On 25 October 2018 the long-awaited amendments to the Taxes and Duties Act regarding the transfer pricing documentation requirements were finally passed.
The amendments were necessary to incorporate the revised standards for transfer pricing documentation required by the Economic Cooperation and Development (OECD) Base Erosion and Profit Shifting (BEPS) plan (Action 1) into the domestic transfer pricing rules and to harmonize the transfer pricing rules with the newly adopted Corporate Income Tax.
It is crucial to mention that the amendments apply to transactions carried out as of 1 January 2018, but the taxpayers are entitled to apply them also to the previous periods.
Three-tier transfer pricing documentation
According to the new standard, transfer pricing documentation consists of three-tier documentation:
(1) Country-by-Country documentation, which includes general data on the location of the multinational enterprise group income, tangible assets, employees, taxes and other factors by country;
(2) Master file. The information in the master file can be divided into the following five categories:
- Organizational structure of the international group of companies – legal and geographical structure
- Group Business Model (a general business description that includes key sources of competitiveness, supply chain description, essential goods and services, group services, geographic markets, functional analysis and reorganisations)
- Intangible assets of the multinational companies group (general description of the intangible property, contracts, etc.)
- Financial Transactions within an International Group – transactions and transfer pricing policies
- Financial and tax items of the international group of companies – consolidated financial statements of the multinational group of companies, advance pricing arrangements concluded within the group.
(3) Local file. The information contained in the local file complements the information contained in the master file and seeks to justify that the price (value) of the controlled transaction that affects the local business tax burden corresponds to the market price (value). The local documentation contains a transfer pricing analysis of the comparative analysis of the controlled transaction conducted by the local taxpayer, including the relevant financial information, and a justification for choosing the transfer pricing method.
Who should prepare the transfer pricing documentation?
In order to avoid misunderstandings, it is important to distinguish between the obligation to comply with the arm’s length (market value) requirements and mandatory transfer pricing documentation requirements.
The obligation to stick to transfer prices is set out in the Corporate Income Tax Act and this obligation applies to the transactions carried out between all related entities. For example, if a company issues the loan to a local affiliated company, the transfer pricing documentation is not required, but nevertheless, the interest rate should still be at arm’s length.
The definition of persons which should prepare the mandatory transfer pricing documentation is much narrower. Therefore, if a transaction with a related party does not require preparing the transfer pricing documentation, still a possible obligation to observe the market value of the transaction should always be considered.
So, who should prepare the documentation for 2018 and beyond?
The transfer pricing documentation should be prepared for the transactions carried out with:
1) a related foreign company;
2) an individual referred to in Paragraph 1 of Article 18 of the Act (namely, the individual owning more than 50% of the shares or voting rights
3) low tax territory (offshore) enterprises;
4) related parties – residents, if the transaction, the commercial or financial relationship according to the functions performed, the risks incurred, controlled or managed, or the assets used, are economically linked (within the same supply chain) to other related foreign company or a person in the offshore territory.
Transactional value thresholds
The amendments introduce thresholds for the controlled transaction values, which creates for the taxpayer’s obligation to submit local and/or global documentation.
If a Latvian entity carries out the transaction with foreign related companies, offshore companies and related individuals, then the following obligations will arise:
(1) The Latvian company is obliged to submit to the State Revenue within 12 months after the end of the financial year:
- Global documentation, if at least one of the following conditions is met:
(a) the amount of controlled transactions exceeds EUR 15 000 000 for the relevant accounting year;
(b) the turnover for the financial year exceeds EUR 50 000 000 and the amount of transactions controlled in any given financial year exceeds EUR 5 000 000;
- The local file where the amount of transactions controlled over a reporting year exceeds EUR 5,000,000.
(2) The obligation to prepare within 12 months after the end of the financial year and, if requested by the SRS, within one month after the receipt of the request, submit:
- global documentation if the taxable person’s net turnover in the relevant financial year does not exceed EUR 50 000 000 and the amount of transactions controlled in the relevant reporting year does not exceed EUR 15 000 000 but exceeds EUR 5 000 000;
- the local file where the amount of transactions controlled in a given accounting year exceeds 250,000 euros but does not exceed 5,000,000 euros.
If the sums related to transactions with related parties are less than 250 000 euros, there is no obligation to prepare the local. However, in such transactions there will also be a need to adhere to the market value and, if necessary, prove market value in compliance with governmental regulations.
The above requirements are summarized in the below table:
Availability of information. The transfer pricing documentation has to be prepared on the basis of the information reasonably available in the reporting year or, if corrections are made to the corporate income tax return, on the basis of the information available at the time the relevant corrections are made.
Language. The Master file must be prepared in Latvian or English. If the global documentation is written in English, the tax administration has the right to request a translation of all or part of the dossier in Latvian and the taxpayer is required to submit the translation requested within one month of receipt of the request.
How frequently the document should be updated? If the factors influencing the transfer pricing methodology have not changed significantly, then the taxpayer is entitled to review the document every three years, except for comparable data which should be updated each year.
Providing search function. Transfer pricing documentation will need to be available in electronic form in the future, which allows search functionality in the text.
Penalties. The tax administration has the right to apply a fine of up to 1% of the controlled transaction, but not exceeding 100 000 euro if the taxpayer has not complied with the deadline for submission of transfer fee documentation referred to in this article and if the taxpayer has substantially violated the requirements for the preparation of transfer pricing documentation.