In the course of the expansion of Austrian start-ups the domestic market is limited. Therefore start-ups are also seeking for interesting foreign markets. On one hand this is possible by providing the goods or services by the domestic company itself, on the other hand it might be attractive to set up a foreign subsidiary in order to serve the foreign market. With regards to any cross-border intercompany transactions an arm’s length compensation needs to be safeguarded to avoid any tax risks.
- Transfer pricing in a nutshell
a.) Arm’s length principle and benefit test
In order to prevent targeted tax-motivated profit shifting, intra-group transactions between affiliated companies (e.g. domestic parent company provides services to a foreign subsidiary) must in principle be conducted on the same terms as transactions with non-group companies. If this requirement is met, it means that a transaction complies with the so called “arm’s length principle”.
The decisive factor here is the type of service involved in each case and the functions/risks assumed by the companies involved. Therefore for each type of service a separate analysis has to be conducted. For services of a general nature provided by a shareholder, for example, the recipient of the service must have a benefit – an economic or commercial value – out of the transaction (“benefit test”) and it needs to be kept in mind that not all services are billable (e.g. shareholder activities can’t be redistributed).
b.) Searching for the right transfer pricing method
The OECD Transfer Pricing Guidelines show five different methods which can be applied when it comes to setting up a so called transfer pricing system: CUP (comparable uncontrolled price), Cost Plus, Resale Price, TNMM (Transactional Net Margin Method) and Profit Split Method. When selecting the method to be used, preference should generally be given to the method that offers the greatest certainty for determining an arm’s length transfer price.
The heart of the decision which method should be used is the so-called function and risk analysis considering the company characterization (e.g. is a company with routine functions involved?). In this context it must be analysed which functions and risks are to be assigned to the parties involved based on the transaction. For example if a R&D service is carried out by a related party the function could be patent development and the risk could be patent disputes. Depending on the function and risk analysis as well as the products or services affected by the transaction, the most appropriate method has to be applied.
c.) Documentation
If a start-up faces a situation in which it is obliged to set up a transfer pricing system, documentation aspects must also be taken into account.
The required scope of transfer pricing documentation must be assessed on a case-by-case basis and is determined not only by the scope of the cross-border business relationships themselves, but also, above all, by the complexity of the respective facts and the industry. In the course of the transfer pricing documentation, a certain minimum information requirement should be covered (e.g. written contract, functions performed and risks assumed, justification for the selection of the transfer pricing method applied and presentation of the appropriateness of the transfer prices).
d.) Tax risk in the event of non-arm’s length settlement
If it comes to a tax audit and the conclusion occurs that the arm’s length principle has not been complied concerning certain intragroup transactions, this could lead to an increase in profit or a reduction in expenses resulting in a higher tax burden.
- Outlook
From the time of cross-border expansion, basically transfer pricing aspects have to be considered. The Austrian Federal Ministry of Finance recently published the revised transfer pricing guidelines[1] which are intended to provide guidance concerning the determination of transfer prices for intragroup service relationships.
If you are confronted with an above mentioned situation the ECOVIS start-up team is happy to guide you through the transfer pricing jungle.
[1] https://findok.bmf.gv.at/findok?execution=e100000s1&dokumentId=ace379c9-6082-4d25-b31a-456515264bee.
Authors:
Christoph Puchner, Managing Partner and Tax Advisor
& Katharina Geweßler, Tax Advisor from ECOVIS Austria,
one of the leading tax consultants in Austria in the startup sector
