Transfer pricing in the Baltics (Estonia, Latvia, Lithuania) and implications of the OECD treaty on BEPS

Base erosion and profit shifting (BEPS) is a term which refers to the negative effects of international companies´ tax avoidance strategies. A common way for companies to achieve BEPS is the use of transfer pricing. Transfer pricing (transfer mispricing) is the setting of the price for goods and services that are sold between related or controlled legal entities within an enterprise. This method can turn company´s profit negative and move income from the country where the value was originally created.

Transfer pricing in Latvia

In Latvia law requires that foreign-related party transactions meet the standards of arm’s-length principle. Furthermore, the Corporate Income Tax Act in Latvia requires transfer pricing adjustments for noncompliant transactions between Latvian companies that belong to the “same group” (i.e. direct or indirect ownership of at least 90% is required). In addition, transactions with a companies located in low-tax jurisdictions are regarded as related party transactions and those transactions have to meet the mentioned arm’s-length requirement.

Transfer pricing in Estonia

Rules regarding transfer pricing in Estonia have been established in the Income Tax Act and in Regulation No. 53 issued by the Estonian Ministry of Finance on 10 November 2006. In general Estonian legislation on transfer pricing relies strongly on the principles established by the Organization for Economic Co-operation and Development (OECD). Taxpayers in Estonia are required to demonstrate that both domestic and cross-border transactions with related parties have been conducted according to the arm’s-length principle. It must be noted that transfer pricing rules in Estonia apply to all types of transactions.

Transfer pricing in Lithuania

In Lithuania tax authorities are authorized to make transfer pricing adjustments in transactions which have been performed between related persons. There are special rules about situations in which companies must document their transaction according to criteria. Rules regarding transfer pricing in Lithuania were introduced by the Corporate Tax Act of 20 December 2001 and more detailed requirements are laid in Order No 1K-123 of the Minister of Finance of the Republic of Lithuania of 9 April 2004. The arm’s-length principle was introduced in Lithuania by the previous act. As in Latvia and Estonia OECD´s Guidelines in regards transfer pricing have been implemented in Lithuania´s domestic legislation.

Transfer pricing and the OECD treaty on BEPS

The purpose of the OECD treaty is to tackle aggressive international tax planning. One of the key elements is to ensure that products and services are taxed in the country where the value is created. The treaty also aims to increase transparency between officials in different member states and to preclude hybrid mismatches which can lead to double non-taxation. The treaty is targeted to be implemented in the domestic legislation of the member states and it will most likely have an effect on bilateral tax agreements that countries have established between each other. One of the key elements in the treaty is to stop the use of transfer pricing and profit shifting used to evade taxes. The use of intra-group loans and related party interest is one of the simplest profit-shifting techniques available in international tax planning. Companies can elevate debts within groups in ways that ensure them most suitable deductions.

OECD´s treaty on BEPS introduces a fixed ratio rule based on which an entity can deduct net interest expenses up to a benchmark net interest (EBITDA) ratio. Arm´s length principle will remain as the main principle, but its use will be enhanced through increased transparency and communication between national tax authorities. Also changes to legislation and bilateral agreements will be introduced. Formulary apportionment was also considered as a leading principle, but OECD concluded that the international consensus on a number of key issues could not be attained in the short or medium term. Our firm will be glad to help your company to prepare all the necessary transfer pricing documentation and ensure that compliance requirements are met.

To find out more about BEPS and its impacts on transfer pricing especially in the Baltics (Estonia, Latvia, Lithuania), please contact our lawyers at info@gencs.eu.

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