Albanian Ministry of Finance issues instruction for implementation of new transfer pricing legislation

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1 25 July 2014 Global Tax Alert News from Transfer Pricing EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: Services/Tax/International- Tax/Tax-alert-library#date Albanian Ministry of Finance issues instruction for implementation of new transfer pricing legislation Executive summary The Albanian Ministry of Finance recently issued an administrative instruction on the implementation of the new transfer pricing legislation introduced in June The instruction, based on the OECD Transfer Pricing Guidelines of 2010, provides further guidance on the application of the arm s length principle and preparation of the transfer pricing documentation., consisting of the Master file and the local country (Albania) file, prepared in line with the EU Code of Conduct on transfer pricing documentation for associated enterprises, is considered to satisfy the requirements of the Albanian legislation. The documentation must be submitted within 30 days from the tax authorities request. If it is in English, it should be accompanied by a notarized translation into Albanian. Lack of transfer pricing documentation does not trigger non-compliance penalties, but protects the taxpayer from the assessment of penalties in case of transfer pricing related audit adjustments. 1 Nevertheless, taxpayers are obliged to submit, by the corporate income tax return filing due date (i.e., 31 March of the following year) the Controlled Transaction Notice which lists the intercompany transactions and the applied transfer pricing method, when their controlled transactions exceed in aggregate ALL 50,000,000 (approx. 357,000).

2 Detailed discussion Controlled transactions The Instruction contains further details on the definition of controlled transactions. It also, clarifies that the burden of proof for demonstrating that, in the absence of 50% or more stake in the voting rights, profits or control of the Board of Directors composition, a person effectively controls the business decisions of the other person, and thus, they are related parties, falls on the tax administration. In addition, it includes, in the first of its Appendices, a list of tax haven jurisdictions with which any transaction is considered a controlled transaction for the purposes of application of the transfer pricing legislation. Comparability analysis The instruction contains details on the five factors that should be considered, to the extent they are economically relevant to the specific facts and circumstances, in determining whether the uncontrolled transactions identified are comparable and thus, can be used for testing the arm s length character of the controlled transactions (see endnote 1). Furthermore, it recommends the use of the nine-step process of the OECD Transfer Pricing Guidelines, in the search for comparables, stressing at the same time that the outcome and not the process itself is of importance. The instruction also refers to comparability adjustments. It states that such adjustments may indicatively target the elimination of differences caused by the application of different accounting practices, differences in capital, functions, assets and risks, differences in contractual terms, and differences between geographic markets. Such adjustments should only be performed if they are expected to increase the reliability of the results. Finally, the instruction states that the tax authorities cannot use secret comparables in testing the arm s length nature of a controlled transaction. Transfer pricing methods The Instruction analyzes and provides examples for the application of the most appropriate transfer pricing method (see endnote 1). Sources of comparable information It is possible to rely on the data of domestic internal and external comparable uncontrolled transactions, and in their absence, it is possible to use foreign comparable uncontrolled transactions, provided the impact of geographic differences and other factors on the financial indicator under examination is analyzed, and, where appropriate, comparability adjustments are made. Tested party The Instruction stresses that as a general rule, the tested party in a controlled transaction will be the one to which one of the transfer pricing methods can be applied in the most reliable manner and for which the most reliable comparable uncontrolled transactions can be identified. Such party will most often be the one having the less complex functions with respect to the controlled transaction and which does not contribute any valuable intangibles. Use of a foreign entity as tested party is possible, provided the domestic taxpayer provides the tax authorities with sufficient information on that foreign entity in order to allow the examination of the conformity of the conditions of the controlled transaction with the arm s length principle. Service transactions The Instruction provides the criteria for evaluating the arms length nature of a controlled service related transaction, namely: The service is actually rendered When it was rendered it was expected to provide the service recipient with economic or commercial value An independent party in comparable circumstances would have been willing to pay for it, or would have performed it in-house The amount charged is at arm s length When the service recipients are several associated parties, the application of allocation keys in allocating the service charges is plausible as long they are consistent with the allocation that would have been made among unrelated parties. Transactions involving intangibles The Instruction requires the application of a two-sided approach in examining the application of the arm s length principle in a controlled transaction involving sale, licensing or co-development of intangible property; namely 2 Global Tax Alert Transfer pricing

