Not every adjustment to transaction prices is a transfer pricing adjustment
Related parties often apply transaction price adjustments in their settlements. The so-called contractual adjustment and transfer pricing adjustment within the meaning of Article 11e of the CIT Act are perceived differently in terms of CIT. Choosing the right category in a particular case raises many doubts for both taxpayers and tax authorities (despite the Ministry of Finance’s binding explanations on transfer pricing adjustments). When analyzing facts of the case, focus should be on the reasons for which the transfer price was adjusted and the adjustment method.
As a reminder, there are two popular models for adjustments in capital groups:
- contractual adjustments, which are an adjustment of the price for individual goods or services, e.g. based on a change in volume or granted discounts;
- profitability adjustments, or adjusting the total financial result achieved by related entities on a given transaction to the arm’s length level (i.e. a level that would be established by third parties), which is usually determined on the basis of a transfer pricing analysis.
In the first case, taxpayers who make a contractual adjustment should account for it on general principles in accordance with Article 12.3j-3m of the CIT Act (on the revenue side) or Article 15.4i-4k of the CIT Act (on the cost side). It means they should include it in the current settlement period.
In the second case, such an adjustment may (provided it meets additional conditions listed in Article 11e of the CIT Act) be considered a transfer pricing adjustment and should be recognized for the period it relates to (the so-called retrospective adjustment).
Inconsistent approach by authorities
Correct classification of adjustments as transfer pricing or contractual adjustments is often difficult. For example, in the interpretation of the Director of the National Tax Information of 7 April 2021 (ref.: 0111-KDIB1-1.4010.29.2022.2.MF), the authority mistakenly considered the contract adjustments made by the taxpayer to be transfer pricing adjustments. The taxpayer acted as a shared services center and provided services to Group companies. After the end of the year, the applicant made adjustments by adjusting the amount of the cost base to the actual costs incurred in connection with the services actually provided. As a result of the adjustments, there was no change (increase or decrease) in profitability on the part of the applicant since it has been applying a fixed margin. The adjustment was related mainly to updating the scope of services, the occurrence of quantitative or qualitative complaints, as well as modifications to continuous services, which were ultimately not implemented in the tax year. The authority, despite the existence of premises indicating that it is a contractual adjustment, adopted a position different from that of the taxpayer and decided that it should apply a transfer pricing adjustment.
Even if the authority confirms the applied adjustment is a contractual one, it may be difficult to classify the costs incurred as a result of the adjustment as tax deductible. A case like that was addressed in the ruling of the District Administrative Court in Poznań of 10 June 2022 (file no. I SA / Po 1080/21). The company, an agricultural producer, adjusted the prices of individual products (agricultural produce) after the end of the year. The taxpayer argued that only after the crops are processed (and their quality assessed) it is possible to determine their real market price; and that prices are influenced by seasonal and demand-supply fluctuations. The authority agreed with the company that the adjustments are related to changes in the prices of specific goods or products and do not constitute transfer pricing adjustments within the meaning of Article 11e of the CIT Act. Still, it did not allow the taxpayer to include the expenses resulting from the settlement of price adjustments as tax-deductible. The taxpayer’s position was only confirmed by the court, which recognized that in the facts of the case the company may settle adjustments of transaction prices on an ongoing basis and to include expenses on this account as tax-deductible.
Points to remember
When making adjustments to transaction prices, you should always pay attention to whether the adjustment is related to seeking a specific profitability (transfer pricing adjustment) or is an adjustment of prices or quantities of individual goods or services (contractual adjustment settled on general principles).
Unfortunately, these examples show that despite the Explanations of the Ministry of Finance on transfer pricing adjustments and a very large number of interpretations and judgments, the approach of the authorities is still inconsistent in this respect. Taxpayers applying for individual interpretations must take into account situations where the authorities mistakenly recognize the contract adjustments made as transfer pricing adjustments within the meaning of Article 11e of the CIT Act. It also happens that even if the authority agrees with the taxpayer that the adjustment should be made on general terms, it may create problems with recognizing the expenses incurred on account of the adjustments as tax costs. Unfortunately, the legal uncertainty related to transfer pricing adjustments will most probably not be amended any time soon.
Senior Consultant in the Transfer Pricing Team
Tel.: (+48) 503 972 120