How to handle year-end transfer pricing adjustments?

The end of the year is a particularly exciting time in the lives of affiliated companies, as there are a number of alternatives for dealing with transfer pricing adjustments. Transfer pricing adjustments have different tax and financing consequences depending on whether they are accounted for at the level of the original transaction or at the level of the pre-tax profit or taxable corporate income. Since 2022, transfer pricing adjustments must be made at the so-called median value of the market range. In this newsletter, we draw attention to this matter and other important aspects of the complex transfer pricing regime. 

What does the adjustment to the median mean?

The essence of the rule is that if it is established that the applied price is outside the arm's length range, the necessary adjustment should be made to the median of the arm's length range unless the taxpayer can demonstrate that a different value best reflects the transaction under consideration (in which case, of course, the different value should be taken into account instead of the median).

According to another, closely related rule, if the applied price is within the arm's length range, no adjustment should be made.

It follows from the median adjustment rule that if the applied price is higher than the upper limit of the arm’s length range, it is still mandatory to adjust (i.e. reduce) the applied price to the median.

What practical problems might arise in connection with the adjustment?

For many businesses, adjusting to the median should result in an additional financial burden, because in most cases the price they charge is below the lower end of the arm’s length range and they have to adjust upwards to the median, which is higher than the lower quartile they used to adjust to. If their domestic partner company is unable to reduce its own tax base by the same amount, the tax burden on the group increases.

What are the international tax implications of the adjustment?

The situation is different in the case of a foreign related company: the foreign partner can reduce its tax base by the amount mentioned if the double tax treaty between the two countries allows this, as well as if the two countries have ratified the Multilateral Convention, Article 17 of which makes such an adjustment mandatory.

In both cases, it is important to meet the administrative requirements that may be attached to the adjustment.

It should also be borne in mind that these international conventions generally do not apply to Hungarian local business tax or innovation contribution (therefore, the adjustments the Hungarian company made to the taxable bases of these two taxes cannot be taken into account in the tax base of its foreign affiliate).

What are the documentation requirements for the adjustment?

The transfer pricing adjustment can be documented by one of three methods:

• by adjusting the corporate income tax base in the Hungarian corporate income tax return without any actual movement of funds between the parties (in this case it is important to issue a document with the appropriate content to allow the other party to reduce its own tax base accordingly, provided the Hungarian corporate income tax rules or, in the case of a foreign related company, international tax law allow this), or
• by issuing an invoice (which implies a financial settlement and charging VAT), or
• by issuing an accounting document/receipt (this also requires a financial settlement, but there is no VAT implication as it is outside the scope of the Hungarian VAT Act).

What accounting rules apply to the adjustment?

Whereas in the case of an adjustment by an invoice or an accounting document/receipt, it is obvious that the amount of the adjustment is part of the net (sales) revenue or costs or expenses of the company, this is not evident in the case the corporate income tax base is adjusted without any accounting document issued. However, the Hungarian Accounting Act requires that the amount of the adjustment be included in the net sales revenue or, as the case may be, in the costs or expenses.

How should the adjustment to the local business tax base be treated?

Finally, the provisions of the Hungarian Local Tax Act on the treatment of transfer pricing adjustments should be mentioned. Under these provisions, in the case of transactions with their related parties, companies in the scope of the arm's length price requirement should determine their net sales revenue, as well as the costs or expenses deductible from the net sales revenue on the basis of the arm's length price. The adjustments may be made by the companies also as a lump sum in their tax base (either as an increase or as a decrease). The administrative condition for a reduction of the tax base is an appropriate document issued by the related party.

Transfer pricing corrections and VAT

In order to determine the correct VAT treatment, a Company must first review the purpose for which the parties make the year-end transfer pricing adjustment.

• If the intention of the parties is to make a subsequent adjustment to the consideration for supplies of goods or services made during the financial year which changes the taxable amount of a previously completed transaction, the transaction will fall within the scope of the VAT Act and should be dealt with at both invoicing and return level.
• Where the year-end transfer pricing adjustment is not related to a previously completed transaction, but is made to meet "adequate profitability", taxpayers will not have to account for a VAT impact.

In deciding the above question, the terms of the contract between the companies concerned should be taken into account. Recently, an increasing number of transfer pricing adjustment cases have been brought before the European Court of Justice, so that increased attention should be paid to these adjustments from a VAT perspective.

The absence of transfer pricing adjustments, their correctness and their proper documentation may also be verified by the tax authorities in the context of a new type of audit from 2025. You can find more information on these new type of audits in our related newsletter here:
https://vgd.hu/en/news/professional-publications-newsletters/the-number-of-transfer-pricing-tax-audits-continues-to-increase

* * *

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

This newsletter provides general information and does not constitute tax advice.