In this article, we seek to answer the question of whether an affiliative relationship between an individual and a company can be said to exist and, if so, whether the transfer pricing rules should apply.
Affiliative relationship
The relevant interpretative provisions of the CIT Act speak of the relationship between a taxpayer and a person in the case of related enterprises. The taxpayer here is understood to be the company, so it is necessary to examine whether the definition of a person under the CIT Act can include an individual. According to Section 4, paragraph 31/b of the CIT Act, a person is a domestic person, a foreign person and an individual.
This means that there may be an affiliative relationship between a private owner and the company held by themif they comply with the provisions on influence contained therein.
Possible effects of an affiliative relationship on the prices applied between the parties
As a consequence of the existence of a relationship, the parties are not obliged to use transfer pricing between themselves, but they are obliged to determine their taxable amount as if transfer pricing had been used and, above a certain threshold, to prepare transfer pricing documentation showing how transfer pricing has been determined.
The taxpayer may then have an obligation to increase the tax base and a right to reduce the tax base.
Tax base reduction
If the price applied between related enterprises differs from the transfer price and, as a result, the taxpayer’s pre-tax profit is higher than it would have been if transfer pricing had been applied, it may reduce its pre-tax profit, provided that the 4 conjunctive conditions set out in the law are met. One of these conditions is that the associated enterprise contracting with the taxpayer is a resident taxpayer or a specified foreign person. Since the individual is not such a person, the company cannot reduce the tax base even if the application of the market price would result in a lower pre-tax profit.
Increasing the tax base
According to Section 18 (1) (b) of the CIT Act, a taxpayer is obliged to increase its taxable amount if the consideration paid results in a pre-tax profit that is lower than the profit that would have been obtained at the transfer price, unless the taxpayer is a private individual not acting as an individual entrepreneur. Thus, the taxpayer will not be obliged to increase its tax base.
Preparation of transfer pricing documentation
The obligation to prepare TP documentation arises under Section 18(5) of the CIT Act even if the taxpayer did not have to/could not have adjusted its pre-tax profit, so this obligation is assessed irrespective of the applicability of the adjusting items.
The detailed rules for TP documentation are set out in the NGM Decree No. 32/2017 (X. 18.), which states in its Article 1 (2) (a) that “The registration obligation under this Decree shall not apply to contracts concluded with private persons other than sole proprietors”.
To summarise the above, although the individual owner and their company may be related parties, transactions between them do not, as a general rule, require the application of transfer pricingadjustments and transfer pricing documentation.
