Do you know that you are a “related party”?

Have you heard of the “six degrees of separation” theory? It’s a concept that assumes that, as a resident of Earth, you can meet any other person in the world with just six or fewer mutual connections between you and that person, whether through acquaintances, friends, or their family members.

What does this theory have to do with transfer pricing? It turns out, quite a lot… because in transfer pricing, even family relationships can be very important. If we look at the definition of “related parties” created for transfer pricing regulations, we can say with 99% certainty that you are a “related party”. But don’t worry, that doesn’t immediately mean you have transfer pricing obligations. You need to “earn” those obligations 😊 However, if you do have them, be cautious – if you don’t fulfill them or do so incorrectly, you might face million-dollar penalties.

Buckle up, because we’re about to embark on an interesting journey… In this post, we’ll guide you through the complex terminology of transfer pricing, explain key concepts, and equip you with a toolkit that will help you navigate the transfer pricing language smoothly.

Mr. Tax’s Toolkit – A few words about basic transfer pricing concepts

In the previous article, we explained what transfer pricing is and that it’s definitely not about “moving funds to tax havens.” If you’d like to revisit that post, here’s the link. This time, we’ll point out who should care about this subject and clarify some of the essential terms that fill the language of transfer pricing consultants. We want to ensure that we communicate smoothly as we take you deeper into the world of transfer pricing in upcoming posts.

“Related Parties” – Who do transfer prices apply to?

You already know from the previous post that transfer prices apply to groups of entities that cooperate with each other and conduct various transactions or settlements. It’s important for these entities to be “related parties.” This means that, for transfer pricing purposes, it’s crucial to determine the relationship between the two sides of the transaction. These relationships, or “connections,” can be both capital-based and personal. While the first type of relationship may not be surprising, the second one might be.

For example, if Company A holds 50% of shares in Company B, they are related in a capital sense. Simple, right? The situation might not seem so obvious when we talk about personal connections. These can arise from relationships between individuals and companies, or even between individuals themselves. Let’s look at some practical scenarios:

• If the Chief Operating Officer of Company C is also a board member of Company D, are these companies related? Yes.
• And if the CEO of Company C is married to a shareholder of Company E, are these companies related? Yes.

Interestingly, personal connections aren’t just limited to marriage; kinship or affinal relationships (in-laws) between individuals can also create related party status. The definition of related parties for transfer pricing purposes is very broad, so if you’re thinking about starting your own business, you might want to consider with whom you’ll be making transactions. Could transfer pricing apply to me too?

What if I plan to only make transactions with unrelated parties? Will transfer pricing not apply to me at all? Maybe yes, maybe no. It depends… and it depends on whether the transactions are conducted with entities from “tax havens,” like Hong Kong, Monaco, or Panama. Are we being inconsistent? After all, we’ve said that transfer pricing has nothing to do with transferring profits to tax havens. No, we’re very consistent. Transfer pricing has nothing to do with transferring profits. On the contrary, it acts as a shield to ensure that no profits are transferred where they shouldn’t be.

Does this mean that I can’t make transactions with entities from tax havens? Oh no! You can. Just make sure that each time these transactions are made at arm’s length.

“Market Terms” – What does that mean? Mr. Tax’s Glossary

Now that you know who is affected by transfer pricing and the types of relationships that matter, let’s take a closer look at the key concepts:

• Arm’s Length Principle – This is the overriding principle of transfer pricing. In transfer pricing, this principle is applied in every instance because it guarantees that both related and unrelated parties are treated equally. All regulations concerning transfer pricing serve to implement this principle. It states that “related parties must set transfer prices on terms that would be agreed upon by unrelated parties.”
• Related Parties – We touched on this in the first part of this post, but if you’re still hungry for more information, feel free to check Article 11a of the CIT Act.
• Controlled Transaction – These are business activities, where terms and conditions have been set or imposed as a result of relationships (it’s important to identify these activities  based on the actual behaviour of the parties, not just the contract).
• Transfer Pricing Obligations – When we talk about transfer pricing obligations, we often refer to:
  • Local transfer pricing documentation (Local File), which describes the terms and process of a specific transaction. The Local File contains a description of the parties involved in the transaction, along with an identification of the functions they perform, the assets involved and the risks they bear.
  • A benchmarking analysis (benchmark), which (with few exceptions) is an inseparable and crucial part of the local transfer pricing documentation. This analysis aims to determine/verify the market level of remuneration in a transaction.
  • Group transfer pricing documentation (Master File), which focuses on showing the entire group’s activities.
  • TPR form, which allows for a synthetic report to the authorities about the terms under which transactions with related parties or entities from tax havens were carried out.

It’s important to note that while the arm’s length principle applies to all related parties, it does not automatically mean that all related parties must fulfill documentation and reporting obligations. The regulations clearly define the conditions under which these obligations arise, and they also list a full set of exemptions. However, once these obligations do apply, they must be fulfilled properly. As you might guess, when entities apply the arm’s length principle, simply documenting and reporting the agreed terms is not that complicated. But the consequences of not fulfilling transfer pricing obligations or doing so incorrectly can be very severe. Penalties can reach tens of millions of PLN.

How can you tell if you’ve encountered a transfer pricing consultant? They’ll be using the terms mentioned above, assuming everyone understands them. Why? Because in the world of transfer pricing, these terms have the same meaning worldwide.

I’m glad you’ve entered our world. You now have the basic “tools” to continue our journey into transfer pricing. In the next post in the “Akademia Pana Taxa” series, we’ll explain the essence of transfer pricing – how to check if the terms of a transaction are market-based. In the meantime, as homework (as befits an academy), think about how many related parties you might encounter on a daily basis?