Increasing transfer pricing audits from 2023 - targeting affiliated companies!
In 2022, significant legislative changes on transfer pricing came into force. The rules on the extent of transfer pricing adjustment and the default penalty for recordkeeping irregularities have been tightened. Additionally, the recordkeeping rules have been modified, and a new transfer pricing reporting obligation has been introduced.
In our experience, businesses have found it difficult to fully comply with these new legal requirements. Many of these changes applied to the financial year 2022. For instance, companies are already required to fulfill the newly introduced transfer pricing data reporting obligation this year for the year 2022.
The data obtained through this reporting will be used by the Hungarian Tax Authority (hereinafter: HTA) in its risk analysis, utilizing Big Data methods for targeted and, somewhat dramatically, 'real-time' controls. Under the HTA’s audit plan, transfer pricing by related companies will face increased amount of audit from 2023.
Priority will be given to auditing the highest-tax-performing taxpayers, particularly those with production within the group or very low profits. Transfer pricing audits of credit or other financial transactions between affiliated companies and compliance with the arm's length price ruling will also be in focus.
Our experience shows that transfer pricing considerations are also increasingly used in the audit of other taxes (e.g. business tax, retail tax, etc.). In transfer pricing audits, the authorities do not show the image of a service provider to businesses, forcing them into a position of explanation. Businesses should be prepared to face the inspections with an appropriate strategy and effective arguments, even if they are only able to defend their perceived or actual rights in the courts or at the appeal stage.
Transfer pricing between related companies has been a priority area of audits for many years. The auditing practices of the HTA have changed significantly over the last 10-15 years. While in the early days tax audits focused mainly on the existence of documentation and formal deficiencies, in recent years the emphasis has shifted to a complex examination of the content of the documentation regarding the pricing of related company transactions and the obligation of record keeping. Under the new type of transfer pricing data service, the HTA will segment the companies concerned, perform a complex customer qualification, identify possible anomalies and inconsistencies, so as to decide on possible courses of action (supporting procedure, compliance investigation or tax audit, etc.). The above-mentioned risk analysis will allow for targeted action and more effective capacity management by the National Tax Administration.
The HTA has conducted hundreds of transfer pricing-related audits in recent years. More than 70 percent of these audits resulted in tax deficiencies, increasing the tax base of the companies involved by a total of HUF 12 billion compared to their declared tax base. According to the statistics in the HTA’s yearbook 2022, which was published this year, the HTA also hevily focused on transfer pricing between related companies last year and identified a tax deficiency of HUF 3.5 billion.
It can be observed that despite the increasingly prevalent narrative from tax authorities in recent years, which has generally led to the marginalization of tax audits (resulting in an increase in supporting procedures and compliance investigations), this trend does not necessarily apply to the field of transfer pricing. The figures and trends mentioned above indicate that affiliated companies, particularly those operating at a loss or with significantly lower profits compared to certain sub-sectors, will encounter the unwavering scrutiny of tax authorities. They may find themselves compelled to defend their rights through lengthy and costly procedures.
The increasing strictness of the legislator is also evident in the fines that can be imposed. In 2023, the HTA may impose an increased default penalty of HUF 5 million instead of HUF 2 million for missing documentation. Furthermore, fines will be determined at the transaction's local document level, and the absence of a primary document may result in a fine. This means that the total amount that should be paid could significantly multiply. In addition to the fines, the tax shortfall itself could be substantial, as transfer pricing impacts not only corporate tax but also local business tax, the innovation contribution, and, under specific circumstances, VAT. The practice of adjusting the tax base by the authorities has also undergone significant changes. If the price set by the taxpayer falls outside the commercial price range (i.e. interquartile range), the HTA will generally make an adjustment to the median of the arm's length price range. This adjustment can lead to a substantial increase in taxes for businesses. Incorrect record-keeping may also raise suspicions of intent on the taxpayer's part. In extreme cases, tax penalty of up to 200% may be levied in this regard.
In transfer pricing audits, tax authorities will concentrate on particular industries and specific transaction groups. The years influenced by the economic crisis following COVID-19 may also undergo scrutiny this year, introducing additional risks for related companies severely impacted by the crisis. Inspections are likely to face stricter regulatory actions than usual, potentially requiring businesses to provide extensive explanations and engage in prolonged legal proceedings.
The risk of tightening audits can be mitigated, and in some cases, eliminated, through appropriate prevention and effective tax audit presence. During prevention, it is advisable to seek expert advisory assistance for reviewing existing contracts and documentation, ensuring compliance with record-keeping and reporting obligations. During audits, turning to a professional advisor is recommended for efficient tax representation, the preparation of statements, and legal remedies.
VGD Hungary, in collaboration with its experienced advisory team and legal partner firms, provides comprehensive support to businesses in both prevention and audit phases, as well as in the provision of tax representation services during legal proceedings.