Common transfer pricing rules in the EU?

On 12 September 2023, the European Commission published a proposal for a transfer pricing directive on transfer pricing harmonisation as part of the BEFIT package ("Business in Europe: Framework for Income Taxation").

In the field of transfer pricing, the OECD Transfer Pricing Guidelines currently provide a common framework for OECD member states, which, while taking into account the OECD Guidelines, may make their own decisions on their local transfer pricing rules. As a result, each OECD member state may have different definitions for significant terms such as related parties or arm's length price range.

To promote harmonisation, the published proposal for a new Transfer Pricing Directive would introduce stricter rules than the OECD Transfer Pricing Guidelines, which would be mandatory for Member States.

The proposed new Transfer Pricing Directive would specify the main terms and approaches to transfer pricing, contributing to a common interpretation and application of the arm's length principle for EU member states and companies operating in these countries. As a result, it would reduce the number of cases where specificities in EU Member States' legislation could jeopardise the functioning of the internal market and lead to double taxation situations, and would further improve the fight against tax avoidance for EU Member States.

In addition, harmonisation could have the significant benefit of facilitating the efficient and clear resolution of disputes between tax authorities in EU Member States and increasing tax certainty for multinational companies.

Definition of associated enterprises

According to the new transfer pricing proposal, EU member states will be obliged to apply a common 25% threshold for the definition of related parties, as follows:

• a person participates in the management of another person by being in a position to exercise a significant influence over the other person;
• a person participates in the control of another person through a holding that exceeds 25% of the voting rights;
• a person participates in the capital of another person through a right of ownership that, directly or indirectly, exceeds 25% of the capital;
• a person is entitled to 25% or more of the profits of another person.

At present, some EU member states - including Hungarian law - consider control above the 50% threshold as a significant influence.

If the new Transfer Pricing Directive is adopted, Hungarian legislators will have to amend the definitions of associated status in the Corporate Income Tax and Dividend Tax.

Further questions and problems may arise from the fact that Hungarian companies and multinational companies with Hungarian involvement have set up their structures based on the current regulations, taking into account the 50% affiliation threshold. If the 25% threshold proposed by the European Commission is implemented in law, groups may need to reconsider and possibly redesign their ownership and management structures.

A further difficulty in harmonising EU Member States' legislation may be that the 25% associated status threshold set in the new transfer pricing proposal sets different criteria for defining groups than those set in the Pillar Two Directive on the implementation of minimum taxation at the EU level and in the BEFIT package.

In addition to the above, the new transfer pricing directive would also stipulate that, if one of the above criteria is met, branches would also be considered related parties. Currently, however, not all EU Member State regulations consider branches as associated enterprises.

Determining the arm's length price

The new transfer pricing directive proposal states that the interquartile range is the arm’s length range and that no deviations from this range are allowed.

According to the amendment of the NGM Decree 32/2017 (X. 18.) published on 28 December 2022, the use of the interquartile range is mandatory in Hungary, the previous flexible approach, which provided the possibility of taking into account a wider range between minimum and maximum values under certain conditions.

In addition, as in Hungary, the new transfer pricing directive proposal stipulates that if the pricing under consideration is part of the arm's length price range, no adjustment is permitted. An exception is made if the taxpayer or the competent tax authority can reliably demonstrate that another element of the arm's length range corresponds to the arm's length price.

Adjustments related to the arm's length price

The proposal for a new Transfer Pricing Directive distinguishes between two categories of transfer pricing adjustments in line with the OECD Transfer Pricing Guidelines.

The primary and appropriate adjustment made by the tax authorities after the company has filed its tax return:

• „Primary adjustment”

During a tax audit, the tax authority of an EU Member State detects that an upward transfer pricing adjustment is required for the taxpayer it is auditing. The tax base is adjusted upwards accordingly.

• „Corresponding adjustment”

As the 'primary' adjustment is an upward tax base adjustment by the EU Member State tax authority, the tax base of the related party involved in the transaction under review may be adjusted downwards by the tax authority of the other EU Member State to avoid double taxation.

Compensation adjustments made by the taxpayer before the filing of the corporate tax return:

• „Compensation adjustment”

Under the new Transfer Pricing Directive, EU member states must allow taxpayers to adjust their transfer prices at the end of their fiscal year, before filing their corporate tax return, provided that certain criteria are met.

As in the past, double taxation could still be mitigated through a mutual agreement procedure, but the new transfer pricing directive would also introduce a new fast-track procedure whereby processes to avoid double taxation arising from transfer pricing adjustments could be completed within 180 days.

The introduction of this fast-track procedure would bring about a significant change in the approach to transfer pricing, as more frequent consultations between the tax authorities of EU Member States would in the long run lead to a more consistent application of the arm's length principle in EU Member States.

It should also be highlighted that the new transfer pricing directive proposal makes a common adjustment to the median mandatory where the transfer pricing adjustment is made by the state tax authorities.

From 2023 onwards, the Hungarian transfer pricing legislation has made the use of the interquartile range mandatory, as well as the median adjustment. Currently, however, most EU Member States do not limit transfer pricing adjustments to the median. It is worth mentioning that, apart from Hungary, the Slovak transfer pricing rules have recently been tightened in this respect.

Obligation to prepare transfer pricing documentation

Taxpayers are required to prepare transfer pricing documentation in accordance with the OECD Transfer Pricing Guidelines to examine arm's length prices.

Currently, in the absence of harmonisation, the obligation to prepare transfer pricing documentation and the regulation of the content and form of the documentation also vary significantly between EU member states. These differences include, among others, different thresholds for the documentation obligation, specific content elements, languages required for the preparation of the documentation, and additional related obligations such as the transfer pricing reporting obligation, which had to be submitted as part of the corporate tax returns for the first time in Hungary in 2023.

Currently, the different rules on transfer pricing documentation pose a significant challenge and additional costs for multinational companies, as they need to be aware of the requirements of each state in which they have a member company. In many cases, the local documentation is prepared by the subsidiaries with the help of local consultants, so that they can meet their documentation obligations in accordance with local legislation. However, the preparation of the main documentation for the whole group of multinational companies requires a significant investment of time and capacity, given that, although a single document would be sufficient, it would have to comply with the regulations of each member company's jurisdiction.

One of the aims of the European Commission is to facilitate the activities of multinational companies in EU Member States. Although the currently published proposal for a Transfer Pricing Directive does not contain any criteria for transfer pricing documentation, the European Commission may in the future specify and complement the new Transfer Pricing Directive by setting out the conditions for transfer pricing documentation requirements, the content, form and language requirements for the documentation and the deadlines for its preparation, in line with the OECD Transfer Pricing Guidelines.

Entry into force

It is proposed that the new transfer pricing directive would enter into force on 1 January 2026, before which EU member states would have to implement it into national law by 31 December 2025 at the latest.

However, implementing the above points of the new transfer pricing directive into national practices will require significant changes and time, it can therefore be assumed that the proposal will not be adopted unanimously in the first instance. EU Member States may propose revisions and corrections to the proposal and could even delay the planned entry into force.

Should you have any questions regarding this newsletter,
the experts of VGD Hungary will be pleased to assist you.

21, November, 2023

Author of this article:

Ms. Agnes Somodi-Mihalecz
Senior transfer pricing specialist
VGD Hungary Kft.