Transfer pricing and tax planning in 2023

Transfer pricing and tax planning in 2023

The legal possibilities in transfer pricing for tax planning have become narrower in 2023. The benchmark range that can be used to determine transfer prices has been reduced, and the possibility of tax optimization with year-end transfer price changes has been basically eliminated. Details of the transfer pricing documentation have retroactively become part of the tax return already for the 2022 tax year.

Transfer pricing provides significant tax planning opportunities for international enterprises. One of the options concerning routine companies in Hungary is to optimally  determine transfer prices between affiliated companies with the help of database analyses (benchmark studies).

The transaction-based net margin method (TNMM) is the main method used to determine transfer prices and it is based on financial data from comparable companies (peer groups). The financial data can be obtained from special company databases containing information on around 500,000 companies operating in Hungary.

Databases for transfer pricing purposes contain financial data that can be used to compile benchmark analyses.  Thus, the profit margin of independent companies, usually on an EBIT basis, is compared and used for determining transfer prices. The Hungarian regulations in this area follow the OECD transfer pricing guidelines and the EU transfer pricing policy.

According to the current rules, the independent profit rates used to determine the transfer price can only be selected within the interquartile range. The previous Hungarian regulations allowed companies a choice within the entire range of benchmark  percentages to set transfer prices. The change in the law already applies to the tax return for the tax year 2022, which must be submitted in 2023.

Mandatory use of the interquartile range

Compared to before, the choice has therefore narrowed from the full range to the interquartile range, i.e. 50% of the range cannot be taken into account. In the case of tax audits, the tax office basically adjusts incorrect transfer prices to the median value, i.e. to the middle value within the range.

The definition of the median and interquartile range is shown in the figure below:

Year-end adjustment of transfer prices

Until now, many companies have used the opportunity to retrospectively review transfer prices before submitting their year-end tax return, thus  modifying the tax base by the end of the financial year within the limits allowed by law in Hungary and the European Union. According to the current rules, this method of tax optimization can only be applied with limitations and it can no longer be used if the current profit rate is within the standard market range. These rules must first be implemented in the tax return for the 2022 tax year.

Determination of transfer prices in practice

When determining the tax base, the legally possible scope for tax planning is illustrated by the following example:

Example:

A Hungarian company sells machine parts to its Danish parent company. The Hungarian routine company established the transfer prices based on the results of the database analysis included in the table above.

a) The company's legally permissible adjustment option with regard to planning the tax burden is currently an EBIT margin between 4.3% and 8.1%. So far, the range of options for setting transfer prices was between 3.6% and 9.7%. The change in the law thus reduces the options of determining transfer prices to follow the value chain.

b) Let us suppose that the EBIT-rate of the Hungarian company at the end of the business year is at 4.5%, i.e. in the lower part of the interquartile range. Based on the company's financials, it might make sense to increase the EBIT margin in Hungary to 8% at the end of the year, i.e. to follow the upper limit of the interquartile range. According to the current rules, this correction is no longer possible, the difference in the EBIT margin of 3.5% will remain with the Danish parent company.

Transfer prices are now part of the income tax return

A new rule to be applied for the first time in 2023 requires data on transfer prices with related parties to be provided in the corporate income tax return retrospectively relating to 2022. The tax return must provide detailed information on transfer prices such as the value and description of transactions, the activity code for transactions and the comparable market price or price range. The purpose of the new regulation is to facilitate for the tax authorities the analysis of taxpayer risk and the selection of taxpayers to be audited.

The deadline for data provision and tax declaration is May 31, 2023. This deadline also applies to the preparation of the transfer pricing documentation. It is therefore important to prepare the transfer pricing documentation within the deadline, as the data are also to be included in the corporate income tax return.

Transfer pricing fines

The obligation to create detailed transfer pricing documentation applies if the total of similar deliveries of goods or comparable services to affiliated companies amounts to at least HUF 100 million (ca. EUR 250,000).

The fine related to transfer pricing documentation has increased from HUF 2 million to HUF 5 million, in case of repeated failure the maximum amount of the fine is HUF 10 million.

Summary

In summary, it can be concluded that the legal possibilities for tax planning using transfer prices have narrowed as a result of the new amendments, while the administrative burden on companies has increased. Nevertheless, transfer prices can be legally optimized for tax purposes, albeit under stricter legal requirements. 

It is important to note that harmonization of profit distribution and value creation should ideally take place when starting a new business in Hungary. The fiscally optimal redesign of existing transfer pricing structures may also be carried out later, however within the limitations of the existing legal framework.