There are situations when Latvian companies make compensating adjustments to their transfer prices—i.e., the companies adjust the total price of transactions conducted in the previous year (or in a different period) based on an invoice or credit invoice—so that the transfer prices comply favorably to the arm’s length principle.
The laws and regulations in Latvia, however, do not address compensating adjustments. Therefore, taxpayers must seek additional information and guidance from international guidelines—such as the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, and the European Union (EU) Joint Transfer Pricing Forum’s report on compensating adjustments.
In general, two approaches to making compensating adjustments are:
Latvian legislation does not directly define which of the two approaches is to be applied. However, there have been situations that, during an audit, the tax authorities imposed a tax “surcharge” after finding that a compensating adjustment was needed.
In one instance, a Latvian company had issued invoices to its related party for management services, and the fee was determined by reference to estimated costs and an additional market premium. As it turned out, the actual costs were greater than had been expected. In this situation, the tax authorities took the position that the Latvian company had to make a compensating adjustment by issuing an invoice for the difference between the service fee: (1) based on actual costs, and (2) based on estimated costs.
In other instances, the tax authorities accept—and even insist—on compensating adjustments that increase the profit of a Latvian taxpayer. Thus, by analogy, it would appear that the tax authorities would allow a downward adjustment to be made.
In a 2011 Supreme Court case—SKA-134/2011 (15 April 2011)—there was an issue concerning a profit-decreasing compensating adjustment made by a Latvian manufacturing company. The Supreme Court rejected the argument raised by the tax authorities that the adjustment was unacceptable because the credit invoice for the compensating adjustments did not indicate any specific transactions for which the adjustments were made—instead, the total profit from supplies made to a related party was adjusted. In particular, the high court drew attention to Paragraph 1.42 of the OECD Guidelines that indicates that in situations when certain transactions are linked so closely or they are so continuous that it is impossible to assess them separately (for example, long-term supply contracts), such transactions require an overall assessment instead of looking at the individual parts.
Although it seems as if the Latvian practice accepts the ex-ante approach, the tax authorities—in deciding whether to accept a downward or upward adjustment—will consider arguments raised by the taxpayer as to why the price actually applied differs from the market price. In addition, for the purpose of making compensating adjustments, the taxpayer must conduct a transfer pricing analysis that, in turn, must be described in the transfer pricing documentation, and this must include the selected transfer pricing methods and comparable data analysis as used for determining the price. In particular, it appears that the tax authorities will, in instances of a profit-decreasing adjustment, pay more attention to the reasonableness and amount of the adjustment.
Read a May 2016 report [PDF 119 KB] prepared by the KPMG member firm in Latvia