Novela Zákona o dani z príjmov – zmeny v oblasti transferového oceňovania a obmedzenie uznateľnosti úrokových nákladov

Amendment to the Income Tax Act - changes to transfer pricing rules and deductibility of interest expenses

We would like to inform you of the publication of an amendment to the Income Tax Act (ITA), which could bring substantial changes to transfer pricing (TP) regulations and announces limitations on the deductibility of interest expenses (link to previous alert).

Transfer pricing

A summary of TP regulatory changes to take effect from 1 January 2023:

• In our view the most significant change is introduction of use of the median value in determining market prices. The proposed wording is in line with the practice of the tax authorities, which have often prepared their own comparability analysis during tax audits and used the median of the results of the benchmarking analysis to calculate the taxpayer’s required profitability. The new provision should only be used if the prices used by the taxpayer in transactions with a related party do not correspond to the arm’s length principle (i.e., they are not set at market level). In practice, non-market prices are considered those which are not within the range determined by the benchmarking analysis. In such a case, the tax authority will levy additional tax on the difference between the actual value of the transaction and the median value. This provision will thus put an end to the debate on whether it is also possible, in the event of a tax audit, to impose tax based on the lower quartile of the observed range (as in the Czech Republic), which is more favorable to the taxpayer.
• The provision of Article 17 sec. 5 of the ITA, which regulates determination of a related party’s tax base, will be divided into two separate points: (a) contains the primary adjustment of the tax base if the prices used by the taxpayer are not market prices, while (b) contains the so-called benefit test, which proves that the transaction actually occurred and was beneficial to the taxpayer. The proposed change is intended to eliminate issues during tax audits where these two rules have often been interchanged. The first part of this provision also defines a significant controlled transaction, which is considered taxable income or tax-deductible expense only when it exceeds EUR 10,000 (in the case of loans and borrowings, the principal is considered). For a transaction that does not exceed this value, the tax authority will not review compliance with the arm’s length principle. By introducing this regulation, the legislator is declaring the introduction of a “safe harbor” in the field of TP and a reduced administrative burden for taxpayers.
• The amendment also seeks to increase legal certainty by adding a direct reference to the OECD Transfer Pricing Guidelines, which are already a widely used interpretative aid for TP. In the past, Slovak courts have challenged the use of the Guidelines as a source of law.
• The definition of a related party in Article 2 should also be amended in point (o) by aggregating the shares of close persons in determining their economic connection. The definition of a foreign related party, which has been replaced by the definition of an economic link for permanent establishments (PE), will no longer be found in point (r).
• For bilateral and multilateral requests for approval of the advance pricing method (APA), the ability to issue a decision for more than five tax periods will be amended. According to the Explanatory Memorandum, it should be possible to apply for the APA retrospectively, i.e., for the tax periods preceding the application.
• The amendment should make it possible to submit TP documentation in a foreign language initially and subsequently, if requested by the tax authority, in Slovak within 15 days. The obligation to submit a request for documentation in a language other than Slovak will thus be removed from the ITA, which should reduce the administrative burden.
• The amendment changes the rules for determining the tax base of a Slovak non-resident’s PE in Slovakia. The proposed wording seeks to harmonize the ITA with OECD methodology, in particular in assessing costs demonstrably incurred for a PE by its founder. In addition, taxable income has been explicitly extended to cover that generated by disposal of a PE’s property. The amendment unifies the terms used and amends the obligation to submit documentation for a PE in relation to the method used to adjust the tax base.

Interest cost limitation rule

From 1 January 2024, due to transposition of the European Directive (ATAD), which is aimed at combating tax avoidance practices, the limitation on the tax deductibility of interest expenses will be modified as follows:

• The thin capitalization rules limiting tax deductibility of interest expenses are currently part of the legislation (Article 21a of the ITA) but these apply to related parties only. Conversely, the new rule limiting interest expenses in Article 17k of the ITA will apply to all domestic legal entities (which are tax residents) or foreign legal entities (tax non-residents) with a PE in Slovakia.
• Exempted from the rule are legal persons whose related parties are only natural persons and certain financial institutions whose business is specifically focused on debt financing (e.g., banks, insurance companies or asset management companies).
• The limitation will apply to interest costs arising from contracts concluded after 31 December 2023 and amendments made after that date to contracts concluded before 1 January2024. Interest costs associated with all forms of debt (e.g., including bonds), other costs economically equivalent to interest, and expenses incurred in connection with raising funds will be considered as borrowing costs (expenses). Interest that is part of the asset’s acquisition value or its own cost will also be limited.
• The limitation will apply to taxpayers whose net interest expense exceeds EUR 3,000,000. In this case, the taxpayer must increase its tax base by the amount by which the net interest expense exceeds 30% of the so-called tax EBITDA. This indicator is not identical to the general accounting EBITDA (the amount of earnings before interest, tax, depreciation and amortization). The proposed amendment requires that the tax base of the respective items must be the base for the calculation. For purposes of interest expense limitation, the tax EBITDA is calculated as the sum of:
  • Individual tax bases (before adjustments under the interest expense limitation rule)
  • Net interest expense (the amount by which tax expense on borrowing exceeds taxable interest income and income economically equivalent to interest income)
  • The tax depreciation of assets
• If the sum of individual tax bases does not reach a positive value, for example due to loss, EUR 3,000,000 will be used for calculation purposes. If the amount of net interest expense is negative (interest income exceeds borrowing costs), the taxpayer may deduct all the interest expense as a tax expense. The same applies to those taxpayers who report net interest expenses for the taxable period in an amount not exceeding the threshold of EUR 3,000,000.
• Net interest expense not included in the tax base will be deductible from the tax base for up to the next five consecutive taxable periods.
• It should be added that the introduction of the new legislation will not result in revocation of the current thin capitalization rule (Section 21a of the ITA). The draft amendment only gives application priority to the new rule on the limitation of interest expenses. If interest costs are capped under the new rule, the current thin capitalization rules will not need to be applied subsequently.

If you have any questions or would like to obtain more information regarding this topic, please contact the author of this article or your usual contacts within EY Slovakia.