The Most Common Transfer Pricing Errors Audited by the Financial Administration
The Financial Administration of the Slovak Republic has long been paying close attention to transfer pricing.
As the volume of cross-border transactions within corporate groups grows, so does the number of tax audits focused on the correctness of transfer pricing, the quality of documentation, and proof of compliance with the arm’s length principle.
Tax audits show that most of the additional tax assessed does not result from intentional violations of the law, but rather from insufficient documentation, incorrectly applied methodologies, or outdated internal processes. Many companies underestimate the fact that the burden of proof in demonstrating the reasonableness of transfer prices lies with the taxpayer.
In this article, we will examine the shortcomings that the Financial Administration focuses on during transfer pricing audits.
1. Missing or Outdated Transfer Pricing Documentation
One of the most common findings is the absence of transfer pricing documentation or documentation prepared merely as a formality. It often happens that a company uses documentation prepared several years ago that no longer reflects the group’s current organizational structure, changes in the functions performed, or new types of controlled transactions.
The documentation should reflect the actual situation during the period under review and include a sufficient explanation of the business model, functional and risk analyses, the selected transfer pricing method, and the economic rationale for the prices used. Merely meeting the formal documentation requirement during a tax audit is not sufficient.
2. Insufficient Functional and Risk Analysis
Functional analysis forms the basis of all transfer pricing documentation. Nevertheless, it is often one of its weakest components. During an audit, tax authorities examine in detail which company within the group performs key functions, what assets it uses, and what business risks it actually bears. If the documentation describes all companies in general terms without linking them to specific business realities, the tax authority may question the accuracy of the entire transfer pricing methodology.
Particular attention is paid to situations where a company declares that it performs only routine activities, but in reality makes strategic decisions or bears significant business risks.
3. Incorrect Selection of a Transfer Pricing Method
Some companies select a method solely because it was used in the past or by another company, without assessing its suitability for the specific transaction. The tax authority examines whether the chosen method was objectively the most appropriate given the nature of the transaction, the availability of comparable data, and the functions performed by the individual parties. If the taxpayer cannot adequately justify their choice, the tax authority may require the use of a different method or adjust the tax base itself.
4. Inadequate Benchmarking Analyses
Benchmarking is one of the most frequently audited areas. A company must be able to explain how it selected comparable companies, the criteria for excluding them, the financial indicators used, and the reasons why the results were considered comparable. The tax authority also focuses on whether the benchmarking is up to date. Another significant risk is the use of foreign comparable companies without explaining why it was not possible to identify suitable local or regional comparables.
5. Lack of Economic Justification for Intra-Group Services
As a rule, the tax authority does not consider an invoice or a framework agreement alone to be sufficient. It expects evidence that the services were actually provided, that they brought economic benefit to the company, and that their scope corresponds to the expenses charged.
Most common questions during an audit:
- What specific services were provided?
- Who performed them?
- What was the result?
- What benefit did they provide to the recipient?
- How was the price determined?
Without sufficient evidence, the tax authority may question the tax deductibility of the expenses.
6. Discrepancies Between Documentation and the Company’s Actual Operations
The tax authority compares the information provided in the documentation with financial statements, internal guidelines, organizational charts, employee job descriptions, minutes of management meetings, and publicly available information. If the documentation describes the company as a low-risk distributor, while internal materials show that it makes strategic business decisions or directs the group’s business policy, this creates significant grounds for questioning the entire transfer pricing policy. Therefore, the documentation must correspond to the company’s actual operations.
7. Lack of Ongoing Monitoring of Transfer Prices
Transfer prices should not be reviewed only after the end of the fiscal year. In many companies, the reasonableness of profitability is verified only during the preparation of the tax return. If a deviation from the benchmark is identified at this stage, the options for correction are often limited. We therefore recommend continuously monitoring the development of financial results throughout the year and, if necessary, adjusting transfer prices even before the end of the accounting period. This reduces the risk of subsequent adjustments to the tax base.
How to Prepare for a Tax Audit?
From the tax authority’s perspective, high-quality transfer pricing documentation is only one part of a successful transfer pricing defense.
Companies should regularly verify whether:
- the documentation reflects the company’s current operations,
- the functional and risk analysis reflects the actual situation,
- the benchmarking is up to date,
- intra-group services are properly documented,
- there is evidence of the economic benefit of the services received,
- the financial results are consistent with the chosen transfer pricing policy.
Regular internal audits allow you to identify risks even before a tax audit begins and significantly reduce the likelihood of a tax assessment. The best protection against a dispute with the tax authority is to regularly review your transfer pricing policy, update your documentation, and continuously monitor the transactions under review.
