Questions and Answers about Transfer Pricing

Transfer pricing is a process that determines the determination of prices applied in the transactions between the related parties, within an international group of enterprises, using subsidiaries, branches or other units of the same group in different countries.

Essentially, transfer pricing concerns the pricing that a company determines to internal supplies (within the group) of goods, services, licenses or financial services between its units operating in different tax jurisdictions.

The Transfer Pricing Legislation in the Republic of Kosovo aims to state:

• Fair and equal tax handling

All entities that carry out economic activity in Kosovo and carry out controlled transactions with related parties must apply prices comparable to those that would be applied in the free market, in accordance with the arm’s length principle

This principle is harmonized with the OECD Transfer Pricing Guidelines, which Kosovo has also acquired as a basis in drafting the relevant regulations.

• Prevention of tax evasion

The legislation helps prevent manipulation of profits, which can occur when multinational companies unfairly use domestic services to shift profits to countries with lower tax rates.

• Ensuring tax fairness

The main objective of transfer pricing rules is to ensure that tax is paid in the country where the real profit is generated. In cases of transactions between related parties, the application of transfer pricing guarantees that the price applied to these prices is comparable to what would be applied under arm’s length conditions, thus ensuring the integrity of the tax system and ensuring fairness for all taxpayers.

All taxpayers registered in the Republic of Kosovo, who carry out controlled transactions with related parties, who exercise activity in different tax jurisdictions, are obliged to implement the legal provisions on Transfer Pricing.

The implementation of this law ensures that the prices applied in these transactions are in accordance with the arm’s length principle, guaranteeing fair and equal tax treatment.

For transfer pricing purposes, related parties are considered to be two or more natural or legal persons who control one another, either directly or through a third party, usually when one party owns 50% or more of the capital or voting rights.

This definition is essential to determine which transactions are subject to transfer pricing rules.

Identification of related parties is crucial, because only transactions between related parties are subject to Transfer Pricing rules. This helps to:

• Correct implementation of tax legislation;
• Preventing tax evasion through artificial profit shifting;
• Ensuring officials and tax transparency, etc.

According to the MF Administrative Instruction No. 02/2017, Related persons are those who have special relationships, who can significantly affect the economic results of transactions between them.

Persons are considered related in the following cases:

• When a person owns or controls 50% or more of the shares or voting rights in another company;
• When a person directly or indirectly controls another person, having influence over decision-making or operations;
• When both persons are controlled, directly or indirectly, by a third party, who has influence over both parties;
• When persons are close to the family, specifically the first, second and third degree, according to the Law on Inheritance in the Republic of Kosovo.

This definition is important to determine whether a transaction is controlled and, as such, subject to Transfer Pricing rules, in accordance with applicable tax legislation.

The Transfer Pricing Rules apply to transactions between related parties involving:

• Transactions involving goods, such as raw materials, ready-made products and the like;
• Service transactions, including marketing, information technology (IT), consulting, administration, management, training, technical services, etc.;
• Transactions with intangible assets, such as copyrights, licenses, patents, trademarks, technical know-how and any type of intellectual property;
• Financial transactions, such as granting loans, interest, guarantee payments and the like;
• Capital transactions, within the term of the sale of shares, other investments, or tangible and intangible assets.

Controlled transactions are those transactions that are carried out between two related enterprises, operating in two different tax jurisdictions.

The controlled transactions occur between related parties within the same group of enterprises, usually with the aim of optimizing the functioning of the group and the overall management of costs and benefits.

In these cases, pricing for goods, services or assets between related entities will not always be done according to market conditions, but is driven by the internal strategic goals of the group, such as:

• Managing tax burden in different jurisdictions;
• Profit sharing within the group according to business structure;
• Distribution of costs between different divisions or units of the group.

For this reason, Transfer pricing legislation requires that such transactions be in accordance with the arm’s length principle, in order to ensure fair and equitable taxation.

The Arm’s Length principle constitutes the main basis of Transfer Pricing rules and is in line with international standards, including OECD guidelines.

This principle establishes that:

• Prices applied in transactions between related parties must be comparable (similar) to those that would be applied to similar transactions between independent parties under similar market conditions.
• If the price used in a controlled transaction deviates from the price that would be used in the market, then an adjustment of this price may be required, so that it can reflect the real value under market conditions.

