Do you sell goods or services to your foreign parent company? Watch out for transfer pricing

If these prices are set differently than two independent companies would agree between themselves, this falls under transfer pricing, and the tax authority has the right to review it.

The risk isn't limited to large multinational groups. It applies to any company that trades with a related party, whether a parent, sister company, or otherwise connected through ownership or personnel, including purely domestic transactions between Czech companies within the same group.

What is transfer pricing and when does it apply to you

Transfer pricing rules apply to any transaction between related parties where an incorrectly set price could affect the tax base in the Czech Republic:

1. Sale of goods and services within a group: Purchases from a sister company, sales of finished goods to the parent company, or services provided between related entities.
2. Licenses and know-how: Payments for the use of a brand, patents, or technological know-how owned by a foreign parent.
3. Intra-group financing: Loans between related parties and interest set outside market levels.
4. Management and administrative fees: Costs recharged from headquarters to the subsidiary for management, IT, or accounting services.

The arm's length principle and documentation

The basic rule is the arm's length principle: the price between related parties must correspond to the price that two independent companies would agree on under comparable conditions.

1. Transfer pricing documentation: Describes the group structure, individual transactions with related parties, and the methodology used to set prices, including a comparison with market conditions.
2. Who needs documentation: Primarily companies with a foreign owner or sister companies in other countries, but also purely Czech groups of companies under common ownership.
3. Risk without documentation: If the tax authority questions the prices set during an audit and the company has no records to defend them, it risks having the difference added back to its tax base.

What to watch out for

1. Prices set by the group's cash flow needs, not by the market

It's common for prices between related parties to be set to suit the group's current liquidity needs, regardless of how independent parties would value the transaction.

1. No updates when market conditions change

Documentation created once and never revisited won't hold up if input prices, exchange rates, or market conditions have changed significantly in the meantime.

1. Risk in an acquisition

Buying a company that traded with related parties? The historical setup of transfer pricing is one of the areas we review during financial due diligence, because unresolved risk passes on to the new owner.

Properly set and documented transfer pricing protects a company during a tax audit and in a future sale. At CATO, we have been helping foreign-owned companies set up and document their transfer pricing since 1996.

I want to review the transfer pricing setup in my company.