Transfer Pricing and Controlled Transactions in Connection with Earnings Management and Tax Avoidance

Katarina Kramarova,T Kliestik

doi:10.1051/shsconf/20219202031

Abstract

Research background: The way of pricing intra-group transactions (controlled transactions in the terms of transfer pricing) should be in line with the arm´s length principle, whether we consider nationally or transnationally related business entities. If this is not the case, these operations are a tool for earnings management between the companies. It is known that income tax is perceived by businesses as an unproductive withdrawal of own funds without obvious consideration, and therefore managing economic transactions at the level of related-party entities in order to minimize the tax liability is obvious and even expected. Purpose of the article: The aim of the paper is to find out if controlled transactions are used in connection with earnings management and tax avoidance in the selected Slovak company using proxies, which may carry this detection capability (ratios of related party transactions, book-tax differences ratio, and discretionary accruals ratio). Methods: The analytical part of the paper follows the Slovak transfer pricing legislation in force. Following the existing research studies, we test hypothetical relationship between the indicators of earnings management, related party transactions and tax avoidance by applying correlation analysis. We worked mainly with publicly available data from financial statements and notes to financial statements. Findings & Value added: The results indicate that the company managed earnings rather downwards, since the values of discretionary accruals ratio were negative. On the other side, it was not proven that earnings management was carried out purely with the intention of minimizing tax liability.

Highlights

According to the OECD, the term “tax” is confined to compulsory, unrequited payments to general government
Prices of intragroup transactions are a mean for allocating the profits between the various legal entities involved in related-party transactions of an economic nature. [3, 4] Methodology for assessing the correctness of intragroup transactions is based on the assessment of compliance with the arms length principle, which in most countries is codified directly in the business and tax legislation
The basic and transnationally accepted principle of transfer pricing – arms length principle – in case of Slovakia is enacted in the Section 18 (1) of the Act No 595/2003 Coll. on Income Tax Act as amended

Summary

Introduction

According to the OECD, the term “tax” is confined to compulsory, unrequited payments to general government. [1] One of the main missions of taxes is to ensure the flow of revenues to the state budget, and to ensure monetary relations associated with the performance of functions of the state; in this context primarily income taxes and value added tax are discussed It is a logical goal of every state to streamline tax collection, tax legislation, and minimize tax avoidance and tax evasion. Prices of intragroup transactions are a mean for allocating the profits between the various legal entities involved in related-party transactions of an economic nature. Transfer pricing was perceived more as an issue of multinational companies and international taxation At present, it is already being addressed at the national level, in close connection with economic activities of resident related parties. It is being discussed how important role it plays in managing earnings in case of related business entities by accepting the existence of the legal frame governing this issue

Objectives

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Conclusion