Transfer pricing
Transfer prices are the prices at which an enterprise transfers physical goods and intangible property or provides services to associated enterprises.
They represent a complex and important aspect of business, in particular for companies operating in different tax jurisdictions. Understanding legal frameworks, documentation requirements and transfer pricing methods is key to successfully managing this issue. In today's globalised economy, proper management of transfer prices can have a significant impact on the overall profitability and tax efficiency of a company.
Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration, Organization for Economic Cooperation and Development - OECD
The OECD Transfer Pricing Guidelines for Multinational Enterprises (hereinafter: MNE) and Tax Administration (hereinafter: OECD Guidelines) of the Organization for Economic Cooperation and Development – OECD provide guidance on the application of the “arm's length principle", which is the international consensus on the valuation of cross-border transactions between associated enterprises.
The OECD Guidelines are used in practice as a generally accepted approach. They are a non-binding legal instrument providing guidance on transfer pricing. They develop techniques aimed at addressing common challenges in the application of the arm's length principle and are continuously reviewed in the light of increasing transfer pricing challenges.
The latest edition of the 2022 OECD Guidelines is available at the following link: OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022 | OECD
Arm's Length Principle
The arm's length principle is the generally accepted international standard for transfer pricing by MNE groups and tax administrations for tax purposes.
As prices are established by associated enterprises, prices may not correspond to market prices.
The arm's length principle requires that the conditions (including prices, but not only them) which are set or imposed between associated enterprises correspond to the conditions that independent parties would have agreed in comparable transactions in comparable circumstances.
Legislative Transfer Pricing Framework in the Republic of Croatia
In the Republic of Croatia, transfer pricing policy is based on the Profit Tax Act (link: Profit Tax Act, Article 13 and the Ordinance on Profit Tax. These regulations require associated enterprises transactions to be determined as market prices, which means that prices should be similar to those that would be applied between unrelated parties under comparable conditions. The Tax Administration of the Republic of Croatia uses the OECD Guidelines in its practice.
Associated enterprises
For the purposes of transfer pricing and demonstrating in the transfer pricing documentation that business relationships between associated enterprises are determined as market prices using prescribed methods, associated enterprises are considered to be enterprises where one enterprise participates directly or indirectly in management, supervision, or capital of the other enterprise, or both parties participate directly or indirectly in management, supervision or capital of the company (Article 13(2) of the Profit Tax Act).
For the purposes of applying Article 13 of the Profit Tax Act, this includes the associated enterprises described above that are residents (if one of the associated enterprises has a preferential tax status (i.e. pays profit tax at rates lower than the prescribed rate or is exempt from profit tax) or has the right in a tax period to carry forward a tax loss from previous tax periods (Article 13(5) of the Profit Tax Act).
Transfer Pricing Methods
Methods used for transfer pricing are the traditional transaction methods (the comparable uncontrolled price method (CUP), resale price method and cost plus method) and transactional profit methods (the profit split method and the net profit method). The purpose of the methods is to demonstrate that associated enterprises acted in accordance with the arm's length principle when dealing with each other. The selection of method should take into account their advantages and disadvantages, the appropriateness of the method to the nature of the controlled transaction as determined by functional analysis, the availability of reliable information necessary to apply the chosen method, as well as the degree of comparability between controlled and uncontrolled transactions, including the reliability of comparability adjustments that may be necessary to eliminate material differences between them.
Where both the traditional transaction method and the transactional profit method can be used with equal reliability, preference is given to the traditional transaction method, or where the comparable uncontrolled price method and another transfer pricing method can be used with equal reliability, preference is given to the comparable uncontrolled price method, while it is necessary to choose the method most appropriate to the particular case.
Transfer Pricing Documentation
One of the key transfer pricing requirements for companies is the transfer pricing documentation. Taxpayers must draw up transfer pricing documentation for transactions with associated enterprises, as business relationships between associated enterprises will only be taken into account if the taxpayer disposes of and, at the request of the Tax Administration, provides data and information on associated enterprises and business relationships with such enterprises, the methods used to establish comparable market prices, the reasons for choosing specific methods and the method in which the adjustment is carried out. Taxpayer must submit this documentation to the Tax Administration upon request, which means that it is not submitted with the annual profit tax return (PD Form).
An integral part of the transfer pricing documentation is the country-by-country report (CbC Report) drawn up by MNE groups whose total consolidated revenue in the preceding tax year exceeds EUR 750 million or a corresponding amount in another currency.
Advance Pricing Arrangement
In order to increase tax certainty, a taxpayer, which is part of the MNE group and carries out transactions with associated enterprises, is allowed to enter into an Advance Pricing Arrangement (APA) in accordance with the provisions of Article 14a of the Profit Tax Act and the Ordinance on the Procedure for the Conclusion of Advance Pricing Arrangement. Advance Pricing and Contractual Relations Arrangement is an agreement between a taxpayer and the Ministry of Finance, Tax Administration and the tax authorities of other countries in which associated enterprises are residents or operate through an establishment. Thus, unilateral, bilateral and multilateral advance pricing arrangements have been made possible.
Taxpayers may submit the APA initiative to the following e-mail address: sporazum.tc@porezna-uprava.hr. More detailed information on the Advanced Pricing Arrangement is available at the following link: Advance Pricing and Contractual Relations Arrangement
Mutual Agreement Procedure (MAP)
Article 25 of the OECD Model Tax Convention provides a mechanism for resolving disputes arising where the actions of one or both of the contracting states give rise or will give rise to taxation that is not in accordance with the provisions of the convention for the taxpayer concerned. In cases of transfer pricing or attribution of profits to a permanent establishment, economic double taxation may result from the profits inclusion in the profits of a company of one Contracting State for which a company of the other Contracting State has paid tax in that other State.
Taxpayers may submit a request to initiate MAP procedure concerning transfer pricing or attribution of profits to a permanent establishment to the following e-mail address: map-hr@porezna-uprava.hr. More detailed information on the MAP procedure is available at the following link: MAP Guidelines
Authorised OECD Approach (AOA)
Business practice typically uses the AOA approach, a methodology developed by the OECD to address certain transfer pricing issues. The 2010 OECD Permanent Establishment Report established the concept of the AOA approach, which presents the idea of treating a permanent establishment as if it were an independent and functionally separate entity engaged in the same or similar activities under the same or similar conditions.
In 2018, the OECD published additional guidance on the attribution of profits to permanent establishments resulting from the amendments to Article 5 of the OECD Model Tax Convention. These guidelines are available at the following link: Additional Guidance on the Attribution of Profits to a Permanent Establishment under BEPS Action 7.
The objective of the AOA approach is to provide a structured approach for the assessment and adjustment of transfer prices, thus reducing the complexity and uncertainty for both taxpayers and the Tax Administration. It is also important to note that the AOA approach also helps companies to comply with international standards and transfer pricing regulations thus reducing the risk of conflicts between different tax jurisdictions, as it provides clear guidelines for pricing between associated enterprises.
The AOA approach is explained in the OECD Model Tax Convention in the commentary to Article 7.
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A more detailed overview of the legal framework, policy and transfer pricing practice in the Republic of Croatia is available on the OECD website at the following link: Transfer Pricing Country Profile - Croatia (oecd.org)