Court confirmed legality of the audit findings on the transfer pricing

The Supreme Court of Ukraine adopted decision approving the supervisory authority's position regarding the payer’s conduction of export with iron ore pellets at prices that do not correspond to the "arm’s length" principle in 2015.

The Court confirmed that the taxpayer did not take into account the actual physico-chemical properties of products specified in the Quality Certificates, namely: the content of impurities (silicon dioxide) and the moisture level during pricing in controlled operations.

The payer used Platts figures with lower iron content when pricing in controlled operations for higher quality coils.

Also, the payer overestimated the cost of freight – in case of actual transportation of pellets by ships of different classes ("Panamax", "Capesize"), adjustment of delivery conditions was carried out only at the maximum rate.

Usually, premium for ore processing is calculated according to the qualitative characteristics of the pellets, in particular, depending on their purpose, but the payer was guided by importance of influence of the sales markets, which, in turn, was critically assessed by the court investigating the case.

The Court confirmed that constant fluctuation of prices on the market of iron ore pellets is not a basis for comparing prices in controlled operations with the average indicator in comparable operations for a certain period (month) without constructing a price range.

At the same time, as established by Article 39 of the Tax Code, amount of taxable profit in controlled operations must be determined by the taxpayer according to the "arm’s length" principle. At the same time, the exporter did not comply with this principle, as he adjusted prices not on the basis of S&P Global Platts indicators, legal meaning of which is defined as the base used for pricing, in particular, in the extractive industry.

Therefore, the Supreme Court of Ukraine confirmed validity of conclusions of the supervisory body, set out in the audit report, and legality of issued tax notification-decision regarding the reduction of negative value of taxation object from income tax for the total amount of 1.3 billion UAH. Having admitted the mistakes, the payer has already paid almost 246 million UAH to the budget.

It is worth noting that for each of the parties to the legal process, proving compliance or non-compliance with the principle of "arm’s length" during the implementation of controlled operations is a rather difficult and complex process. Difficulties and controversial issues arise for both taxpayers and tax authorities. Most often, such tax dispute does not arise due to a deliberate violation by taxpayers of tax legislation on the transfer pricing but due to differences in approaches to methodology, business calculations and representatives of regulatory authorities.

For legislative settlement of contested issue, on January 18, 2022, the Ministry of Finance of Ukraine approved Procedure for establishing compliance of conditions of controlled operation with regard to raw materials to the principle of "arm’s length". This Procedure will allow taxpayers who participate in controlled operations with raw goods to correctly determine amount of taxable profit according to the "arm's length" principle. At the same time, the specified Procedure will provide opportunity for the controlling body to carry out high-quality tax control by establishing compliance of conditions of controlled operations with the "arm’s length" principle, which will further ensure mutual understanding and effective cooperation with taxpayers.