Czech Republic: Economic challenges potentially affecting transfer pricing

Many companies operating within the Czech economy are part of multinational groups. These companies trade with other companies within the corporate group, using a certain agreed transfer price for mutual supplies and deliveries. Transfer prices are very often set in a simplified manner, applying a price equalling costs and profit markup or a market price reduced by a certain margin.

In late 2021 and early 2022, there were several market events that continue to put intragroup contractual relationships to a significant test.

• These events include electricity price increases of more than 100% year-on-year and the rise in the REPO rate from 0.75% in August 2021 to 3.75% in December 2021, resulting in an increase in market interest rates.
• Another important factor is a rise in inflation to 6%, while according to the Czech National Bank, expected inflation may reach 10% in January 2022. This inflation then puts pressure on wage increases—all this amid a persistent structural labour shortage on the market.
• Problems continue to prevail in supply chains, particularly in the automotive industry. This sector will face further challenges this year, not least in the context of the transition to electro-mobility and the need to prepare for the “Green Deal.”
• Finally, consider the appreciation of the Czech crown against the euro.

This market turmoil gives rise to questions that businesses must ask: Can the price increase in the Czech market be passed on to group customers? Would independent businesses make price adjustments? Retrospectively or prospectively? Does the current transfer price setting still allow for the generation of sufficient cash flows? Which group company can end up holding the short end of the stick when considering the distribution of functions and risks?

Tax professionals are increasingly witnessing situations that require attention and strategic consideration for the future. As an example, consider a company that expanded its production and financed this investment with debt in the past. If the interest on this loan was, for instance, set as a floating rate linked to PRIBOR, then this was a design that worked perfectly in an environment with low reference rates. But will the operating profit generated be sufficient to meet the debt service requirements under the current circumstances? And taxpayers need to think not only about debt; export-oriented companies in the position of contract manufacturers will have to consider which of the contracting parties will bear the effect of the appreciation of the Czech crown. And the tax authority has a clear view on this question, especially when the inspection takes place after a gap of two to three years. Discussions with the tax authority in this respect are usually quite vigorous and based on the tax authority’s assumption that the development of the exchange rate had been clear.

The above challenges also may materialize during the preparation of the financial statements and when deciding what to write in the notes to the financial statements or in the annual report. With the passage of time, the tax administrators will want to replenish the state treasury and businesses need to be well prepared for discussions with them—for instance, by keeping minutes of meeting, emails, and other supporting information that document the considerations given and decision made (usually with limited information regarding future developments). Taxpayers need to consider having justifications for the conclusions reached and details of who made the relevant decisions and also have sufficiently robust documentation.

Read a February 2022 report prepared by the KPMG member firm in the Czech Republic