Report on Controlled Transactions | Transfer Pricing in Practice: How the Approach Determines the Outcome

In transfer pricing matters, businesses are often convinced that the risk is theoretical or applies only to ‘very large’ or international companies. Practice shows otherwise. Often, the decisive factor is not the transaction volume or structural complexity, but how well the company is prepared to justify its prices when the SRS (State Revenue Service) asks questions.

Below are three typical examples from practice that illustrate how the same economic situation can lead to completely different outcomes.

Example 1: Provision of services within a group

A Latvian company provides administrative and IT services to its parent company abroad. The price is set by applying a markup that the company considers ‘reasonable’ based on internal calculations.

Scenario without analysis

The SRS, analyzing the data submitted in the controlled transaction report, concludes that the markup is significantly lower than for similar service providers in the market. Since no comparable company analysis has been prepared, the SRS determines the market interval itself and makes an adjustment to the profit level. The result is additional CIT (Corporate Income Tax) and late payment penalties.

Scenario with timely assessment

As a result, the SRS receives data-driven information from the very beginning. The company’s financial indicators fall within the market interval, the chosen method is understandable, and the data over the years does not contradict itself. In such a situation, the SRS has no basis to ask additional questions or make adjustments, as the submitted data itself confirms the transactions’ compliance with the arm’s length principle. Practically, this means that the audit ends before it even begins.

Example 2: Manufacturing company with low profit

A Latvian manufacturer operates as a contract manufacturer for a group. Profit is stable but low. The company’s management believes this is normal because ‘we are not taking risks’.

Scenario without a clear position

The SRS compares the company’s indicators with other manufacturers in the industry and concludes that the profit is below market level. The company is unable to prove why this particular profit level corresponds to its functions. An adjustment is made for several years.

Scenario with structured justification

The company has clearly documented that it operates as a low-risk manufacturer, with limited functions and no market risks. A comparable company analysis confirms that a lower profit is acceptable in such a model. The SRS concludes that the arm’s length principle has been observed.

Example 3: Intra-group financing

A Latvian company receives a loan from a related party. The interest rate is determined based on bank offers or data published by the Bank of Latvia for loans of similar terms and risk.

Scenario with proper justification

If the loan interest rate corresponds to bank offers or is determined using Bank of Latvia data, this in itself is a strong market justification. In such a case, the company can clearly demonstrate that the financing terms do not differ from those it would receive from an independent lender. During an SRS audit, such justification usually does not raise significant questions, as the interest rate is based on publicly available, objective market indicators.

When risks still arise

Problems arise in situations where the interest rate is formally determined by referencing a bank offer, but without a clear link to the specific borrower’s risk profile, loan term, or collateral. In such cases, the SRS may question whether the chosen rate truly reflects market conditions for the specific company, rather than a general reference to a ‘bank rate’.

Conclusion

In these situations, the crucial difference is not in the transactions themselves, but in the approach to their pricing. Transfer pricing disputes most often do not arise because the company acted obviously inappropriately, but because the transaction prices were not initially evaluated taking into account market price levels and applicable regulatory frameworks.

In the era of structured data, the SRS sees not only the transaction but also the result in comparison with others. If the company itself has not made this comparison, the SRS will.

That is precisely why, in practice, the involvement of a professional consultant often means not a more complex process, but a more peaceful outcome. Because in transfer pricing, the main question is not – will the SRS ask. The main question is – will the company already have an answer.