3 the price at a which a comparable independent party would be willing to transfer or share the benefits of his intangible property and the value and usefulness of such property in the business of the transferee. In assessing comparability for a transaction involving intangible property, the following factors will be among those considered: The expected benefits from the intangible property; Any geographic limitations in the exercise of relevant rights; The exclusivity or not of the exploitation; Whether the transferee will be participating in the further development of the intangible. Transfer pricing adjustments A transfer pricing adjustment shall be made by the tax authorities only with the written approval of the Director of the General Tax Directorate (GTD). In general, when the tax authority makes a transfer pricing adjustment, it should use the median of the market range, unless the taxpayer or the tax authority proves the circumstances of the case warrant adjustments to a different point, in the sense that adjustment to such other point would better reflect the application of the arms length principle. With respect to the nature of the transaction and the contractual terms, the tax authorities, in examining the transaction, should in principle do so based on the transaction as it has been structured by the parties. However, tax authorities should also examine whether the conduct of the parties conforms to the terms of the contract, or whether the parties conduct indicates the terms have not been followed or are a sham. In the latter case, further analysis is required to determine the true terms of the transaction. Moreover, tax authorities can only disregard the actual transaction undertaken by the parties or recharacterize it if: The economic substance of the controlled transaction differs from its form. The arrangements made in relation to the controlled transaction, viewed in their totality, differ from those that would have been adopted by independent parties behaving in a commercially rational manner and, in addition, the structure examined practically impedes the tax authorities from determining consistency with the arm s length principle. Corresponding adjustments for the avoidance of double taxation The instruction details the procedure and the information to be included in the taxpayer s request for a corresponding adjustment for the purposes of elimination of the double taxation of profits resulting from a transfer pricing adjustment made by the tax authorities of a tax treaty country. The request should be made in compliance with the applicable tax treaty provision on corresponding transfer pricing adjustments and provide the necessary data in order for the tax authority to conclude on whether such an adjustment from an Albanian side is appropriate, in light of the arm s length rule. This procedure does not limit the right of the taxpayer to request the initiation of Mutual Agreement Procedures based on the applicable tax treaty. The request should be submitted to the GTD, which should notify the taxpayer on the outcome of the request within three months from its receipt. The new legislation requires taxpayers to submit transfer pricing documentation to enable the tax authority to verify that the conditions in controlled transactions are consistent with the arm s length rule. The documentation should be submitted only upon the tax authorities request and within 30 days from the date of the request receipt. should contain the following: Overview of the taxpayer s business operations and organization chart; Description of the group corporate organization structure to which the taxpayer is a member and the group s operating structure; Description of the controlled transaction(s), including analysis of the comparability factors and details of applied transfer pricing policies; Explanation of the most appropriate transfer pricing method selected, and, where relevant, of the financial indicator; Global Tax Alert Transfer pricing 3

4 Comparability analysis, including description of the process carried out to identify comparable uncontrolled transactions, explanation of the basis for the rejection of any potential internal comparable uncontrolled transactions, description of the comparable uncontrolled transactions, analysis of the comparability of the controlled transactions and the comparable uncontrolled transactions and information on any comparability adjustments made; Explanation of any economic analysis and projections relied on; Details of any advance pricing agreements or similar arrangements in other countries applicable to the controlled transactions; Conclusions on the consistency of the conditions of the controlled transactions with the arm s length principle, including details of any adjustment made to ensure compliance; and Any other information that may have a material impact on the determination of the taxpayer s compliance with the arm s length principle with respect to the controlled transactions. The instruction allows the use of the two-tier approach with Master file and Country (Albania) file, prepared in line with the Code of Conduct on transfer pricing documentation for associated enterprises in the European Union and the Annex thereof, approved by Resolution 2006/c176/01 of 27 June 2006 of the EU Council. may be submitted either in electronic form or in paper format, in Albanian or in English language, accompanied by an Albanian notarized translation. Update of the TP documentation should be updated annually. However, taxpayers with a turnover of less than ALL 50,000,000 that use external comparable uncontrolled transactions, can use the same comparable data for three consecutive fiscal years, provided there have been no material changes in the conditions of the controlled transactions, the external comparable uncontrolled transactions and their respective economic circumstances. Controlled Transaction Notice The obligation to submit the Annual Controlled Transaction Notice applies to taxpayers who engage in controlled transactions where aggregate value exceeds ALL 50,000,000. When determining the annual aggregate transactions volume, taxpayers should take into account all intercompany transaction amounts, i.e. without off-setting credit and debit values. The Notice should be submitted by 31 March of the following year. In Appendix 2 of the Instruction there is provided a template of the Notice. Implications The Instruction provides clarity regarding how the arm s length rule is expected to be applied, thus contributing to legal certainty and predictability. However, more clarity is needed regarding the issue of re-characterization of contractual arrangements by the tax authorities and whether the conduct of the parties with regard to the allocation of risks will be examined by reference to which party can effectively exercise control over the relevant risk. Moreover, group affiliates should discuss the requirements with their headquarters to ensure the relevant information and supporting documentation is obtained early enough to allow timely preparation of the transfer pricing documentation file and the Controlled Transaction Notice. Endnote 1. See EY Global Tax Alert, Albania introduces new transfer pricing legislation, dated 2 June Global Tax Alert Transfer pricing

5 For additional information with respect to this Alert, please contact the following: Ernst & Young Albania SHPK, Tirana Alexandros Karakitis alexandros.karakitis@al.ey.com Anisa Jasini anisa.jasini@al.ey.com Global Tax Alert Transfer pricing 5

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