Until recently Bulgaria was one of the last countries among its neighbors and across south-eastern Europe which did not require taxpayers to regularly prepare, maintain or submit transfer pricing (TP) documentation, regardless of the materiality or complexity of their related party transactions.
As of January 1, 2020, this will no longer be the case. A long-awaited bill, enacted in August 2019, introduced an enhanced TP regime, which will require qualifying multinational enterprises with headquarters or taxable presence in Bulgaria to prepare and regularly update a local and master file in support of their inter-company transactions.
The new rules are the first major development of the Bulgarian TP rules since 2007 and represent a turning point in the practices of the larger corporate taxpayers and the Bulgarian National Revenue Agency (NRA).
The 2007 Transfer Pricing Regime
The currently applicable TP regime dates back to 2007, when the country joined the EU, and is based on two main pillars: the 2007 Corporate Income Tax Act (CITA) introduces the arm’s length principle, while the 2006 Tax and Social Security Procedure Code (TSSPC) deals with the related statutory definitions and procedural rules.
The Bulgarian TP rules in the CITA and the TSSPC do not impose taxpayer obligations to prepare TP documentation, unless requested by the tax authorities in the course of a tax check or audit. Instead, in 2008 the NRA prepared a non-binding TP Manual (made publicly available in 2010) recommending a best practice approach for taxpayers in documenting and supporting the arm’s length nature of their transactions with affiliates.
The TP Manual has been made obsolete in many aspects by later updates to the Organisation for Economic Co-operation and Development (OECD) TP Guidelines and has now been overhauled by the binding new TP regime.
The 2020 Amendments
The 2007 legislation was meant to establish the foundation for future development of a more detailed and binding legal regime. However, it was not until the recent amendments to the TSSPC, or 13 years later, that Bulgaria introduced binding TP documentation rules.
The main purpose of the new rules is to bring the Bulgarian TP rules in line with the OECD BEPS Action 13 report “Guidance on the Implementation of Transfer Pricing Documentation and Country-by-Country Reporting” (respectively the new Chapter V of the 2017 OECD TP Guidelines).
Under these new rules, Bulgarian corporate taxpayers or permanent establishments should prepare and update annually a local file to document the arm’s length nature of their transactions with related companies and sole traders for the fiscal year, starting on January 1, 2020. In addition, the above-mentioned groups should also prepare and update annually a master file, if they are part of a multinational group of companies (i.e. a group comprising entities or permanent establishments in more than one jurisdiction).
The new rules do not replace, but build on the existing TP requirements of the CITA and the TSSPC. Therefore, even corporate taxpayers that do not fall within the scope of the new rules should be able to support the arm’s length nature of all transactions with affiliates if requested to do so during a tax check or audit.
The following three groups of taxpayers are explicitly exempt from the new rules:
- businesses engaged in domestic transactions only (domestic business exemption);
- small and medium-sized enterprises (SME exemption); and
- tax-exempt taxpayers and activities.
Domestic Business Exemption
The final OECD BEPS Action 13 report encourages participating countries and jurisdictions to direct the new three-tier TP documentation requirements obligations mainly at transactions between a local country affiliate and associated enterprises in different countries and jurisdictions.
In line with this recommendation, the amendments exempt from the new documentation requirements taxpayers that do not engage in any transactions with foreign affiliates or permanent establishments; they are exempt from the obligation to prepare a local file.
To avoid disproportionate costs and burdens on SMEs, the new rules limit the scope of the TP requirements for taxpayers satisfying the following criteria:
- balance value of assets of less than 38 million Bulgarian lev ($21.6 million); and
- net sales of 76 million Bulgarian lev; or
- average headcount less than 250 employees.
Seemingly setting a bright line rule for taxpayers, the SME criteria have opened up significant room for debate and conflicting interpretations among tax practitioners, as it remains unclear which of the three criteria should be applied cumulatively, and which alternatively (whether breaching the balance sheet or the average headcount test alone would suffice to breach the threshold). The uncertainty created makes further changes likely to the TP rules clarifying the SME exemption threshold.
In the absence of further guidance and available practice by the tax authorities, it seems prudent that taxpayers take a conservative and cautious approach to the thresholds.
Tax-exempt Taxpayers and Activities
Specifically carved out from the new TP requirements are taxpayers or certain activities exempt from corporate tax in Bulgaria or subject to alternative taxes, as follows:
- publicly traded in Bulgaria collective investment schemes;
- national investment and other alternative investment funds;
- special investment vehicles;
- certain gambling activities;
- shipping activities subject to alternative taxation;
- the Bulgarian Red Cross.
The common denominator in all the above cases is that they concern taxpayers or activities which are not subject to corporate taxation (i.e. they are either subject to alternative taxes or fully exempt from corporate taxation) and therefore their TP position with affiliates does not affect their taxable base.
