In the realm of transactions between related entities, adherence to the arm’s length principle plays a key role. One of the challenges is properly accounting for profitability adjustments, particularly in the context of VAT. Recently, we had the opportunity to work on an individual tax ruling on this matter for one of our clients, and we are pleased to share the highlights of our findings.
What is a Profitability Adjustment?
A profitability adjustment is a mechanism to align the achieved margin with the market level, determined based on comparative analysis (benchmarking). In practice, this means that if the actual margin in transactions with related entities deviates from the established range, it may need to be adjusted through an additional payment—commonly referred to as an “in-plus” adjustment.
A crucial aspect of this process is its global nature—the adjustment concerns the entirety of cooperation between the parties over a given period (e.g., a fiscal year), rather than individual invoices or transactions.
Is a Profitability Adjustment Subject to VAT?
Tax law and interpretations by tax authorities provide clarity on this issue. In most cases, profitability adjustments:
Are not subject to VAT – They are not treated as a supply of goods or services because they do not involve any reciprocal performance.
Do not require VAT base adjustments – The adjustment relates to the overall profitability of cooperation, not specific transactions.
How Should a Profitability Adjustment Be Documented?
The best practice, confirmed in the tax ruling obtained for our client, involves using accounting notes or other accounting documents. VAT invoices or corrective invoices are not applicable in this context, as the profitability adjustment remains outside the scope of VAT.
Why is This Important?
Improper handling of profitability adjustments can lead to disputes with tax authorities and, consequently, significant financial risks. Therefore, it is essential not only to document such adjustments properly but also to rely on tax interpretations that safeguard the company’s interests.
Summary
Profitability adjustments are tools that ensure compliance with the arm’s length principle in controlled transactions. However, to use them safely, it is necessary to ensure compliance with tax regulations and proper documentation.
We are proud to have assisted our client in obtaining a tax ruling confirming the correctness of the applied solutions. The case was handled by attorney at law PhD Ewa Jędrzejewska.
If you face similar challenges, feel free to contact us.
