Transfer pricing – Recent Romanian experience

1 Aprilie 2010

ERNST & YOUNG S.R.L.

Current business environment and transfer pricing

Transactions, inter-company pricing, supply chains, structuring and funding are increasingly in the Romanian tax authorities' spotlight. More than ever, transfer pricing policies and tax effective supply chain management that supports the business strategy in this challenging business climate can help maintain competitive advantage and give value to shareholders.

Transfer pricing in Romania – Expected tendencies and recent experience

Further to the introduction of specific Romanian transfer pricing documentation rules at the beginning of 2008, our experience shows that during most of the tax audits conducted by the tax authorities starting from the second part of 2008 onwards on multinationals, transfer pricing documentation represented one of their main areas of tax authorities' concern.

In addition, recent practice shows that the requests for transfer pricing documentation were addressed by the authorities in all types of tax audits, however in some cases such requests for a transfer pricing file were used by the authorities as a tool for delaying the conclusion of the tax audit (especially on VAT reimbursement audits – with significant cash flow implications on the audited companies, which could not receive the refund until the lengthy process of the transfer pricing file preparation was over).

Furthermore, for companies which have already a certain transfer pricing documentation in place it would be important to assess whether such documentation meets the Romanian documentation rules and to make sure that it is contemporaneous (i.e., updated each two or three years, or depending on the industry, even on the annual basis).

To date, the number of transfer pricing adjustments made by the Romanian tax authorities is quite limited, while in more cases where a proper transfer pricing documentation was available, the authorities have only made inquiries on the transfer pricing policy applied without any adjustments or rechecking of data.

Nevertheless, as the scrutiny on these matters is expected to increase, the degree of preparedness of multinationals operating in Romania would be put to test and it is very likely that the transfer pricing policies would be challenged especially considering reduced profitability levels or losses already started to be recorded in this period.

Considering that many Romanian companies are experiencing decreases in operating profits, maintaining a proper transfer pricing policy and related documentation for related party transactions becomes essential for such companies to mitigate transfer pricing related risks.

Thus, unless Romanian multinationals would have a strong and documented defense of their transfer pricing policies it is probable the number of adjustments and related penalties* to be imposed by tax authorities would increase in near future.

The Romanian regulations provide for a tool to reduce the inherent risk associated with the intercompany transfer pricing policies, and namely the advance pricing agreements to be concluded between the tax authority and the taxpayer.

Advance Pricing Agreements (APAs)

An APA represents an agreement between one or more tax authorities and a multinational corporation in which the tax authorities pre-approve a transfer pricing methodology, and the related pricing for the related party transactions undertaken by a taxpayer.

In effect, an APA represents a tool to resolve transfer pricing issues before they arise in a tax audit on transfer pricing matters.

A transfer pricing study being part of an APA provides the required support for the pre-approved methodology and related pricing.

The term provided under the domestic rules for the issuance of an APA is quite significant, namely 12 months for unilateral APAs and 18 months for bilateral/multilateral APAs. As regards the costs for entering into an APA, apart from the costs incurred with the preparation of a transfer pricing documentation, taxpayers have to consider the following fees payable to the Romanian tax authorities for the issuance/amendment of an APA:

• Eur 20,000/Eur 15,000 – in case of large taxpayers or for agreements on transactions with a consolidated value exceeding Eur 4 million; and

• Eur 10,000/Eur 6,000 – in all other cases.

APAs are issued for a period up to 5 years, however this term may be extended for long term agreements. Also, the APAs produces effects only for the future. As an exception, the APA may be also applied in the year when the APA request was submitted/APA was issued, provided:

• It is specifically mentioned in the APA; and

• The APA request is submitted before the underlying transaction is concluded.

Taxpayers part of an APA have to submit annually to the tax authorities a report on observance of the APA terms and conditions. Non-compliance with this requirement leads to the cancellation of the APA.

Even if it represents a rather time consuming process, entering into an APA provides certain advantages to companies such as:

• Benefits corporate planning by accurately determining a company's tax liability;

• Tax authorities will not challenge the transfer pricing policy of the company during the term of the APA – binding on tax authorities as long as the APA terms are observed; and

• It allows the company to maintain a good relationship with the tax authorities.

However, even if the advance APA have been regulated under the Romanian law already for a number of years, practice shows that the APA program did not produce so far any positive outcomes, as so far only a handful of APA applications were submitted towards relevant Romanian tax authorities and to the best of our knowledge no APAs were issued.

We believe that at this stage the number of applications for obtaining an APA is quite low mainly due to the lack of confidence of the multinationals in the APA program and its perceived practical benefits as a controversy management tool, as well as the fact that the APA program is quite expensive and very time consuming. Also, regarding the lack of APAs solved to date, in our view this is mainly due to the fact that the tax authorities are still learning the practicalities of transfer pricing and are still rather reluctant in getting into such agreements.

*Such adjustments would trigger a profits tax liability of 16% and late payment interest of around 36% p.a.

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