The applicant, a limited liability company (hereinafter: the “Company”), acting as a distributor of products in an international capital group, entered into a distribution agreement providing for the achievement of a specified operating margin (2.5%), falling within the arm’s length range determined by a benchmarking analysis (1.84%–7.53%, median 3.22%). The Company anticipated the possibility of making transfer pricing adjustments to align its financial result with the level specified in the distribution agreement, due to price fluctuations in transactions with a related party resulting from final sales prices agreed with end customers.

The Company’s doubts concerned, among other things, the possibility of making a transfer pricing adjustment in a situation where the achieved result is already consistent with the arm’s length principle (i.e., falls within the arm’s length range determined by the benchmarking analysis), as well as the permissibility of making adjustments more frequently than once a year (quarterly or monthly) and the related tax consequences under Article 15(1ab) of the CIT Act.

In the Company’s view, the provisions of Article 11e of the CIT Act do not preclude making a transfer pricing adjustment, both when the achieved result is not arm’s length and when it is arm’s length but differs from the contractually agreed target, which also falls within the arm’s length range. Furthermore, the Company indicated that the provisions do not limit the frequency of transfer pricing adjustments; therefore, monthly or quarterly adjustments should also be permissible and effective for tax purposes under Article 15(1ab) of the CIT Act.

The tax authority considered the Company’s position to be partially incorrect. In the authority’s view, a transfer pricing adjustment under Article 11e of the CIT Act is permissible only when the original transaction result falls outside the arm’s length range - that is, when the transfer price does not comply with the arm’s length principle. According to the authority, an adjustment made when the result originally fell within the arm’s length range determined by the benchmarking analysis, even if it deviated from the value stipulated in the agreement, does not meet the conditions set out in Article 11e of the CIT Act, as it does not align the transfer price with arm’s length terms. At the same time, the tax authority acknowledged that the CIT Act does not prohibit making transfer pricing adjustments more frequently than once a year (e.g., quarterly or monthly), provided this reflects the behaviour of independent entities under comparable market conditions.

Expert Commentary

The commented ruling of the Director of KIS raises significant practical questions regarding the scope of the concept of a transfer pricing adjustment under Article 11e of the CIT Act. The authority held that an adjustment from a financial result within the arm’s length range determined by benchmarking analysis to the level specified in the agreement — also within that range — does not meet the statutory requirements. In our opinion, this approach narrows the concept of a transfer pricing adjustment in a way that may create discrepancies between the formal classification of settlements adjusting the terms of controlled transactions and the parties’ actual economic intent, which is to implement the arm’s length principle through appropriate adjustments. Nevertheless, it should be noted that, under a literal interpretation of Article 11e of the CIT Act, the position presented by the Director of KIS is difficult to challenge.

Accepting that such adjustments to transaction terms do not constitute transfer pricing adjustments for CIT purposes gives rise to practical uncertainties, inter alia, as regards the correct timing for recognising the tax effects of such adjustments. Where these adjustments do not meet the conditions set out in Article 11e of the CIT Act and do not result from an accounting error or an obvious mistake (most often their source is an update of costs, revenues, or the result of the transaction), they should be settled on an ongoing basis rather than in the period to which they relate. Moreover, in the transfer pricing information return (TPR-C), such true-up adjustments should not be shown separately as transfer pricing adjustment amounts for a given transaction.

Is such a distinction between true-up adjustments - those prompted by results falling outside the arm’s length range and those arising from contractual arrangements (where, given the established arm’s length range, an adjustment was not formally required) — justified? It appears not, as it introduces unnecessary complications in tax settlements and reporting. Therefore, it seems essential to clarify the provisions of the CIT Act so that any adjustment aimed at aligning the price with an arm’s length value, as confirmed by a benchmarking analysis or stipulated in the agreement, would be recognised as a transfer pricing adjustment under Article 11e of the CIT Act, regardless of whether the original result or price fell within the arm’s length range determined by the benchmarking analysis. This would ensure regulatory consistency, reduce the risk of abuse, and prevent unintended interpretative discrepancies in tax practice.

Authors: Aleksandra Krzemień (Senior Consultant) and Maryna Dyptan (Consultant).