In this context, the tax authority has the right to intervene and make adjustments to the declared prices, if it considers that they are not in accordance with the Arm’s Length principle. This helps to guarantee tax services and prevent tax evasion through unrealistic prices in transactions between the related parties.

Comparability is a fundamental element in the application of Transfer Pricing rules and aims to ensure that prices applied in transactions between related parties are in line with the arm’s length principle.

Comparability implies that prices in transactions to related parties (controlled transactions) should be comparable with those that would apply to similar transactions between independent parties (uncontrolled transactions), which operate under normal market conditions.

So, the basic rule of transfer pricing is to compare prices between controlled and uncontrolled transactions, for the purpose of determining whether the price used is fair and in line with tax standards and international practices.

To apply comparability, It is first necessary to identify the controlled transactions carried out between related parties. Once identified, these transactions should be categorized according to their nature (such as goods, services, intangible assets, etc.), handling each category separately, if possible. This division helps to more accurately compare the terms of these transactions with similar transactions carried out between independent parties, in order to assess compliance with the arm’s length principle.

To determine whether two transactions are comparable in the context of transfer pricing, these key factors should be analyzed:

• Characteristics of property, goods or services provided – include the comparison of similar products or services in respect of nature, quality and their function.
• Functions performed by the parties in the transaction – includes the activities and responsibilities of each party in the transaction, including using of assets and its exposure to risks.
• Contractual terms – the contractual relationships between the parties, such as the terms of the payments, deadlines and delivery conditions.
• Economic circumstances – includes the market in which the parties operate, competitive conditions, the level of economic development and other factors relevant to the transaction environment.
• Business strategy – the strategic goals of the company, such as market development or the introduction of new products, which may be in the applied price.

The assessment of these factors helps determine whether a related party transaction is comparable to a similar transaction between independent parties, in compliance with the arm’s length principle.

When assessing controlled transactions between related parties, an essential step is functional analysis, which aims to understand the real role and contribution of each party to the transaction.

In general, in relations between independent enterprises, compensation reflects the functions performed, assets used and risks assumed by each party. The same approach is applied to transactions between related parties, to ensure that the price applied is in accordance with the arm’s length principle.

What does the functional analysis include?

Functional analysis aims to identify and evaluate:

• Main activities and responsibilities undertaken by each party to the transaction;
• Contributed or used assets (such as technology, equipment, property rights, etc.);
• Risks assumed, such as financial, commercial, operational risk, etc.

The analysis focuses on what the parties actually do and the concrete contribution they make to the value creation process.

What is meant by “functions performed” (Functional Analysis)?

Functions performed include all activities undertaken by an entity in a given transaction, such as: production, distribution, sales, management, support services, research and development, as well as other functions that have an impact in the determination of the transfer pricing.

The analysis and function of these functions is to determine the right allocation of profits within related groups and for correct implementation of transfer pricing rules, in accordance with the arm’s length principle.

In the context of transfer pricing analysis, the identification and assessment of the functions performed by each entity within the group is essential for the fair distribution of income and profits between them. These functions reflect the role that each entity has in creating value and the risk it assumes, and therefore directly influence the determination of transfer pricing.

Some of the main functions include:

• Production of goods

A company that is responsible for producing goods (e.g. a manufacturing plant) plays an important role in value creation. It assumes a certain level of operational risk and, therefore, should be rewarded in line with its contribution and the risks taken.

• Provision of services and support

The entities within the group may provide various services, such as management, technical support, logistics, etc. These services should be compensated in accordance with their nature and added value, through a reasonable transfer pricing and in accordance with the arm’s length principle.

• Research and development (R&D)

A company that develops new products or innovations contributes to the value through creating intangible assets (such as patents, trademarks, or technologies). Its role in intellectual property should be reflected in the distribution of profits.

• Sales and marketing

The functions related to sales and marketing are key to promoting and placing products on the market. Companies that perform these functions directly affect income generation and must receive a relevant portion of profit derived from these activities.

• Risk management

Some entities may undertake the management of financial, operational or commercial risks. Effective risk management strategies can have a significant impact on the performance of the group and should be considered when determining the transfer pricing.

Assets are resources used in business activities and are important for determining transfer pricing. They are divided into several categories:

• Tangible physical assets – include machinery, equipment, facilities, inventory or other tools used for production or provision of services.
• Intangible assets – such as patents, trademarks, copyrights, designs, computer programs and technical know-how, which have great characteristics in creating values.
• Financial assets – include cash, investments or other monetary resources used to finance internal activities or subsidiaries.
• Human assets – the knowledge, skills and expertise of employees, especially in functions such as research and development or management, may constitute an important contribution in creating the value.

