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Transfer Pricing

12 December 2019

There are numerous articles on Transfer Pricing that mainly represent legislative regulation. Therefore, with a view to creating a more comprehensive content in Armenian and being guided by the deduction method, let us try to switch from a general idea to a specific and private analysis of the regulations effective in the Republic of Armenia.

Before presenting the whole set of Transfer Pricing Regulations of the Republic of Armenia, I would like to take you, my dear reader, on a short journey to see where the idea of Transfer Pricing Regulations come from, who handles them on international level, which countries already apply them, etc.

Prior to making a historical overview, you need to understand what the transfer price is. The transfer price is a non-market price, that is, a price that is not formed in accordance with market value but by internal agreement. The meaning of the word transfer is: transportation, transferring, cash flow (in the financial context), which clearly indicates the purpose of transfer pricing.

Transfer pricing is the procedure for determining the financial indicators of controlled transactions between related taxpayers.

The first reference to transfer pricing dates back to the late 19th century in England. During this time, the need to generate domestic price arose due to the demand for separation of structural units within enterprises, coupled with the division of labor and the emergence of first workshops.

The second phase of the transfer pricing development dates back to the 1930s-1960s with the diversification of the activities of industrial enterprises in the United States, Japan, Germany, as well as the formation of financial and industrial groups, while the complexity of the organizational and legal structure of the enterprises, in its turn, became the driving force behind the development of transfer pricing theory.

In publications published in the United States in 1955-1957s, the National Association of Accountants of the United States made the first attempts to define approaches to forming a domestic price.

The third stage of transfer price development took place in 1960s-1990s. During this period, major holding companies were formed in England, USA and Japan, while transfer pricing became a tool in the corporate management of production, and transfer prices were used by large foreign companies.

One of the first countries to adopt regulations in the area of ​​transfer pricing in the mid-1960s was the United States of America. It should be noted that adoption of such laws was typical for US legislation, as hundreds of multinational companies were located and operating there. As a result, governments of many countries started to think of adopting similar principles that would set the procedure of transfer price tax regulation, especially those countries, where the companies were actively engaged in business in emerging countries’ markets. Thus, these countries firstly included France and Great Britain, and secondly - Canada, Japan, Australia and the Netherlands.

In 1976, the first legislative regulation of transfer pricing was made at international level. In particular, the main international documents adopted on this issue are the Declaration of the Organization for Economic Co-operation and Development on International Investment and Multinational Enterprises (21 June 1976), and the first Guide on Transfer Pricing and Multinational Enterprises (1979).

At the international level, benchmark for transfer pricing is set by the Organization for Economic Co-operation and Development (OECD) through guidelines, interpretations, and various legal acts. The member countries undertake to implement the mentioned acts and adapt their policies to these processes, while non-member countries are guided by them in conducting analysis, although they do not make legal reference to and are not obliged to apply these acts. All OECD member and non-member countries try to solve various socio-economic problems through joint efforts.

As of 2019, Transfer Pricing Regulations have been adopted by 124 countries worldwide. These regulations are of crucial importance for countries in making tax policy more transparent and aimed at ensuring the fairness and accuracy of transfer pricing worldwide.

Transfer pricing regulations in the Republic of Armenia will apply from January 1, 2020. According to Chapter 73 of the RA Tax Code, transfer pricing regulations with regard to transactions considered as controlled shall be applicable where the sum total of all the controlled transactions carried out by a given taxpayer during a given tax year exceeds AMD 200 million, and the taxpayer shall be required to submit a notice on controlled transactions to the tax authority.

The tax authority carries out tax control established by law through ascertaining the completeness of calculation and payment of taxes and payments prescribed by the Code, as well as their conformity with the arm's length principle, which means that the financial indicator set in controlled transactions should not differ from that used in comparable uncontrolled transactions.

We should now try to understand which transactions are considered as controlled and who are the related parties. A transaction is considered to be controlled if it is made between related taxpayers who, for the purposes of law, are considered to be related:

  • if one of the taxpayers directly or indirectly participates in the management, control of the other taxpayer, or has interest (share, stock, ownership) in the latter’s charter or share capital;
  • the same taxpayer directly or indirectly participates in the management, control of 2 (and more) other taxpayers, or has interest (share, stock, ownership) in their charter or share capital;  
  • the taxpayer directly or indirectly owns or controls 20% or more of the voting shares of the other taxpayer;
  • etc.

Within the framework of transfer pricing regulations, the tax authority will carry out tax control over Profit tax, VAT and Royalties. In order to check the conformity of transaction with the arm's length principle, it is necessary to compare the controlled and uncontrolled transactions to determine whether there are no significant differences that may significantly affect the financial indicators subject to examination by the relevant transfer pricing method, or economic circumstances in which the transactions have been carried out, in particular:

  • the similarity of geographic markets,
  • the size of each market and the level of its economic development,  
  • the market level (retail or wholesale),
  • production and sales expenses conditioned by the location,  
  • level of competition in the corresponding goods or services markets,
  • economic situation of the production sector in question,  
  • level of development of production and transport infrastructures,
  • level of state intervention in pricing procedures,
  • absence of purchasing power of the consumer, 
  • business strategies adopted by related taxpayers as regards transactions,  
  • strategies pertaining to expanding into new markets,
  • diversification (differentiation) of fields of activities,
  • introduction of innovations,
  • risk prevention,  
  • political changes,
  • other circumstances.

One of the following five transfer pricing methods is used to check the transaction conformity with the arm's length principle: comparable uncontrolled price method, resale price method, cost plus method, transactional net margin method, profit split method. The sphere of the arm's length is determined by the Government of the Republic of Armenia.

The Government of the Republic of Armenia has recently developed three draft decisions that have not yet entered into force. The latter relate to approval of the procedure for implementing the reconciliation procedure, the procedure for determining the sphere of the arm's length, the procedure for applying the transfer pricing methods.

Transfer pricing team of "BDO Armenia" CJSC is ready to assist entities, that have concluded a transaction of AMD 200 million and more, in planning and implementation of transfer pricing system, as well as preparation of documents required by law. Where appropriate, we engage transfer pricing specialists from our company's international network, represented in over 162 countries worldwide.