The recently adopted tax law changes significantly expand the definition of related parties. As of 2015 not only those companies will qualify as related parties which are connected in their ownership chain, but also those with an overlap in their management. As a result, the number of transactions where parties have to apply arm’s length pricing will increase. The new definition may, however, cause uncertainties as well.
The primarily objective of the so-called “transfer pricing” rules is to prevent the realization of tax benefits by applying manipulated pricing practice between affiliated entities. To this end, the tax laws require related parties to determine their tax base by applying arm’s-length prices, even if they use a different price in their transactions.
Until now the shareholding relationship determined who are considered as related parties. Two companies were related if one of them had more than 50% direct or indirect voting right in the other, or if a third company had such an influence in both of them. A recently adopted amendment of the corporate income tax act will amend this definition from 2015. In the future two companies will also be considered as related parties if, as a result of their overlapping management, a decisive influence is exercised between them on their business and financial policies.
The extended definition triggers many unanswered questions. On one hand, what should be considered as overlapping management? Should the management of two companies be considered overlapping if one of their executives is the same person? Or at least half of the management should be the same? Or the entire management? It is even more disturbing that there is no guidance what the practical meaning of “influence” is, neither when an influence should qualify as “decisive”, nor how the “as a result of the overlapping management” phrase should be interpreted. But even if these questions are answered by the tax authority, it will still cause difficulties to apply the extended definition to specific cases.
The topic has a key importance, as both tax and non-tax laws have special rules on related parties. In addition to the transfer pricing requirements, related parties are also subject to numerous reporting and documentation requirements. Further, the amendment was drafted carefully enough not to leave room for extended tax planning. While real estate transactions between related parties are exempt from transfer tax, companies that qualify related parties under the new definition are explicitly excluded from this exemption.