Controlled Transactions Overview | How the SRS Performs Transfer Pricing Adjustments in Practice and How CIT Surcharges Arise

When the State Revenue Service (SRS) initiates a transfer pricing audit, entrepreneurs often expect a discussion regarding the documentation format or specific methodological nuances. However, in practice, the SRS focus is usually much more pragmatic – on whether the company’s financial results correspond to what an independent market participant would achieve under similar circumstances.

If the answer to this question is negative in the view of the SRS, transfer pricing adjustments follow, and it is at this exact moment that the transfer pricing issue transforms into a very specific tax risk.

From Price to Profit – The SRS Perspective

It is important to understand that the SRS rarely “corrects” an individual invoice or a single transaction price. In practice, the adjustment almost always occurs at the profit level. The SRS compares the profitability achieved by the company with the market level that would be expected, taking into account the company’s functions, risks, and assets used.

If the company’s profit is lower than this market level, the SRS concludes that the difference is related to inappropriately determined transfer prices and adds this difference to the taxable income.

From the entrepreneur’s perspective, this is often a surprise – because “the prices were already there,” “contracts were concluded,” and “money was actually paid.” However, in the case of transfer pricing adjustments, legal form yields to economic substance.

How the “Correct” Profit Level is Determined

The SRS usually relies on data from comparable companies. Independent companies with a similar business profile are selected, and the profit they earn under market conditions is analyzed. As a result of this data, a market range is determined – the boundaries within which profit would be considered consistent with the arm’s length principle.

If the company’s indicators are outside this range, the SRS considers that there are grounds for an adjustment. And crucially – if the company itself has not prepared a convincing economic analysis, the SRS will use its own assumptions and data.

How the CIT Surcharge is Formed

As a result of a transfer pricing adjustment, the company’s taxable income increases. In Latvia, this means additional corporate income tax, which is calculated by applying not only the CIT rate but also a coefficient that effectively increases the amount payable.

Consequently, the financial impact of the adjustment is often significantly larger than entrepreneurs initially expect. Furthermore, in addition to the tax, late payment interest may also be calculated if the SRS considers that the tax was not paid on time.

It is important to emphasize – an adjustment does not always mean that the company has acted in bad faith. Often, it is the consequence of incomplete analysis or erroneous assumptions about what would be “normal in the market.”

Why Disputes Arise at This Stage

Most transfer pricing disputes arise not over whether the arm’s length principle is applicable, but rather how it should be applied in the specific situation. The choice of method, the tested party, the selection of comparable data – these are issues where boundaries of interpretation exist.

If the company has not considered these issues in advance, the conversation with the SRS already takes place in defense mode, and the room for maneuver is limited.

What Does This Mean for Companies in Practice?

Transfer pricing adjustments are almost always the consequence of decisions made much earlier – at the time of price setting, rather than during the audit. That is why the most significant risk management occurs before the involvement of the SRS, not during it.

Timely evaluation of pricing policy, a clear understanding of the company’s role within the group, and a professional perspective on how these data will appear in the SRS analysis are often decisive in practice. Because when adjustments are already being calculated, the discussion is no longer about theory – it is about very specific amounts.