The assessment of asset utilization helps determine the role and importance of each related entity in the revenue generation process, influencing the way profits are shared within the group.

Transfer pricing risks are factors that affect the potential for profits or losses that a company may incur from a controlled transaction. Risk management is essential for determining transfer pricing and ensuring that profits and losses are shared fairly between related entities.

• Market risk – It is related to price variations in the global or domestic market. For example, a company may be exposed to changes in commodity prices, currencies, or market demand.
• Operational risk – It is related to the possibility of failures in production, transportation or service delivery, which may affect the quality and cost of goods and services.
• Financial risk – It is related to financial assistance such as interest, exchange rate, borrowing losses or limited liquidity.
• Credit risk – It is related to the possibility of insolvency or delay in payments by the parties involved in the transaction.
• Legal and regulatory risk – It is related to the possibility of non-compliance with tax laws and regulations, as well as the possibility of investigations and sanctions by tax authorities.
• Risk of data loss (privacy risk) – The use of technology can also bring the risk of losing data or protected information that could damage the company’s reputation.

To share profits fairly, it is important that the risks associated with the assets and functions being separated are clear and managed. Entities that take on more risk should be compensated more for this, through a profit distribution that reflects these risks.

The comparability assessment is an essential process to assess whether the price used in a transaction between related parties is in accordance with the arm’s length principle.

This assessment involves analyzing transactions between related parties and comparing them with similar transactions that occur between independent parties under comparable conditions. The result of this assessment helps determine the fair and acceptable price for tax purposes.

Comparability assessment is an essential process in transfer pricing analysis, in order to ensure the compatibility of transactions between related parties with the arm’s length principle. This process includes the following steps:

1. Identification of transactions between related parties

Initially, all transactions between related parties are identified, such as:

• Sale of goods,

• Provision of services,

• Financial relations (lending or borrowing),

• Transfer of intellectual property.

2. Understanding the circumstances of the transaction

Key elements of the transaction are analyzed to understand its nature and purpose, including:

• The functions performed by each party,

• The risks taken,

• Assets used.

3. Identification of comparable market transactions

Similar transactions between independent parties are required, which can be used as a reference for comparison.

Comparisons can be made with:

• Internal transactions (within the company itself), and

• External transactions (obtained from the market).

4. Assessment of comparability factors

 There are five essential factors to assess whether a transaction is comparable:

5. Use of transfer pricing methods

After assessing comparability, one of the methods set out in the Administrative Instruction MF No. 02/2017 is selected to assess the transfer pricing in accordance with the market principle.

6. Correction of minor differences (if any)

In case there are minor differences between the compared transactions, they can be corrected to make the transactions more comparable (e.g. by adjusting interest rates, payment terms, geographical location), in order to make the comparison more accurate and objective.

Regulatory actions within the framework of the comparability assessment aim to ensure that transfer pricing applied in transactions between related parties is in line with the arm’s length principle. These actions are necessary to ensure transparency, fairness and to prevent tax evasion.

If significant differences between the price used and the market price are identified during the analysis, regulatory actions may be taken to correct prices and ensure that they are in line with the market principle. This may include:

• Accurate calculation of profit margin:

If the transfer pricing is significantly lower or higher than the market price, an appropriate profit margin for related parties should be determined.

• Transfer pricing adjustment:

If a party has applied a price higher or lower than the market price, it may be necessary to adjust the price to reach a fair level that reflects market reality.

• Profit sharing arrangement:

If a controlled transaction has resulted in an unreasonable distribution of profits among related parties, adjustments may be needed to ensure that profits are distributed in accordance with each party’s actual contribution to the creation of profits.

Sources of comparable transfer pricing information are data and information that can be used to assess the comparability of transfer pricing between related parties.

To assess whether a transaction between related parties is in accordance with the market principle, various sources of comparable data are used, divided into two main categories:

1. Internal company data

Internal company data is information that is directly related to controlled transactions between related parties.

This means that when a company has transactions with a related party, but at the same time the same company carries out transactions with independent parties, then the prices applied to the independent party can be compared to those prices that were made to the related party.

2. External market data

This data is collected from external sources and provides information about similar transactions between independent parties that occur in the open market. Some of these sources include:

a)   Industry reports and market research

• • Independent industry reports – provide information on prices and profit margins used in similar industries, and can help determine appropriate transfer pricing.

