How to set a price between related parties in the digital economy

The Chamber of Deputies approved an amendment to the International Cooperation in Tax Administration Act, which introduces a new obligation in the digital economy for operators of digital platforms. 

The term digital platform can be understood as all software, including online portals and websites or parts thereof, as well as applications, including mobile applications, accessible to users and enabling sellers to connect to other users to perform targeted activities, such as selling goods and services, offering real estate or cars for use, directly or indirectly.

Domestic operators of such platforms will be obliged to submit a notification to the tax authorities by 31 January 2023, under which they must report sales made by both domestic and foreign users of the platform no later than 31 January each year.

The rationale for the new obligation is to obtain the information needed for fair income taxation in tax jurisdictions where the source of income is from the digital economy. This is particularly the case where domestic businesses use platforms whose operators are based abroad for sales. Often these are businesses belonging to a group of connected persons. In such a situation, it is important to correctly set the pricing model based on which the platform operator is entitled to remuneration.

Until now, the tax administration could only obtain information on the existence of sales via foreign platforms from the international exchange of information on the withholding tax paid for the right to access such platforms. In accordance with most double taxation treaties, the Czech Republic is entitled to the tax that a domestic user of a foreign platform is obliged to withhold if it pays the platform operator a royalty for access to the platform.

In practice, it is possible to encounter tax audits aimed at verifying the connection between the licence fee paid for the use of the platform and the reported taxable income. An example is the story of a domestic company that paid a licence fee for the right to access software developed by a group of related parties. Among other things, the software allowed the domestic company to offer its services to independent companies that had access to the group platform.

The tax administrator questioned the payment of the licence fee by referring to the failure of the domestic company to prove the extent to which the software developed by the foreign entity was used. Subsequently, the tax authority used publicly unavailable information on software prices obtained from its dawn raids to determine the tax.

It is significant that the tax audit concerned a tax period for which the Transfer Pricing Directive was in force, which did not contain a chapter dealing with the method of determining transfer prices of intangible assets to the extent that this issue is addressed in the current version of the Directive from February 2022.

It is clear from public discussions in the field of OECD that the question of how to correctly price an intangible asset and its right to use in the context of transfer pricing has long been difficult to answer.

This is also supported by recent European case law, namely the judgment of 30 June 2022 in SAS Ferragamo France. This judgment can be regarded as ground-breaking. Where until now tax administrations have tended to focus their attention in tax audits on disputing the amount of royalties paid, in the present case the tax authority has drawn up a comparative analysis of the remuneration due to the users of the intangible asset.

To avoid the need for evidence in the event of a tax audit, domestic businesses should be able to transparently demonstrate how the platform operator's remuneration is reflected in the price of goods, services or rented real estate. The way remuneration is set should respect the functional and risk profiles of both parties to the transaction.