TALKING TAX: Transfer pricing regulation in the Baltics

  • 2006-06-28
  • by Tomas Davidonis
Countries have been monitoring their tax burden for ages, and likewise taxpayers have been trying to manage their own. By way of reducing tax payments, multinationals have developed the practice of shifting profits to lower tax jurisdictions by manipulating prices underlying intercompany transactions. The practice 's transfer pricing 's could be understood as the shifting of profits by way of increasing or decreasing prices.

The history of transfer pricing regulations as we know it these days goes back to the 1960s when the United States introduced transfer pricing regulations in their internal revenue code. The OECD has played a significant role in the international context by releasing its Transfer Pricing Report in 1979, which since then has been constantly updated. For testing transactions on their compatibility relative to market prices, the OECD has introduced an arm's-length principle requiring the comparison of related party transactions with transactions of unrelated parties. Despite all the arguments against using the "arms length principle," it has become the accepted principle for its application.

No surprise, then, that transfer pricing has become a relevant issue for the Baltics, and governments have introduced respective transfer pricing regulations over the years. Relevant laws of Lithuania, Latvia and Estonia dictate that income indirectly transferred from one associated entity to another by increasing or decreasing the prices of goods or transferred in any other way, may be adjusted by the tax administrator and recalculated for tax purposes.
In Lithuania, credit, insurance and financial institutions and enterprises annually generating more than 10 million litas (2.9 million euros) in income are required to possess the transfer pricing documentation. Also, most Lithuanian enterprises must report annually on the transactions with the associated companies. Reporting and documentation requirements are established in Latvia and Estonia, as well.

If a taxpayer fails to substantiate the soundness of transactions, it might result in increased taxes, application of default interest and tax fines. Furthermore, failure to comply with documentation and reporting requirements may lead to an administrative liability for the undertaking or its management.
Consequently, transfer-pricing regulation is a serious challenge for multinational companies operating in the Baltics. It is highly advisable for such companies to review the group transfer pricing documentation and, upon the need, to adjust it respectively to requirements of transfer pricing regulations in the Baltics.

Tomas Davidonis is a senior associate at Sorainen Law Offices in Vilnius