  • Competitor analysis– provides information about the prices used by competitors and helps in determining the fair transfer pricing.

b)   Data from independent databases

• • Commercial databases – There are several well-known database sources that provide data on prices used by independent companies in similar transactions.

  • Tax authorities’ reports and instructions – Many countries and tax authorities publish transfer pricing reports and guidance. These reports can provide comparative data that can be used for transfer pricing assessment.

  • OECD publications – OECD publishes detailed transfer pricing guidelines and reports, which include comparable data from different countries and can be used to assess industry practices.

  • World Bank and IMF reports – provide economic and financial data that can help estimate prices and profit margins in different markets.

In accordance with international transfer pricing guidelines (such as those of the OECD) and the guidelines set out in the tax legislation of the Republic of Kosovo, the determination of transfer pricing is made by choosing one of the approved methods for assessing the comparability of transactions between related parties.

The methods approved in Kosovo for determining transfer pricing are:

• Comparable Uncontrolled Price (CUP) Method – compares the prices applied in transactions between related parties with those applied in similar transactions between independent parties.
• Resale Price Method (RPM) – is based on the price at which a product is purchased from a related party and then resold to an independent party, deducting a reasonable profit margin.
• Cost Plus Method (CPM) – is applied by adding an appropriate profit margin to the cost of producing or providing a service, to determine the transfer pricing.
• Transaction Net Margin Method (TNMM) – analyzes an entity’s net profit margin from a controlled transaction, compared to similar margins achieved in the market by independent parties.
• Profit Sharing Method (PSM) – used when transactions are too interrelated to be separated, dividing the total profit realized between the parties according to each party’s contribution to the transaction.

The choice of the most appropriate method is made taking into account the nature of the transaction, the availability of data and the possibility of ensuring a result that is consistent with the market principle (arm’s length principle).

CUP (Comparable Uncontrolled Price) method is the most direct and reliable method of applying the market principle and may be more appropriate than other methods, in cases where it can be applied reliably. It requires a very high degree of comparability of the product or service and is appropriate in cases involving the sale of goods or financial transactions such as loans.

This method compares the price charged for goods or services in a controlled transaction with the price charged in the comparable uncontrolled transaction.

• Advantages – provides a clear and direct basis for comparison, based on real market prices.
• Disadvantages – it may be difficult to find comparable transactions that are similar to those between related parties.

The Resale Price Method (RPM) is used when a product is purchased from a related party and then resold to an independent party. The resale price is compared to prices in similar transactions between independent parties, deducting a reasonable profit margin for the seller.

This method is appropriate when a company is engaged in the sale of goods and benefits from a distributor who does not perform many other functions, such as manufacturing or product development.

• Advantages – simple and useful when selling uncomplicated goods and it may be possible to identify appropriate market prices.
• Disadvantages – cannot be used for every type of transaction and may be difficult to implement in more complex cases.

The Cost Plus Method (CPM) compares the profit margin applied to the cost basis of the controlled transaction, compared to the profit margin of the uncontrolled transaction.

This method may be appropriate for comparable manufacturing or service operations, while it is less appropriate when a manufacturer or service provider makes a distinct and valuable contribution.

• Advantages – can be used when there is no clear information on market prices and is easy to implement when there is clear data on costs.
• Disadvantages – does not take into account variables that can affect market price, such as quality and demand.

The Transactional Net Margin Method (TNMM) examines the net profit related to an appropriate base (e.g. expenses, sales, assets) that a taxpayer executes from a controlled transaction and compares it to what third parties would have received in similar circumstances.

 This method is used when it is difficult to compare transfer pricing and when there is sufficient data on the net profits achieved by independent companies.

• Advantages – it is a flexible method that can be used for a wide range of transactions and is useful when there is not much comparable pricing information.
• Disadvantages – may be less accurate than some other methods and may require a lot of analysis to determine the appropriate margin.

The Profit Split Method (PSM) is appropriate when there is a joint activity between related parties and the profits need to be split fairly, in accordance with each party’s contribution.

This method is generally used when each party to a transaction:

• • Made unique and valuable contributions,
  • Are integrated to the extent that their contributions cannot be reliably assessed separately from each other, or
  • Engage in sharing the main risks related to the transaction.

