Although Romania is not a member of the OECD, the OECD Transfer Pricing Guideline is the cornerstone for local transfer pricing legislation. Therefore, it can be assumed, that the Romanian tax authorities will take into consideration the Draft Handbook on Transfer Pricing Risk Assessment, as with any technical paper issued by the OECD.
Introduction to transfer pricing risk assessment
Tax administrations need to identify taxpayers and their intra-group transactions which present a high transfer pricing risk, in an accurate manner and with a high degree of confidence, to reduce expenditure and the allocation of resources.
Questions to be answered in a transfer pricing risk assessment process
The risk assessment should look out for specific warning signals of potential significant risk while also, as appropriate, taking note of indications of low transfer pricing risk, such as a low volume of controlled transactions.
Signs which administrations might associate with a high transfer pricing risk could be: failure to obtain the profitability that would be expected of similar companies, engaging in significant transactions with related entities in jurisdictions with lower tax rates or recording losses for several years in a row. Large payments of royalties, rental or management fees, and of deductible interest can also have a significant impact on the corporate income reported by a taxpayer and, as such, are usually a red-flag during the assessment process.
Assessing when transfer pricing risk exists and when it does not
The main transfer pricing risks that should be taken into account can arise from recurring transactions, large or complex one-off transactions, or a lack of compliance with general tax regulations.
If the company’s results are consistently low or not in accordance with market or industry trends or if the group records substantial, disproportionate income in low-tax jurisdictions, tax administrations should look further into the reasons behind this situation. The Handbook considers that high potential risk may also be found in relation to the following:
- Significant value transactions with related parties in low tax jurisdictions (where distorted transfer pricing is more likely to be put in place).
- Intra-group services (where it is important to identify whether any benefit has been brought by the rendering of such services).
- Royalty and management fees and insurance premium payments (especially delicate when several such payments are being made).
Business restructuring can also require some attention during a risk assessment process if the process is accompanied by decreases in the profits of distribution or manufacturing entities or if valuable assets are being transferred to a low-tax jurisdiction.
Low transfer pricing risk is expected in some cases. This can be where:
- • The taxpayer has significant unrelated minority shareholders which would oppose the diversion of profits to the majority shareholder.
- • The taxpayer’s transactions are carried out with related parties in higher-tax jurisdictions.
- • Similar transactions are carried out with independent parties and a simple comparison could swiftly determine any transfer pricing risk.
- • Consistent transfer pricing policies are maintained in the group across all jurisdictions.
- • Most of the company’s transactions are being carried out with independent parties.
Sources of information for conducting a transfer pricing risk assessment
Some of the most important sources of information can be: the transfer pricing documentation prepared by taxpayers, questionnaires issued to selected taxpayers, meetings with the company’s personnel, the firm’s tax returns, publicly available information on the internet or databases, customs data or even the patent office in the case of transfer of intellectual property are all sources which can help the tax authorities have a better understanding of the taxpayer’s business and what other information would be helpful, thus increasing efficiency.
Risk assessment process – selecting cases for transfer pricing audit
A successful risk assessment process should be consistent in its steps and should exercise judgment at each stage. This process can also be improved by the use of specialists who can provide insight into a specific industry. It should be finalized through a summary of the work carried out, indicating the risks observed and also through drafting an audit plan in consequence of the above
Building productive relationships with taxpayers – the enhanced engagement approach
Some countries recommend that more discussions take place between the tax authorities and the tax payers involved before tax returns are made or even before the transactions actually take place. This can help solve any disputes at a point when relevant information and key employees are available and it can help cut the time needed to review transfer pricing issues. It can also reduce the overall number of disputes as well as providing an opportunity to explain and clarify any misunderstandings.
Transfer pricing risk assessment process in Romania
In our experience, in recent years most transfer pricing audits carried out in Romania have focused on taxpayers that registered operating losses or on taxpayers that operate in certain economic sectors that are considered “tax risk areas” by the authorities. We are not certain whether the Romanian authorities use a specific risk assessment process to select taxpayers to be subject to transfer pricing audits.
In this context the OECD Draft Handbook on Transfer Pricing Risk Assessment could be a useful tool for the Romanian authorities as well as for taxpayers that want to evaluate their transfer pricing risk.