Transfer Pricing and averaging – between practicality and risk

The TP-R form and transfer pricing documentation relate strictly to a specific financial (tax) year. This means that the data presented in these documents – such as transaction values or profitability indicators – should refer exclusively to that reporting period.

In practice, however, businesses may, for various commercial reasons, present averaged data, e.g. from a three-year period, which is then compared against benchmarking results.

But do tax authorities accept such an approach?

Why is averaging results in benchmarking analyses problematic?

The TP-R form is an annual filing requirement for taxpayers, used to report in detail the controlled transactions executed in the given reporting year. Pursuant to the provisions of the CIT/PIT Acts, the obligation to prepare transfer pricing documentation applies to the specific tax year in which the statutory thresholds have been met. As a result, all data – both in the documentation and in the TP-R form – must relate solely to transactions carried out during the respective period.

In practice, it is not uncommon for taxpayers to average financial results over several years (typically three) and compare those to benchmarking results. However, this approach remains controversial. Averaging may distort the actual profitability of a transaction in the year under review – the very year to which the documentation pertains. While certain business justifications may support the use of averaged results – e.g. due to seasonal fluctuations, one-off extraordinary events, or industry-specific factors – such an approach does not fully align with the applicable regulations and may thus create tax risk.

It is worth noting the methodology typically applied in benchmarking analyses. In practice, the financial result of the tested party in a given tax year is often compared to a three-year average of data derived from independent comparable entities. This approach is consistent with OECD Guidelines, which permit the use of multi-year data to smooth out the effects of abnormal fluctuations, and it aligns with current Polish practice.

Nonetheless, the Polish tax authorities and legislature expect that the financial data disclosed for the tested party should relate solely to the reporting year in question. Use of averages may be perceived as an attempt to obscure deviations from the arm’s length principle in a specific year. Importantly, even if a taxpayer presents averaged results for a transaction, the tax authority may still analyse year-specific data – for example, by requesting the financial outcome of the particular year in question in order to assess whether the terms applied were at arm’s length. This analysis may involve cross-referencing TP-R disclosures with other sources, such as statutory financial statements.

Moreover, this cautious approach to averaging is not unique to Poland – in many jurisdictions, similar practices are either treated with scepticism or outright rejected. Tax authorities generally expect that the data relate directly to the year covered by the documentation obligation.

Swiss case law: a cautionary tale

A recent ruling concerning a Swiss pharmaceutical company headquartered in Zug offers a relevant example. In 2018, the company reported a negative operating margin of -21.8%, which it attributed to restructuring activities. However, from that year onwards, the company operated as a limited risk entity – a model which, by definition, should not generate losses under normal market conditions.

The company argued that its results were in line with the market, referencing a three-year average operating margin of 1.2% for 2016–2018, falling within a benchmark interquartile range of 1.1%–7.3%.

The Swiss Federal Tax Administration (SFAP), however, did not accept this position. It adjusted the 2018 margin to the lower bound of the benchmark range – 1.1% – and assessed additional taxable income of CHF 8,922,473 (approximately PLN 40 million). In its reasoning, SFAP emphasised that the taxpayer failed to demonstrate any extraordinary circumstances justifying such a substantial loss, nor did it prove that the terms agreed with related parties were at arm’s length.

Of particular note, the SFAP reaffirmed that tax adjustments must respect the principle of annuality – taxpayers are not permitted to offset income for one year against prior-year surpluses. The periodicity principle under Swiss tax law prohibits using past performance to justify current-year outcomes, even if those past margins fall within the benchmark range.

This approach was echoed in the Argentine Supreme Court’s ruling of 13 August 2024 (case ref. CSJN 13/08/2024) involving Volkswagen Argentina S.A., which concerned the arm’s length character of the company’s income in 1999–2001. Although the company included extraordinary gains from debt forgiveness, tax authorities challenged the results, asserting that the company had not been remunerated at arm’s length. While lower courts ruled in favour of the company, the Supreme Court ultimately sided with the tax authority.

Industry specificity – long-term projects

In the area of transfer pricing, there are no black-and-white solutions – each case requires an individual assessment, taking into account the specific circumstances and business context.