• Advantages – can be useful for complex transactions, such as those involving the development and distribution of intangible assets.
• Disadvantages – it is more complex and requires in-depth analysis to determine the fair profit sharing

The selection of the transfer pricing method depends on several key factors, such as:

• Nature of the transaction: The type of goods and services provided, as well as the complexity of the transaction, may influence the selection of the most appropriate method.
• Availability of comparable data: If there is sufficient data on comparable market prices, comparable uncontrolled price methods such as (CUP) may be the most appropriate method.

To determine compliance with the arm’s length principle for a controlled transaction, the most appropriate method is applied and it is not required to apply more than one method. The taxpayer has the right to cross-reference or support the application of the most appropriate method by applying one or more of the other transfer pricing methods.

When a taxpayer has applied one of the transfer pricing methods set out in Article 28 of Law No. 06/L-105 on Corporate Income Tax, the Tax Administration of Kosovo, in order to determine that the conditions of the controlled transaction are in accordance with the arm’s length principle, shall base its determination on the transfer pricing method applied by the taxpayer, unless it is established by TAK that the method applied by the taxpayer is not the most appropriate method..

The tested party is the enterprise from among the related parties that is selected to be compared with independent entities in the transfer pricing analysis. The selection of the tested party for transfer pricing is a key process in determining which of the related parties will be the subject of the analysis and will be compared with independent entities for the purposes of the transfer pricing assessment.

In the context of transfer pricing, the cost plus method, the resale price method and the net transaction margin method require that one of the parties be the “tested party” and that this party will be compared with independent entities to determine whether the transfer prices are in accordance with the arm’s length principle. In this process, the importance of choosing the tested party is that it should provide a clear and reliable basis for comparing the results of profits, costs and profit margins.

• Simplicity and consistency: In general, the tested party should be the party that has the simplest operational structure and is the most consistent in terms of its functions and the risks it takes. This means that it has fewer changes in its activities, making it easier to compare it with other independent companies.
• Available data: The tested party should be the one with the most available data to compare with independent companies. If there is more information available to test a party, then it will be more suitable for use.
• Ease of justification: If one party has a simpler role and does not have many functions, it is more suitable to be the tested party. For example, a distributor may be more suitable to be tested than a manufacturer who has a wide range of functions and assets.

Transfer Pricing service transactions cover a wide range of activities, from the provision of management, consulting and financial support services, to technological, marketing or research and development services. The use of transfer pricing for services should follow the arm’s length principle, whereby the transfer price should be consistent with the prices that would have been used in transactions between independent parties under similar conditions.

In particular, for service transactions, it is important to determine:

• the nature of the service (what type of service is provided), and
• the value that this service has in the market context.

Within the framework of transactions between related parties, a number of different services may be included, such as:

• Administrative and support services – include services related to the management, supervision and support of business processes, such as administrative consultancy, financial services, or support in the areas of IT.

• Consulting and advisory services – include services provided by consultants for management, strategy development, marketing and risk consulting and process improvement.

• Technological services – systems customization, support and services for software development and maintenance, services for IT fields, as well as research and development of new technologies.

• Marketing and advertising services – marketing and advertising activities that can be provided by one company to another company, including brand promotion and increased market exposure.

• Research and development services – research and development of new technologies, including the development of new products and innovative services.

Low value-added services are those services that have the function of supporting business processes, but that do not have a direct and major impact on the creation of the economic value of the product or service provided.

Characteristics of low value-added services may be:

• Support services, such as administration, supervision and technical support.
• Common and necessary services, such as office cleaning, inventory management, simple technical assistance, and handling internal information.
• Services that do not directly contribute to profit or that are related to routine and ordinary business activities.

These services do not include services that are critical to the development of intellectual property (e.g. brand development services, patents, research and development). Instead, they are services that can be provided by a group entity without requiring specialized knowledge or large investments.

Therefore, services of this type are not related to strategic or important functions of the group and are usually compensated with lower fees, in accordance with their nature.

In order to treat these services from a tax perspective, it is important that the transfer pricing is in line with the arm’s length principle. However, since these services have a low added value, the rules and practices for transfer pricing are simpler and can be applied in a more flexible manner. Many tax authorities, including Kosovo, are inclined to allow the use of a simpler approach for valuing these services.

Methods used for transfer pricing valuation may include:

• Cost Plus Method – used to determine the transfer price for services provided by a group entity. The price may be based on the costs incurred in providing the service, and
• Markup Method – this is a simple method for low value-added services, where a certain profit margin is based on the direct costs of providing the service (e.g., for administrative expenses, which are of a simpler and more common nature).

