Why is it important to accurately determine the functional profile?

The functional profile should be understood primarily as the role of an entity in a transaction. It depends on its business activity in the market or in the transaction (e.g. manufacturer, distributor) and its level of involvement in the transaction in terms of functions performed, assets involved and level of risk exposure. Determining the functional profile of an entity in a transaction translates into the correct choice of method for calculating and verifying the market nature of the remuneration in that transaction. Therefore, it is worth paying attention to the correct determination of the functional profiles of the parties to a controlled transaction.

As practice shows, during a tax audit, the authorities may question the functional profile of the taxpayer or its counterparty and, consequently, point to its inconsistency with the remuneration agreed in the transaction. An example is the judgment of the District Administrative Court in Gliwice of 6 September 2023 (ref. I SA/Gl 1563/22).

Facts and position of the First Instance Authority

The company operates within an international capital structure and manufactures products for the automotive industry. In the course of the customs and tax inspection carried out and, consequently, of the tax proceedings, the First Instance Authority drew attention to the tax and balance sheet loss recorded by the company in the years 2010-2013 and 2016-2018, and in the course of the years 2010-2018 the company was already incurring a loss at the operational stage. Moreover, an analysis of the consolidated financial statements of the Group of related entities to which the company belonged for the audited year (i.e. 2016) showed that in terms of profitability of the production companies, only the Polish company made a loss.

As the Authority stressed, the main objective of a business should be to maximise profit. By contrast, incurring losses over an extended period, without attempting to change the business strategy, may indicate that the reported results do not reflect the true value of the business in question. According to the Authority, this was precisely the case for the company.

Consequently, the Authority conducted a functional analysis of the company, during which it determined that it was a manufacturer with limited functions and risks (so-called contract manufacturer). The company was primarily responsible for manufacturing, performing quality control, packaging, warehousing, delivering products to customers and invoicing. Importantly, the company was not involved in research and development, organisation of sales of finished products or promotional and marketing activities. As such, it was not exposed to market or credit risk. Instead, strategic functions (i.e. negotiating and signing contracts) were conducted by a central entity within the Group. The Company was therefore only a beneficiary of the arrangements made by the related party and third parties.

The Authority also found that the company’s shareholder systematically financed the company’s unprofitable production activities by granting a loan on terms far more favourable than market terms and by taking up new shares at a price higher than the nominal value and transferring the surplus to supplementary capital. Thus, in the Authority’s view, the group entity artificially sustained the existence of the unprofitable company, as the operation of the company served the objectives of the Group as a whole.

Group entities also entered into a service agreement. The allocation keys adopted under this agreement at unprofitable operations meant that the increase in the value of production and sales achieved by the company entailed a greater burden of intra-group service costs.

On this basis, the Authority concluded that the company’s business conditions within the Group were pre-determined and imposed and therefore not in line with market conditions. This led to unjustified losses in the company, given the functions it performed.

Consequently, the Authority determined the taxpayer’s income and the tax due, without taking into account the conditions arising from existing relationships, on the basis of an analysis based on the reasonable margin (cost-plus) method.

The company appealed against the decision of the First Instance Authority.

Second Instance Authority

The Second Instance Authority shared the position of the First Instance Authority. However, it overturned the appealed decision and determined income at a lower amount. The reason for this was a different assessment of the Appellate Authority as to the value of changes in the stock of products, which affected the amount of costs adopted for the calculation.

The company disagreed with the Second Instance Authority’s assertions and filed a complaint with the District Administrative Court.

The position of the DAC

The District Administrative Court in Gliwice agreed with the Authority regarding the determination of the functional profile and the legitimacy of the income revaluation.

In the Court’s opinion, the agreement concluded confirms the imposition of business conditions on the company and the exertion of significant influence on the financial result. It also needed to be emphasised that the company had been operating unprofitably for years and was only able to maintain liquidity thanks to the financial support of the capital group.

Furthermore, according to the DAC, “The authority correctly pointed out, referring to the OECD Guidelines, that the establishment of the company’s business profile in the profitable automotive sector at the time, as a manufacturer with limited functions and risks, determines the thesis that this type of entity should achieve a low but stable profit. Meanwhile, the company did not achieve a positive result and was in fact the only company in the Group with a negative financial result, incurring losses already at the operational stage”.

The DAC, however, overturned the contested decision on the grounds that taxable income had been incorrectly determined because of the failure to account for losses from previous years.


As the position of the Authorities presented in the judgment discussed above shows, an incorrect determination of an entity’s profitability in the context of its functional profile in a controlled transaction may involve a significant risk in the event of an tax audit. The Tax Authorities pay particular attention to entities with a limited functional profile when they incur losses. This is because, by definition, this profile should involve achieving a stable and low level of profit.

Accurately determining the functional profile, and then properly selecting the method and manner of calculating remuneration, can therefore protect the taxpayer from doubts on the part of the authorities and mitigate the risk associated with estimating additional taxable income. Therefore, it is important to establish the functional profile of the entities already at the stage of planning the controlled transaction, so from the beginning the method of calculating the remuneration is reasonable and in accordance with the arm’s length principle. In this case, those entities and groups that have clearly defined the roles of the entities in the creation of the group value chain and have an established “Transfer Pricing Policy” have an advantage.