Secondment of executives from the parent company and its impact on the transfer pricing methodology

In this judgment, the question of the effect of the secondment of employees of a foreign parent company to senior management positions of a Czech subsidiary on the functional profile of the subsidiary was addressed. The tax administrator questioned the fully-fledged functional profile of the subsidiary solely on the basis that the top management positions were filled by foreign employees seconded by the parent company under the international hire of labour ("IHOL") arrangement.

Therefore, the tax administration automatically considered the presence of the seconded employees in the management functions of the subsidiary as evidence that the subsidiary is an entity with limited functions, since the parent company, through the seconded employees, effectively exercises the strategic management of the subsidiary.

Let’s just remind that the reclassification from a fully-fledged entity to an entity with limited functions has significant implications for the company from a transfer pricing point of view, as the entity with limited functions should achieve a stable level of profitability over time (within an arm’s length interval) and should not make losses (possibly only in very exceptional cases).

Therefore, in that case, the tax authority reassessed the transfer pricing methodology used by the subsidiary (which was based on the premise of its fully-fledged functional profile) and assessed the additional tax arguing that the loss it had made was not the result of its stand-alone business but part of a group strategy.

The Regional Court confirmed this view of the tax administrator and stated that "in accordance with its view, the mere participation of the parent company's employees, or their secondment by the parent company, and their decision-making at the subsidiary can be assessed as the exercise of the parent company's influence on the subsidiary."

The judgment is therefore an important warning for Czech companies whose top management positions are filled by seconded employees from the parent (or other related) company. It should be perceived that the tax administrator in such a case is likely to view the subsidiary as an entity with limited functions with all the consequences arising therefrom (see above). Proper setup of management processes and the related transfer pricing methodology, including properly prepared transfer pricing documentation, are therefore key to minimising tax risks.

A cassation complaint against the Regional Court's judgment has been filed with the Supreme Administrative Court, which may further reverse the legal assessment of the issue at hand. Nevertheless, it is advisable to see the above described approach of the tax administrator as a possible trend and to check whether a similar arrangement does not pose a risk in your company.

Authors:

Vít Fritsche, Tax Department Manager

Michaela Miarková, Senior Consultant, Tax Department