One of the key aspects of international business and tax policy is transfer pricing. Tax regulations require companies operating within larger groups, as well as companies dealing with at least one related entity, to prepare transfer pricing documentation. The term “related parties” refers to physical or legal entities connected through ownership interests, control, or significant influence over business decisions.
Transfer pricing refers to the price arising from transactions between related entities. Therefore, companies that engage in transactions with related parties during a fiscal year (either as a buyer or supplier) must prepare transfer pricing documentation.
Related parties and definition
You should note that tax rules do not automatically treat every company with a certain percentage of capital participation in another legal entity as a related party for transfer pricing purposes. In this context, transfer pricing rules treat as a related party any individual or legal entity through which the taxpayer can control or significantly influence business decisions. In most jurisdictions, tax authorities presume this level of influence when an entity holds, directly or indirectly, at least 25% of the shares or voting rights in the taxpayer’s governing bodies. Therefore, related parties exist when companies own at least 25% of shares, participation, or voting rights in each other’s governance structures.
In North Macedonia, this ownership threshold is slightly lower, set at 20%.
Regulations extend the definition of related parties to include family members of individuals related to the taxpayer.
Finally, most tax systems automatically classify entities from jurisdictions with preferential tax regimes as related parties when a company engages with them, regardless of the aforementioned criteria.
Structure of transfer pricing documentation
Regarding the structure of transfer pricing documentation, taxpayers submit it either as a full report or as a shortened report.
The report should include:
- analysis of the group of related parties to which the taxpayer belongs,
- analysis of activities,
- functional analysis,
- the choice of methods for verifying the compliance of transfer prices with prices set according to the “arm’s length” principle,
- conclusion,
- appendices.
The first two points are for informational purposes and essentially serve to familiarize the tax authorities with the business operations and internal organization of the group in which the taxpayer operates, as well as its position within the group. Additionally, the taxpayer informs the tax authorities about industry trends, factors influencing price determination in the relevant activity, and the risks associated with operating in that sector.
Functional analysis and choice of methods
The functional analysis is one of the central parts of the Transfer Pricing Report. In this section, the taxpayer must provide a detailed description of transactions with related parties conducted during the analysis period. The taxpayer must describe these transactions in a manner that clearly identifies the functions and risks that the participants assume, the assets involved, the key factors influencing price determination, and the taxpayer’s essential economic position in the transactions.
Methods for verifying transfer pricing compliance
Based on the functional analysis, the taxpayer then determines the method for verifying the compliance of transfer prices with “arm’s length” prices. The taxpayer must choose the most appropriate method, or the one that best suits the particular case. The Corporate Income Tax Law recognizes six methods for verifying compliance:
- Comparable uncontrolled price method – under this method, the taxpayer compares the prices of goods, services, or products sold in controlled transactions with the prices charged in comparable uncontrolled transactions.
- Resale price method – under this method, the taxpayer determines the price at which it sells goods purchased from related parties to unrelated parties. The taxpayer then reduces this price by an appropriate gross trading margin achievable under existing market conditions. The resulting amount represents the price at which the taxpayer could have purchased the goods from unrelated parties
- Cost-plus method – in which the costs of goods, semi-finished products, or services sold by a related party to another related party are first determined. Then an appropriate gross margin that could be achieved under existing market conditions is added. The resulting price is the price at which goods, semi-finished products, or services could have been purchased from unrelated parties.
- Profit split method – which eliminates the impact of special conditions on profits from transactions between related parties. This elimination is carried out by determining the profit split that unrelated parties would expect from participating in one or more transactions. The profit shares are then allocated to the related parties.
- Transactional net margin method – which examines the net profit achieved in relation to a base such as total costs, sales revenue, assets, or equity in transactions with one or more related parties. This net profit is compared to the net profit of similar companies under similar conditions.
- Any other method – if none of the previously mentioned methods are suitable for the given circumstances.
After selecting a method, the taxpayer determines whether the prices in transactions with related parties comply with the arm’s length principle or whether the taxpayer must make adjustments under the chosen method. The taxpayer then records the total amount of adjustments (revenues and expenses) arising from transactions with each related party, as stated in the transfer pricing documentation, in the appropriate section of the Tax Balance, thereby increasing the corporate income tax base.
Transfer pricing report in short form
As for the option to prepare a shortened report, this is available in cases where the transaction values are not materially significant, or if the transactions are one-off, “ad hoc” transactions. In this regard, Serbia has a legal threshold of 8 million RSD, Montenegro has a threshold of 75,000 EUR, and North Macedonia has a threshold of 10 million MKD.
If the taxpayer meets the conditions for preparing a shortened Transfer Pricing Report, the taxpayer needs to include only basic transaction data, namely a description of the transaction, its value, and the name of the related party involved.
Thus, tax regulations allow taxpayers in Serbia, Montenegro, and North Macedonia to prepare a shortened Transfer Pricing Report. However, in North Macedonia, tax regulations exempt companies with annual revenues below 300 million MKD from the obligation to prepare Transfer Pricing Reports.
Regulations in Slovenia, Croatia, and Bosnia and Herzegovina do not recognize the category of shortened Transfer Pricing Reports.
An exception to the above are financial transactions, such as loans and credits. If the taxpayer has conducted a loan transaction during the year, they are obligated to prepare a full Transfer Pricing Report regardless of the loan amount, as loan transactions cannot be described through a shortened report.
Safe harbor rules for intercompany loans and credits
Regulations in Slovenia, Croatia, and Bosnia and Herzegovina do not recognize the category of shortened Transfer Pricing Reports.
An exception to the above are financial transactions, such as loans and credits. If the taxpayer has conducted a loan transaction during the year, they are obligated to prepare a full Transfer Pricing Report regardless of the loan amount, as loan transactions cannot be described through a shortened report.
Regulations in Serbia, Montenegro, Croatia, and Slovenia also prescribe “safe harbor” rules regarding intercompany loans, where the relevant ministries set interest rates according to the “arm’s length” principle. Therefore, when taxpayers use interest rates prescribed by the relevant ministries to calculate loan interest, they do not need to adjust the tax balance for the loan transaction, as such interest complies with the arm’s length principle.
Conclusion: The importance of proper transfer pricing management
Taxpayers recognize that transfer pricing rules can significantly affect taxation. They manage transfer prices carefully to meet legal obligations. They also use sound planning to reduce tax liabilities lawfully.
Our transfer pricing team
They have extensive experience in the field of transfer pricing, both in the domestic market and in the markets of the former Yugoslavia. Their understanding of both local and international regulations is their key strength. ETL Consulting operates in over 60 countries worldwide, and we know this is the team ready to take on your tasks. Our team provides expert advice and support in preparing complete transfer pricing documentation. We also apply the appropriate methods to verify that prices in transactions with related parties comply with the arm’s length principle.
ETL Consulting team is ready to support you in all stages of the process. Our goal is to ensure compliance with legal regulations while simultaneously optimizing your tax obligations.
Take advantage of this opportunity and schedule your first meeting with us – completely free of charge!
Author of the text: Ivana Rakočević, Senior Tax Consultant
