When transfer pricing documentation becomes mandatory and what it means in practice

Transfer pricing often becomes relevant only when a company is suddenly asked for its justification or when the SRS sends a letter with questions about transactions with related parties. However, the law has long established when documentation is mandatory, when it must be submitted upon request, and when a simplified justification is sufficient.

An important caveat to keep in mind when structuring related-party transactions: even if documentation is not mandatory, the arm’s length principle must still be observed.

Why is transfer pricing documentation needed at all?

The purpose of the documentation is to prove that the company’s transactions with related parties (parent, subsidiary, sister companies, or owners) take place according to the arm’s length principle – i.e., at the same level as independent parties would conclude them in the market.

In practice, this means that if a company lends money to an owner, leases premises to a related company, or sells goods to a subsidiary, it must prove that the set price, interest rate, or markup is at market level.

When is documentation mandatory?

According to Section 15.² of the Law “On Taxes and Duties,” the preparation of transfer pricing documentation is mandatory if the company exceeds certain thresholds.

What does upon request by the SRS mean?

If a company does not meet the full documentation criteria, the SRS can still request evidence that transactions were conducted in accordance with the arm’s length principle. This means the company must be able to prepare a simplified justification, for example:

1. a comparison with similar transactions in the market,
2. an internal calculation of interest rates or markups,
3. or at least the economic logic behind why the price was set at that specific level.

The burden of proof remains with the company – and this is often the stumbling block for small and medium-sized enterprises.

The important caveat that many ignore

The fact that the law does not mandate the preparation of transfer pricing documentation does not mean that a company is free to set any prices in transactions with related parties. This also applies to transactions between local Latvian companies.

For example:

1. if a parent company in Riga provides management services to a subsidiary in Liepāja,
2. or if an owner leases premises to their own company, these transactions are considered related-party transactions and must be at market level.

What does this mean in practice?

In practice, it means that:

1. it is worthwhile even for smaller companies to perform a simplified transfer pricing analysis to prove that prices, markups, or interest rates are not artificial.
2. The SRS has the right to request explanations even in cases where full documentation is not mandatory.
3. The best strategy is not to wait for a request but to proactively prepare a simple, clear justification – this helps avoid adjustments and penalties.

Summary

The requirement for transfer pricing documentation is not just a formal obligation – it is a guarantee of the company’s security. Even if the law does not require documentation to be prepared, the arm’s length principle applies to everyone. Therefore, it is wiser to prepare evidence in a timely manner than to later explain to the SRS why “we thought it didn’t apply to us.”