Transfer Pricing Disputes — the Tax Code Framework
A transfer pricing dispute arises when the tax authority considers an operation between related persons inconsistent with the arm's length principle and adjusts taxable profit. Such disputes are governed by a combination of distinct norms of the Georgian Tax Code: the definition of related persons, the concepts of controlled transactions, the general principle and methods of valuation, and the rules of administrative proceedings. On this page these norms are analyzed in detail from the practical standpoint of how a taxpayer can defend its position at every stage of the dispute.
The essence of a transfer pricing dispute is simple: the state considers that a price or other condition agreed between connected persons differs from what would have applied between independent enterprises, and taxes the profit lost through that difference. To mount a defense, the taxpayer needs to know three things: who counts as a related person, by what standard the operation will be evaluated, and within which formal rules the complaint must fit.
Related Persons and Controlled Transactions
Under the Code, related persons are those between whom the existence of special relationships may influence the conditions or economic results of their activity or of persons they represent. Special relationships include, for example, the case where persons are founders (participants) of one enterprise, if their aggregate share is not less than 20 percent; where one person participates directly or indirectly in the other person's enterprise with a like share; where a person exercises control of an enterprise; where an individual is subordinate to another individual by position; and also kinship and membership in a partnership.
The circle of kinship is broadly defined: for the purposes of Georgian tax legislation, relatives include the first line — spouse, parent, child, sister, brother — and the second line as well. Control, for the purposes of these norms, means membership of a supervisory board, directorship and the right to appoint persons to these positions, as well as holding 20 percent of a voting share or shares. An individual is also treated as an indirect holder of a share where it is held by his relative.
The concept of the subject matter of the dispute — the controlled transaction — is likewise defined by the Code: two persons are related if one participates directly or indirectly in the management, control or capital of the other, or if the same persons participate in the management, control or capital of two persons. A person participates in the management, control or capital of an enterprise if it directly or indirectly holds more than 50 percent of the enterprise or practically exercises control over its entrepreneurial decisions. Any transaction between related persons is controlled — and it is from here that the tax authority's power of examination begins. A transaction in which one party is a resident of a country with preferential taxation is treated as controlled regardless of relatedness.
The Arm's Length Principle and Valuation Methods
If a Georgian enterprise carries out one or more financial or commercial operations with a related enterprise that is not a Georgian enterprise, each such enterprise determines its taxable profit in accordance with the arm's length principle. Taxable profit conforms to the arm's length principle if the conditions of the operation do not differ from the conditions that would be agreed between independent enterprises in comparable circumstances in comparable transactions. Where the established conditions do not conform, any amount of profit that would have accrued to an enterprise had the conditions conformed — but did not accrue because of the non-conformity — may be included in taxable profit and taxed accordingly.
For valuation the Code names five methods: the comparable uncontrolled price method, under which the price set on goods and services transferred in a controlled transaction is compared with the price in a comparable uncontrolled transaction; the resale price method, which compares the margin obtained on resale; the cost plus method, which compares the markup applied to costs incurred; the net margin method, which compares the net profit margin in relation to a corresponding indicator; and the profit split method, which attributes to each participant the share of profit or loss that an independent enterprise would presumably have received. The arm's length price is determined by the method most appropriate to the particular case.
Administrative Proceedings and the Formal Requirements for a Complaint
A tax dispute may be considered within the system of the Ministry of Finance of Georgia and in court, and at any stage of a tax dispute within the Ministry's system the complainant has the right to apply to a court. Procedure before the court is determined by administrative procedural legislation. This means that in a transfer pricing dispute the taxpayer has a choice: to continue the fight within the administrative system or to move to court.
At the complaint stage, the formal requirements are decisive: the dispute-resolution organ will not accept a complaint for proceedings if it lacks the complainant's identification or personal number, if contact details are missing, if the essence of the request cannot be discerned, if a copy of the challenged decision is not attached, if the pages are unnumbered, if the document is illegible, if it is not drawn up in the state language, or if it is unsigned. A complaint submitted by a representative must be accompanied by a document confirming the authority of representation. Where a defect exists, the complainant is notified in writing and given not less than 5 days to cure it; the organ may nonetheless accept the complaint despite the defect if it does not substantially hinder its consideration.
Frequently Asked Questions
When is a transaction treated as controlled?
Any transaction between related persons is controlled. Relatedness arises through participation in management, control or capital — including holding more than 50 percent of an enterprise or practical control over its entrepreneurial decisions. A transaction with a resident of a preferential-tax country is also treated as controlled.
What is the arm's length principle?
Taxable profit conforms to the arm's length principle if the conditions of the operation do not differ from those which independent enterprises would agree in comparable circumstances. In case of non-conformity, the tax authority may include the lost profit in taxable profit.
Can the dispute be moved to court?
Yes. A tax dispute is considered within the Ministry of Finance system and in court, and at any stage of the administrative proceedings the complainant may apply to a court.
Which defects cause a complaint to be refused?
For example, the absence of the complainant's number or contact details, unclear substance of the request, unnumbered pages, absence of the state language, or lack of signature. Not less than 5 days are given to cure a defect, and the complaint may be accepted despite it where consideration is not substantially hindered.
How We Help on Legal.ge
The Legal.ge team assists you at every stage of a transfer pricing dispute: we assess the justification of relatedness, analyze the appropriate valuation method and comparability arguments, prepare the complaint in compliance with all formal requirements, and represent your interests both in administrative proceedings and in court. Contact us on Legal.ge — your dispute will be resolved under professional control.