However, the application of the above carve-outs may raise practical difficulties, as in many cases only part of the taxpayer’s activities is exempt from corporate taxes (e.g. only the eligible shipping or gambling activities), which calls for a careful delineation between the carved-out activities and those subject to corporate tax and the new TP requirements.
Content of the Local and Master File
Taxpayers that may not benefit from one of the above exemptions should prepare a local file (and a master file, where applicable) to support the arm`s length nature of their material inter-company transactions with related companies or sole traders, domestic or cross-border. Transactions with individuals other than sole traders are explicitly excluded from the new documenting requirements.
The amendments introduce detailed requirements for the content of local and master files, largely in line with the recommended three-tier documentation standard of the OECD (Annex I and II to Chapter V of the 2017 TP Guidelines).
The amended TSSPC measures the materiality of the concerned inter-company transactions in absolute terms (before value-added tax and excise duties, where applicable), as follows:
- for sales of goods—400,000 Bulgarian lev per annum;
- for inter-company financing—a principal of at least 1 million Bulgarian lev or interest of 50,000 Bulgarian lev per annum;
- for provision of services and all other transactions—200,000 Bulgarian lev.
Deadlines and Filing Obligations
According to the new rules, local and master files should be contemporaneous and should be available at the time of filing of the taxpayer’s tax return for the respective year. This is a major development for Bulgarian taxpayers, who were required by the previous regime to present a TP documentation report only in the event of a tax audit and if the tax inspectors explicitly requested them to do so.
Companies or permanent establishments which fall within the scope of the new rules should have their first local files for FY2020, meeting the new content requirements, in place not later than March 31, 2021 (i.e. the filing deadline for the 2020 CIT returns). The first master file under the new rules should be available within 12 months from this deadline, or no later than March 31, 2022.
The local and master file should not be filed with the tax administration unless explicitly requested by the Bulgarian tax authorities.
The local and master file should be updated annually by March 31 each year. A new comparability analysis should be prepared at least once every three years, unless changes to the relevant comparability factors occur earlier. In any event, the financial results of the selected comparable companies or transactions should be updated annually.
The amendments envisage penalties for non-compliance with the new documentation requirements, which in certain cases may reach up to 0.5% of the total value of the qualifying inter-company transactions.
In effect from January 1, 2020, amendments to the TSSPC introduce enhanced TP rules requiring a broad range of taxpayers to prepare and regularly update their TP documentation.
Since the new rules are limited to multinational group of companies, most—if not all—covered taxpayers should prepare TP documentation comprising both a local and a master file. In contrast to the existing regime, these new requirements are binding, quite detailed and associated with significant penalties for non-compliance.
Along with the already effective country-by-country reporting rules, the amendments bring the Bulgarian TP regime in line with the OECD three-tier documentation standard.
The amendments aim to place the main compliance burden of the enhanced requirements on large multinational enterprises. However, their broad scope and relatively low thresholds could potentially affect a larger range of groups and taxpayers in various domestic and cross-border situations.
The new TP rules introduce detailed requirements to the content of the local and master file, which should be contemporaneous and available at the time of filing of the respective annual corporate tax return. However, the often vague wording of the applicable thresholds and exemptions raises practical difficulties, and opens the possibility of conflicting interpretations.
All multinational groups present in Bulgaria should carefully consider the impact of the new regulations on their TP policy and positions in the light of each specific subsidiary or establishment.
The introduction of mandatory TP documentation also marks an important development from the perspective of the Bulgarian tax administration. Over the past several years the NRA has made continuous investment in its expertise and capabilities in TP matters including in the training of tax inspectors and access to TP databases. TP issues have attracted increasing attention and scrutiny during tax checks and audits, which resulted in a noticeable rise in the number of TP disputes and controversies. Not surprisingly, inter-company financing, licensing, transfers of intangibles, management services and costs sharing arrangements were among the main topics leading to challenges and disputes with the tax administration.
The new TP documentation requirements will give further incentive to the Bulgarian tax authorities to improve their expertise in TP matters and will likely push TP issues further up in the list of their audit priorities in future.
Multinational groups of companies with a presence in Bulgaria should carefully consider the impact of the new TP rules. In particular, the following planning points seem relevant:
- Multinational groups of companies should carefully assess whether they fall within the scope of the new TP requirements and whether they could benefit from the available exemptions.
- The existing group TP documentation policy should be reviewed in view of the enhanced local and master file content requirements.
- Multinationals should align their practices in preparing TP documentation reports to the new requirement for regular updates under tight deadlines.
- The existing inter-company pricing and adjustments practices should be aligned accordingly to meet the new contemporaneous requirements.
- Multinationals should prepare for increased scrutiny of their TP practices and supporting documentation by the Bulgarian revenue authorities. Inter-company financing, management services and intangibles-related transactions will likely be at the forefront of future tax inspections.
Atanas Sabev is a Senior Manager with PwC.
The author may be contacted at: email@example.com
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.