For many entities operating within multinational capital groups, the approaching end of the year usually means verification of intra-group settlements and making the necessary adjustments in order to comply with the arm's length principle. Since 2019, the Polish Corporate Income Tax Act ("CIT Act") is enriched with new provisions regulating transfer pricing adjustments.

Wording of the new regulation

According to the new Art. 11e of the CIT Act, if a transfer pricing adjustment is made, then depending on the type of such adjustment (in plus or in minus), the following conditions must be met (jointly), in order to be able to recognize the adjustment in the tax result:

  1. The terms of the transaction during the year are at arm's length;
  2. There has been a change in significant circumstances affecting the terms and conditions of the transaction determined during the tax year or the actual costs incurred or revenue received which affect the calculation of the transfer price are known;
  3. At the time of the adjustment the taxpayer has a statement of the related counterparty that this entity has also made the adjustment in the same amount as the taxpayer;
  4. A related entity that also made the adjustment has its residence in Poland or another country that has an agreement (double tax treaty) with Poland or other legal basis for the exchange of tax information;
  5. The taxpayer will confirm the adjustment in the tax return for the year to which the adjustment applies.

In the event that the adjustment results in:

  • increasing revenues or reducing the taxpayer's costs (“in plus” adjustment), in practice it is necessary to meet conditions 1 and 2,
  • reducing revenues or increasing the taxpayer's costs (“in minus” adjustment), it is necessary to meet all of the above conditions (1-5).

Why is TP adjustment so important?

Appropriate classification of the intragroup settlement as (i) not being an adjustment, (ii) TP adjustment referred to in the Art. 11e of the CIT Act ("KCT11e") or (iii) adjustment other than KCT11e, has a significant impact on the period in which such settlement should be recognized, and in extreme cases - even whether the taxpayer has the right to include such settlement in the tax result.

In light of the above, the question arises when the settlement should be treated as an adjustment and when should it be considered more narrowly - as KCT11e? Although the CIT Act has a very broad definition of the "transfer price" itself, it was not decided to define also a "transfer pricing adjustment".

As a result, due to numerous doubts with respect to what types of settlements can be considered as KCT11e, and other issues that raise questions of the taxpayers, the Ministry of Finance issued explanatory notes on transfer pricing adjustments within the meaning of Art. 11e of the CIT Act (and, corresponding to the provision of the CIT Act, Art. 23q of the Polish Personal Income Tax Act) ("Explanations"). Explanatory notes do not constitute a binding source of law in Poland, but complying with them gives some protection to the taxpayer, as provided for in the Tax Ordinance.

Due to the importance of the subject in question, we decided to introduce you to the content of the Explanations and share the reflections that accompanied us while reading.