Therefore, any blanket statement suggesting that averaging results is always inappropriate cannot be justified. What matters most are the underlying factors that support the application of an averaged approach. The reasoning behind applying such an approach and disclosing it to the tax authorities is of crucial importance. Particular attention must be paid to the specifics of the taxpayer’s operations and the characteristics of the industry in which it operates.

In industries based on long-term projects – such as real estate, construction, infrastructure, renewable energy, or shipbuilding – the use of averaged results may be grounded in commercial rationale. Long-term projects, such as the development of residential complexes or ships, have specific features that significantly impact the financial results during the initial years of implementation. These early stages are usually cost-heavy, involving investments, procurement of materials, construction work, or engineering. Revenues and, in turn, profits tend to arise only at later stages, once the project begins to generate income.

For entities operating in such sectors, a major challenge lies in appropriately attributing revenues and costs to a specific financial year. Given the extended timelines of these undertakings, financial outcomes in individual years may significantly deviate from the typical margins expected for comparable transactions. A single fiscal year may reflect substantial investment outlays uncorrelated with revenues, or conversely – record profits resulting from projects executed over the course of several preceding years.

In such cases, taxpayers may consider presenting their results on an averaged basis, as a more accurate reflection of the actual profitability over a longer time horizon. However, even in these particular circumstances, caution is required – averaging does not relieve the taxpayer from the obligation to present data in line with the relevant reporting period. It always necessitates a robust justification and proper documentation of how the structure of the projects has impacted the financial outcomes.

Otherwise, tax authorities may challenge the legitimacy of this approach, arguing that it contravenes the principles of comparability and the arm’s length nature of the transaction. Regardless of the methodology applied, if losses are incurred, the taxpayer should be prepared to provide a solid business rationale that explains the reasons for such losses and confirms the commercial soundness of the actions taken.

Example: real estate development

A company embarks on a long-term housing development project in Pomerania, involving the construction of 20 single-family homes.

In 2023 (Year 1), it incurs substantial initial costs – including land acquisition for PLN 13.5 million and PLN 1.2 million in fees for advisory and design services from related parties. In 2024 (Year 2), construction begins, with associated costs reaching PLN 12 million. Revenue is not realised until 2025 (Year 3), when the homes are completed and sold, generating PLN 32 million in sales and an operating profit of approximately PLN 5.3 million.

In such a scenario, the company may report significant losses in the first two years (e.g. PLN -14.7 million in 2023 and PLN -12 million in 2024), with all profitability concentrated in 2025. Assessing arm’s length conditions on a single-year basis (e.g. just 2023 or 2024) could lead to an incorrect conclusion that the company is operating below market terms, when in fact, the entire project is profitable on a cumulative basis.

Averaging vs. annual reporting – the Polish TP-R context

Polish regulations are relatively flexible in this area, as the legislator has provided for a compensation mechanism. While a taxpayer must report financial results for a specific year, they may simultaneously indicate that a compensation has been applied – i.e., that a lower income in one year is offset by higher profits over a three-year period, including the year in question.

This mechanism allows for:

• compliance with the requirement to demonstrate profitability for the reporting year, and
• presenting the result as part of a broader, long-term business context – particularly relevant in cyclical or project-driven industries.

However, compensation may only be applied in specific cases – when a related entity’s income in one tax year is lower than what would be expected at arm’s length, but the three-year period shows a higher-than-expected profit overall. Eligibility for this approach must be carefully assessed in each case.

Recommendations for completing the TP-R form – minimising risk

Transfer pricing is not an exact science. There is no universal approach – everything depends on the context, transaction structure, and sector.

Here are key recommendations to ensure compliance and reduce the risk of challenges from tax authorities:

• Pre-implementation analysis – A proactive approach is essential. Ensure that any adopted methodology can be logically and convincingly explained.
• Robust supporting documentation – A well-prepared position paper can be a powerful tool in defending your approach during a tax audit.
• Assessment of compensation eligibility – In certain cases, compensation may be both economically and fiscally justifiable. It should be evaluated early in the documentation process.

Should you wish to explore this topic further or have any questions, we invite you to get in touch. We are happy to support you in ensuring full compliance with current regulations while taking into account the specific characteristics of your business.