In Kosovo, a 7% margin is applied to low value-added services.

Documentation of such services is important to prove that the transfer pricing applied is in line with international practices and the requirements of tax authorities.

The documentation must include:

• Description of the services provided, specifying the nature of the services and the rationale for providing them within the group.
• Costs incurred in providing these services, including administrative and support expenses.
• The method used to determine transfer pricing (e.g. costs incurred or profit margin), and why that method is appropriate for these types of services.

Intangible assets include any form of property that does not have a physical form but has economic value, such as:

• Patents – rights to inventions and new technologies.
• Trademarks – symbols and names that identify and distinguish products and services in the marketplace.
• Copyright – rights to creations such as books, music, software, etc.
• Special licensing terms – rights to use specific technology or brands.
• Brand experience and reputation – the value created by market knowledge and brand image.
• Licensing and exclusivity rights – including rights to distribute products and services in different markets.

The importance of intangible assets is great because of the impact they have on creating value and profits for a company.

Controlled combined transactions occur when a company (or a group of companies) enters into several related transactions with another company (or group), which are closely linked to achieve a common purpose or to provide functions, assets or services in an integrated manner. This type of assessment requires a detailed analysis of the functions, assets and risks allocated between the various transactions involved.

For example, a company that provides management and marketing services may provide a range of services to another company within its group. In such a situation, it may be difficult to estimate the price of each transaction separately, because they may be linked in a way that helps each other to generate value. In this case, a combined approach may be used to value the transactions.

In the event that the price used in a transaction between related parties does not match the prices that would be applied in a similar transaction between independent parties, the tax authorities have the right to make tax adjustments, changing the taxable base to reflect a more appropriate price.

Transfer pricing adjustment can be done in several ways:

• Price adjustment used to achieve a price that is similar to the market price, using transfer pricing methods that are set out in guidelines and laws.
• Adjustment of inappropriate profits, which can occur when the profit generated by the transaction is not in accordance with Arm’s Length Principle.

The median is a statistical indicator used to determine the central value within a set of comparable data (such as prices, margins, or financial indicators) obtained from transactions between independent parties.

In the context of transfer pricing, the median is used for:

• Determine the midpoint of a range of comparable prices or margins;
• Reduce the impact of extreme values, which can distort the analysis;
• Serve as a reference point for the tax authority if the price applied by the taxpayer falls outside the market range.

The use of the median is a practice recommended by Administrative Instruction MF-No. 02/2017 and by OECD guidelines, as a reliable tool to assess whether a transaction between related parties is in accordance with the arm’s length principle.

According to Administrative Instruction MF-No. 02/2017, the median is used to determine the market range of comparable prices. The median is fifty percent (50%) of the results of uncontrolled comparable transactions that form the market range. In practice, this means that 50% of the results are lower than the median, while 50% of the results are higher. ​

In cases where the financial indicators of controlled transactions are outside the market range, the Tax Administration of Kosovo (TAK) may adjust the taxable profit of the taxpayer to adjust it to the median of the market range, unless TAK or the taxpayer proves that the circumstances of the case require adjustment to another point in the market range.

This process is done in this way:

1. Collection of comparative data – financial data is identified and collected from independent companies that have conducted comparable transactions (sales, purchases, services, loans, etc.).
2. Creating a comparable range – from the data collected, an interval (range) of margins or other indicators (such as prices, return on sales, assets, etc.) that are common to independent parties is created.
3. Using the median as the center point of the range – the median defines the midpoint of this range: half of the values are below the median, half are above it. This is more stable than the mean, as it reduces the influence of extreme values.
4. Comparison of the taxpayer’s result with the median – if the taxpayer’s indicator (e.g. net profit margin) is within the comparable range – in particular close to or at the median – then the transaction is considered in accordance with the market principle.
5. Adjustment by TAK if outside the range – if the taxpayer’s result is outside the market range, TAK may make a tax adjustment by placing the taxable profit at the median of the range, unless the taxpayer proves that the circumstances of the case require another point within the range.

Example:
If the analysis yields the following margins: 4%, 6%, 7%, 9%, 11%, then the median is 7%.

If the taxpayer has applied a 3% margin, TAK may make an adjustment to 7%, to ensure that the price used matches the market.

