliance with the legislation in the field of the transfer pricing in view of the official sources of information, such sources should be used by taxpayers in the first place as well. According to Mr. Romanchuk, they are designated for the first method, because they contain information on market prices. However, one should bear in mind that it is necessary to look not only for the name of the goods, but also for the terms of transactions. Transactions are recognized comparable if they are carried out under the same business and financial terms.

The method of comparable uncontrolled price may seem to be the simplest method, which can be applied in almost every instance. In addition, the advantage of this method is the most accurate result. Another advantage is that it can involve only one comparable transaction. However, this method is not used very often in international practice. This can be explained by the fact that the requirements of the first method pertaining to the characteristics of goods (works, services) are quite firm. “We can use it only on the condition that goods, works and services are identical or homogenuous, and also commercial and financial terms of the transaction should match”, said Mr. Romanchuk.

The method of resale price can be used if the taxpayer resells the product as a distributor. The Tax Code of Ukrane allows for the resale price method in cases, where the resale involves sorting, repackaging, making separate batches, and combination of goods, or actually making semi-finished goods. According to Larysa Vrublevska, associate partner of the ILC EUCON, head of the Transfer Pricing School, this method will provide a more accurate result if the span between acquisition of the product and its subsequent sale is insignificant. Over time, it becomes more likely that there will be a need to consider more factors for any comparison, such as changes in the market, changes in the exchange rate, and changes in the cost structure.

The resale price method can be used only for the buyer in a controlled transaction.

The “cost plus” method is often used to determine the cost of services and works, as it is difficult and almost impossible to find information on comparable transactions to use the method of comparable uncontrolled price. Mrs. Vrublevska admits that this method should be applied to transactions where there is a direct relationship between cost and profit. Therefore, this method is appropriate for manufacturers. However, when looking for a comparable transaction, significant attention should be paid to factors that directly affect the cost. For the “cost plus” method, such factors would include production assets, personnel, as well as risks assumed by the party.

The net profit method is applied if there is no or too little information to apply the “resale price” method and the “cost-plus” method or, in other words, it is necessary to substantiate the impossibility of such methods.

The profit distribution method is applied based on the evaluation of the contribution of each party to the transaction.

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