The most important theses of the Explanations

  1. Transfer pricing adjustment should be understood as correction (adjustment) of the transfer prices. Not every transfer pricing adjustment constitutes a transfer pricing adjustment within the meaning of Art. 11e of the CIT Act (KCT11e).
  2. The purpose of KCT11e is to adjust transfer pricing for a given settlement period according to the arm's length principle (“ALP”).
  3. KCT11e conducted in order to ensure compliance of transfer prices with ALP is not, in fact, an independent economic event, but a part of a controlled transaction, a group of controlled transactions or, more broadly – settlements between related parties.
  4. The assessment of whether a specific adjustment constitutes KCT11e should not be determined by the form of the accounting document on the basis of which the adjustment was made (e.g. a note, correction invoice), but only by the economic essence of such adjustment, including the functional profile of the parties to the controlled transaction. In a situation where the transfer pricing adjustment does not change the remuneration for already made transactions – a specific supply of goods or services provided for the benefit of related entities - but is aimed at adjusting the company's profitability to the market level, such adjustment is outside the scope of VAT taxation, i.e. not subject to VAT. Consequently, it is not documented with a VAT invoice.
  5. KCT11e is a retrospective adjustment, i.e. it relates to the settlements between related parties made in the past. The concept of KCT11e does not include changes in transfer prices between related entities made for the purpose of transactions carried out in subsequent settlement periods (e.g. updating of price lists for the next month, quarter, year).
  6. A taxpayer makes a KCT11e where, despite having acted reasonably and fairly in entering into the transaction to comply with the arm's length price setting approach (ex-ante), the ex-post transfer price applied by the taxpayer is not arm's length.
  7. Moreover, the cause of KCT11e is not, in particular, an accounting error or other obvious error. If the adjustment of revenue (cost) is caused by an accounting error or other obvious error, the taxpayer should make the adjustment backwards, i.e. in the period to which the error (obvious error) relates.
  8. Adjustment of the revenue (cost), not covered by KCT11e and resulting from other reasons (discount, rebate, change in the scope of the service) is made according to general rules provided for in the CIT Act.
  9. It is possible to settle KCT11e with respect to a related entity that is not a party of the direct transactions with the taxpayer (related entity).
  10. In general, the transfer pricing method used by a taxpayer when determining the terms of the transaction, should be the same as for conducting KCT11e.
  11. KCT11e covers, as a rule, transfer pricing adjustments for a given tax year, conducted after the end of the year. It is not excluded to conduct KCT11e during the tax year, after the end of another reference period, e.g. a month or a quarter.
  12. The tax results of a controlled transaction are determined for a given tax year. KCT11e should be, as a rule, conducted before submitting the annual tax return for a given year and should cover a period not longer than the tax year. It is also possible to conduct KCT11e after the submission of the annual tax return.
  13. Already at the stage of concluding a controlled transaction, related parties should determine - to the best of their knowledge (in particular, using available comparative data) - the terms of the controlled transaction on which unrelated parties would agree. Such obligation results from Art. 11c para. 1 of the CIT Act.
  14. When assessing the justification of conducting KCT11e, it is also taken into account, among others, whether the agreement concluded between related parties provides for a clause regarding the possibility of retroactive correction (adjustment) of the price, margin, mark-up, financial result. The lack of a contractual correction (adjustment) clause does not preclude the performance of KCT11e.
  15. When a related party issues an accounting document that forms the basis for making a KCT11e and provides it to the taxpayer, receipt of that document satisfies condition 3, i.e., the condition of having a related party's statement of transfer pricing adjustment, as long as it also meets the requirements for accounting evidence under the rules adopted by the applicable accounting regulations.
  16. Where a KCT11e in minus is made on the basis of an accounting document issued by the taxpayer itself (without receiving an accounting document from a related party), the taxpayer should obtain a statement from the related party that an adjustment has been made.
  17. If, at the time of filing its annual tax return, the taxpayer does not have a statement from the related party that the related party has made a transfer pricing adjustment in the same amount as the taxpayer, then the taxpayer will not include the adjustment in its annual return for the period to which the KCT11e applies. Upon receipt of the related party statement, the taxpayer shall adjust its annual return for the tax year to which the adjustment relates.
  18. If there is a need for two opposite KCT11e (in plus and in minus) between the same related parties, due to the broader catalog of conditions for in minus adjustments, the taxpayer for tax purposes should make such adjustments separately.
  19. KCT11e in minus, not meeting the conditions specified in Article 11e points 1-5 of the CIT Act, cannot be made under the general rules resulting from Article 12, paragraphs 3j-3m of the CIT Act (on the revenue side) and Article 15, paragraphs 4i-4k of the CIT Act (on the cost side). A CIT11e in plus that does not meet the conditions of Article 11e(1-2) of the CIT Act should be made under the general rules.
  20. A transfer pricing adjustment that does not result from a material change in circumstances or the adopted transfer pricing method based on budgets (plans/cost estimates) is not subject to examination under the conditions of Article 11e of the CIT Act (non-KCT11e adjustment) and should be performed under the so-called general rules.

In 2020 and 2021 it should be also noted that there is an exemption (introduced under the so-called Anti-COVID Act) from the taxpayer’s obligation to have a relevant statement – as a condition to account KCT11e in minus when determining the amount of tax revenues and tax deductible costs. At the same time, the exemption covers only adjustments made within a specific period of time, i.e. during the COVID-19 crisis, so the provision uses a reference to the state of epidemic emergency and state of epidemic declared in connection with the COVID-19 pandemic and covering the entire territory of the Republic of Poland. The wording "adjustment conducted for the tax year" used in para. 1 of this provision covers not only the annual transfer pricing adjustments, but also those adjustments conducted more frequently (e.g. quarterly, semi-annually).The changes are effective from the beginning of the COVID-19 pandemic – both when the statement is made during this period and when it covers this period.

What are the key takeaways of reading the final version of the Explanations?

  1. It should be ensured that the transfer prices applied during the year are at arm’s length. According to the Art. 11c para. 1 of the CIT Act, related parties are obliged to set transfer prices on terms that would be agreed between unrelated parties. Failure to meet this condition may, in the case of KCT11e in minus, result in the inability to recognize in minus adjustment in tax result.
  2. The issue of transfer pricing adjustments should also be properly regulated. Although the Explanations indicate that the lack of a contractual adjustment clause does not preclude making KCT11e, the assessment of the appropriateness of making KCT11e takes into account, among other things, whether the agreement concluded between related entities provides for a clause concerning the possibility of retrospective adjustment of price, margin, mark-up, financial result.
  3. As far as possible, it is advisable to avoid material year-end negative KCT11e by appropriate price planning during the year / on-going prospective adjustment of prices. A special approach is required for pricing with entities from countries or territories with which Poland does not have a double tax treaty and at the same time there is no legal basis for the exchange of tax information.