Transfer Pricing Documentation — Why It Is Decisive
Transfer pricing documentation is the foundation on which a taxpayer defends its prices: in relations with the tax authority a bare declaration is not enough — an explanation and analysis is needed which shows why the price of controlled transactions conforms to the arm's length principle. The Georgian Tax Code regulates this field through distinct norms: the concepts of controlled transactions, the general principles of valuation, the valuation methods, and the special provisions establishing the taxpayer's duty of explanation. This page explains what a taxpayer needs to know when preparing documentation.
The importance of documentation becomes clear the moment the tax authority begins to examine an operation: properly prepared material reduces the risk of adjustment and strengthens the taxpayer's position in a dispute. Documentation should therefore not be treated as a formality — it is an instrument of tax security.
Controlled Transactions — What the Documentation Must Capture
The first task of documentation is to show which transactions are controlled and why. Under 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. Participation means directly or indirectly holding more than 50 percent of the enterprise or practically exercising control over its entrepreneurial decisions.
Any transaction between related persons is controlled, while a transaction between independent persons is independent. Moreover, a transaction in which one party is a resident of a country with preferential taxation is treated as controlled regardless of relatedness. Documentation must therefore reflect the group structure, participation shares and functional roles — it is precisely this that determines which transactions fall within the controlled category.
The Arm's Length Principle and the Burden of Explanation
The general principle of valuation is the arm's length principle: a Georgian enterprise conducting financial or commercial operations with a related foreign enterprise determines its taxable profit in accordance with that principle. Taxable profit is considered conforming if the conditions of the operation do not differ from the conditions which would be agreed between independent enterprises in comparable circumstances. Otherwise, the lost profit may be included in taxable profit.
The burden of explanation is established by the Code directly: at the request of the tax authority, the taxpayer is obliged to explain on what basis it considers the profit received to conform to the arm's length principle, and is entitled to submit sufficient information and analysis to support that explanation. This means that documentation must accumulate the evidence on which the explanation will rest.
Valuation Methods and Their Reflection in Documentation
The central part of documentation is the choice and justification of the valuation method. The Code names five methods for valuation: the comparable uncontrolled price method, the resale price method, the cost plus method, the net margin method and the profit split method. The price conforming to the arm's length principle is determined by the method most appropriate to the case — so what matters in documentation is not only the application of the chosen method but also the demonstration of why it is the most suitable for the particular transaction.
Comparability is likewise regulated by the Code: an independent transaction is comparable with a controlled transaction if there is no difference between them material to the financial indicator being tested, or, where a difference exists, a reasonably precise adjustment has been made. Documentation builds its comparative analysis precisely along this logic: the selection of comparable transactions, the identification of differences and, where necessary, the reflection of adjustments.
The Duty of Explanation and Procedural Rules
The special provisions of the Code also address important procedural questions: the rules of applying valuation methods, the determination of comparability, the procedure for correcting an operation, the information to be submitted to the tax authority, the list of documents, sources of information on market prices, the rules for applying price ranges, and the applicable time limits are determined by an order of the Minister of Finance of Georgia. It is also established that the examination of controlled transactions is carried out in accordance with the corresponding provisions, and the decision on it is taken by the head of the Revenue Service. This means that the detailed requirements for documentation are laid down in a separate legal act, and knowing it precisely is a precondition for preparing the documentation.
The norm on corresponding adjustments deserves separate mention: if a foreign tax authority made a correction to the conditions of a transaction between an enterprise taxed in Georgia and its related enterprise, as a result of which a portion of profit already taxed in Georgia was taxed in that country, and Georgia has a double taxation treaty with that country, the Georgian tax authority — at the request of the taxpayer — verifies whether the correction conforms to the arm's length principle and, if it does, makes the correction and adjusts the taxpayer's tax amount accordingly. This mechanism is an instrument for balancing the risk of double taxation, and its use also depends on properly prepared documentation.
Frequently Asked Questions
On whom does the duty of explanation rest?
On the taxpayer — at the request of the tax authority it must explain on what basis it considers the profit received to conform to the arm's length principle, and it is entitled to submit sufficient information and analysis.
Which method should the taxpayer choose?
The Code names five valuation methods; the price conforming to the arm's length principle is determined by the method most appropriate to the case, so the choice depends on the nature of the transaction.
Where are the detailed documentation requirements set out?
Questions of the information to be submitted, the list of documents, information sources and time limits are determined by an order of the Minister of Finance of Georgia.
What happens if a foreign tax authority makes a correction?
If a portion of profit already taxed in Georgia is taxed in another country and a double taxation treaty exists with it, the tax authority verifies the correction at the taxpayer's request and adjusts the tax where the correction conforms to the arm's length principle.
How We Help on Legal.ge
The Legal.ge team assists you in preparing and updating transfer pricing documentation: we identify controlled transactions, select the valuation method and build the comparative analysis, prepare the explanation for the tax authority, and help you comply with the requirements established by the Minister of Finance's order. Contact us on Legal.ge — your controlled transactions will be documentarily protected.