Tax deductibility of the services provided by the group is often subject to review by Tax Authorities. Do you know which steps should not be underestimated so that a possible tax audit does not surprise you?
In case of tax audits focused on transfer pricing, in practice, we often encounter that Tax Authorities scrutinize the costs of services received from related parties within the group. From our experience, taxpayers many times do not have sufficient supporting documents available at the time of the tax audit to prove the meeting of necessary conditions for tax deductibility. The consequence is often significant additional assess of tax.
In our experience, these are the most common causes:
- Service is an intangible economic asset. It is consumed at the same time as it is performed/provided. Because of this characteristic of services, it is more difficult to prove that the services have been carried out than to prove the supply of tangible assets, e.g. goods or machinery.
- Taxpayers do not keep enough records. The existence of an invoice and contract may not constitute sufficient proof.
- The subject of tax audit are closed tax periods. Often five, sometimes more, years back. Due to such a large time gap, various complications arise. E.g. it is not possible to access the relevant documents or the persons engaged when the service was received are by the time of the tax audit no longer employees of the taxpayer. The service provider may also not be able to help the situation for similar reasons or may no longer exist at all.
- But it is also a frequent reason that the burden of proof is disproportionately shifted by the Tax Authorities on to the taxpayer in violation of the law.
Among the conditions of tax deductibility that the tax authorities examine are:
- Can the taxpayer prove that the service was truly provided? In practice, in addition to contracts and invoices, the tax authorities mainly require evidence such as outputs of the provided services (e.g. reports, opinions, recommendations), work reports, minutes of meetings, e-mail communications, etc.
- Can the taxpayer prove that the service provided in this way had benefited the taxpayer and how it is related to his business activities?
- Can the taxpayer prove that the price of the service is arm's length within the meaning of the transfer pricing rules? In the case of the cost-plus method, which is often used in transfer pricing of services, it is necessary to prove not only that the amount of the profit mark-up is arm's length, but also the cost base itself and the way it is allocated among the different recipients of the service within the group.
There have been a number of court decisions on this topic in Slovakia as well as in the Czech Republic, which include, for example, the following conclusions:
- Invoices by themselves are not sufficient evidence to prove the supply of goods and the provision of services without additional evidence confirming their real fulfillment.
- A condition for the deductibility of costs is their direct link to the business activity and also to the income.
- If costs in a group of related parties are allocated according to a certain key, supporting documents for this key must be provided for the whole group, not only for the costs allocated to the taxpayer.
In conclusion, we stress that the taxpayer must bear the burden of proof in the first place, which means he has to prove that he actually received the services and that they benefited him. The transfer pricing itself is only examined subsequently. In our experience, taxpayers often have a problem with the first step and so the tax authorities in many cases do not even proceed to examine the transfer pricing during the tax audit and consider the full costs to be non-tax deductible.
Please feel free to contact our experts before the tax authorities request your transfer pricing documentation. We will be glad to help you and look into your transactions with your related parties.
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