Transfer prices

Amendments to transfer pricing regulation put more focus on profit shifting

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Author: Parol Jalakas

From 2022, an updated regulation will take effect, regarding the methodology for determining transactions between related persons. Since it was adopted in 2006, Minister of Finance's regulation no. 53 had been in force unchanged. The changes made now are based on the new international transfer pricing guidelines adopted in 2017 in the context of the OECD BEPS (Base Erosion and Profit Shifting) action plan in order to limit unjust profit shifting in the new technology-based economic environment.

The amendment to the regulation will mean greater detail throughout the entire documentation process. Documentation of the master file and local file will be more thorough and comparability analysis will become more detailed.

In connection with analysis of comparables, the definition of the price range of comparables was clarified. The arm’s length range used for determining the market price of a good or service in Estonia is the inter-quartile range. That excludes top and bottom extremes when performing the analysis and ordinarily they would not be equated with a market price. In addition, the term “low value-adding services” has been introduced, which under OECD guidelines means that no additional comparability analysis must be performed in the case of a 5% mark-up on certain standard services. It also notes that if the company’s business model has not changed, the comparability analysis can be used in documentation for up to three years.

For financial transactions, a list of circumstances with a material bearing is provided; these must be taken into account in the fair pricing of financial transactions. The list includes various loan conditions, the possibility of obtaining a loan from alternative parties and assessment of the capability of servicing the loan. Above all, the above applies to unsecured loans, as the pricing of secured loans can be verified from publicly available loan statistics.

In addition, the requirements for documentation of intangibles will be supplemented. When determining the arm’s length value of intangibles the expected future benefit, stage of development and rights to enhancements, revisions and updates related to the asset must be taken into account. When determining the arm’s length value of intangibles the contribution of each party must be considered and the company’s area of activity, role in the business chain and competition conditions all play a role in determining arm’s length price.

Finally, the amendment clarifies the documentation requirements, which are somewhat more detailed from next year. The amendment to the regulation specifies a three-tiered structure of documentation: the local file (previously known as “taxpayer file” name in Estonian regulation), the local file and the country-by-country report. The existing requirements for these files will continue to apply after the amendments but the amendments increase the level of detail. One requirement that was supplemented is the detailed description of the company’s supply chain. Besides that, later information that influences determination of arm’s length transfer price must also be filed.

The amendments send the signal that Estonia is keeping up with the global steps for fighting base erosion and profit shifting. Taxpayers who conduct transactions with related persons must keep a closer eye on the correct methodology for determining arm’s length transfer prices.

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