The use of the median is standard practice and supported by Administrative Instruction MF-No. 02/2017 on Transfer Pricing.

A corresponding adjustment is the adjustment that the second country makes to the taxable income of the related enterprise, in order to reflect the same value that was used by the first country for the transaction, respecting the arm’s length principle.

According to the Administrative Instruction of the Ministry of Finance No. 02/2017 in Kosovo, the possibility of appropriate adjustments is foreseen in cases where related parties are located in different jurisdictions and a Double Taxation Agreement (DTA) exists.

In the case of a primary adjustment of transfer prices by the tax authority of one country (e.g. Kosovo), the tax authority of the other country (where the related enterprise is located) may make a corresponding adjustment to the taxable income of the other party, in order to:

• To avoid double taxation, and
• Ensure the correct implementation of the arm’s length principle.

If a tax authority outside of Kosovo has made an adjustment to the price of a controlled transaction with a business registered in Kosovo, then this business may request the Kosovo Tax Administration (KTA) to make the corresponding adjustment in Kosovo.

The procedure includes:

• Submission of a written request to TAK by the taxpayer in Kosovo.
• Including supporting documentation that proves that the adjustment made by the tax authority of the other country is in accordance with the market value (arm’s length principle).
• Review by TAK to verify the compliance of the regulation with market price principles.

If TAK finds that the adjustment is fair and based on comparable market prices, then it carries out the adjustment of the relevant tax in Kosovo, avoiding double taxation.

Every taxpayer who has carried out controlled transactions, which during a calendar year reach or exceed the amount of three hundred thousand euros (€300,000), is obliged to complete and submit the “Annual Controlled Transactions Notification” form.

Submission of this form is done:

• Along with the annual tax return and financial statements.
• In physical form, at the Department for Transfer Pricing and Digital Economy at TAK.
• Within the deadline for submitting the annual Corporate Income Tax return.

Transfer pricing documentation is a set of documents that proves that transactions between related parties were carried out in accordance with the arm’s length principle. This documentation is divided into two parts:

1. Master File – for the international group:

• • The legal and organizational structure of the group,
  • Description of the group’s businesses (main activities and markets),
  • Intellectual property (patent rights, trademarks, copyrights, etc.),
  • Group transfer pricing policies,
  • Cost Sharing Agreements,
  • Description of financial agreements within the group (loans, guarantees, etc.),
  • Group financial position (consolidated annual report).

2. Local File – for the entity in Kosovo:

a) General information, such as:

• • Description of the company in Kosovo,
  • The economic activities it carries out,
  • Related parties and their relationships,
  • Legal organization and management structure.

b) Functional Analysis (FAR Analysis), such as:

• • The functions performed by the taxpayer,
  • Assets used in transactions (equipment, IP, intangible assets, etc.),
  • The risks it assumes (financial, commercial, operational, etc.).

c) Description of transactions with related parties, such as:

• • Type of transactions (sale of goods, services, loans, IP, etc.),
  • The monetary value of each transaction,
  • Supporting documentation (contracts, agreements, etc.).

d) Choice of Transfer Pricing method:

• • Method applied (CUP, Cost Plus, Resale Price, TNMM, Profit Split),
  • The rationale for choosing the method,
  • Documentation for comparative analysis.

e) Benchmarking Analysis:

• • Comparable companies used (independent parties),
  • Their financial data,
  • Adjustments for differences in functions or risks,
  • Profit margin range to assess whether the transaction is within acceptable rates.

f) Financial information:

• • The taxpayer’s financial statements,
  • The relevant accounts of related transactions,
  • Compliance with accounting and tax standards.

According to Article 29 of the Administrative Instruction of the Ministry of Finance No. 02/2017 on Transfer Pricing, the following are obliged to prepare the documentation:

• Any taxpayer in Kosovo who carries out transactions with related persons in foreign tax jurisdictions,
• Even taxpayers with turnover lower than EUR 300,000, if TAK requests this documentation.

The award transfer documentation must be:

• Prepared on time (in advance) – before submitting the annual income tax return.
• To be submitted within 30 days from the date of the TAK request.
• Updated annually or when significant changes occur in transactions or structure.

To be compliant with transfer pricing rules, you must:

• Identify all related parties,
• Document all transactions with them,
• Apply a justified pricing method to controlled transactions,
• Keep Master File and Local File updated,
• Declare correctly on your annual tax form,
• Be prepared for a tax audit by the Tax Administration.