Bulgaria fully applies the OECD Transfer Pricing Guidelines. Bulgarian transfer pricing rules were initially introduced in the Corporate Income Tax Act (CITA), Tax and Social Security Procedures Code (TSSPC), as well as in the Ordinance № H-9 for implementation of the TP methods, issued by the Minister of Finance on 29 August 2006. Following international trends, a Manual providing guidance on Transfer Pricing issues was published in 2010 by the Tax Authorities.
Who is affected?
Under the definition of related party and the rules set out in the legislation, if related parties perform transactions then those transactions should be performed in accordance with the arm’s length principle.
According the TP Guidelines of NRA, which has recommendable but not obligatory character, only the small businesses are exempted from preparation of TP documentation.
Related Party Definition
The definition of related parties in the Bulgarian jurisdiction is very broad and includes situations where one party directly or indirectly participates in the management, control, or capital of another party.
It is important to be note that in Bulgaria even a 5% shareholding relationship is sufficient according to the TSSPC to define two entities as related parties.
Transfer Pricing Methods & Data used
For transfer pricing purposes, taxpayers should follow the implementation of one or combination of the following methods:
- The Comparable Uncontrolled Price (CUP) method
- The Resale Price Method (RPM)
- Cost Plus Method (CPM)
- Transactional Net Margin Method (TNMM)
- Profit Split Method (PSM)
Despite the fact that the Manual published by the NRA does not have a mandatory character, it is highly recommended that all taxpayers follow the requirements and prepare Transfer Pricing Documentation for a specific tax year by the due date of submitting the annual tax return. With the proper Transfer Pricing Documentation in place companies mitigate the risk of tax authorities assessing the transfer prices under their own analysis.
Transfer Pricing Audit and Penalties
In Bulgaria there is no a specific tax audit procedure related to transfer pricing issues. However, related party transactions are matter of control performed as a part of the general tax audit procedures.
During a potential tax audit an adjustment, increasing the taxable basis is highly possible in the absence of relevant documentation. However, it is important to note that in transactions related to goods, the tax authorities generally seek price adjustments but in services transactions they tend to focus on the real substance of the provided services.
Differences between the transfer prices and the market prices can be considered as hidden profit and a penalty provision of 20% of the respective difference may be applied.
Additionally to the above adjustment, every legal entity which incorrectly determines its tax obligation is subject to a penalty ranging from EUR 250 and up to EUR 1,500.
In case the audited entity does not submit the required TP documentation during a regular tax audit, the effective penalty is in the range between EUR 125 and EUR 250.
According to the Bulgarian legislation, there is no deadline for the submission of TP documentation to the NRA. Documentation is provided by the company during a tax audit and upon request from tax auditors. The time frame for submission of the TP file in this case is 7 – 30 days, but in the practice it is required within 14 (fourteen) days after the request is provided.
On January 2014, the National Revenue Agency published a table (Appendix 4 on the annual CIT Return Form) which was initially approved by the Ministry of Finance on 17 December 2013, according to which, up to 31st March of the following year, every legal entity is obligated to complete the table that contains information regarding related party transactions. Disclosures related to transactions with entities based in a jurisdiction with a preferential tax system should also be included in the said appendix 4.
Statute of limitations on TP adjustments
The general statutory limitation period for tax liabilities in Bulgaria is 5 (five) years, effectively from 1st January of the following year, when the tax liabilities were due.
According to the Bulgarian legislation, the interest rate that is defined in the loan agreements among related parties should be following the arm’s length principle as well. Specifically the agreed upon interest rate should not diverge from the market interest rate. The Bulgarian National Bank regularly publishes average rates of interest for different types of loans and credits. The following factors are usually considered when establishing the arm’s length rate:
- amount and duration of the loan;
- the debtor’s credit rating;
- the currency of the loan;
- the securities and guarantees provided;
- the country in which the debtor is located; and
- the industry in which the debtor operates.
Thin capitalization rule
In order for interest charges to be deductible from the tax basis, a “thin capitalization rule” should be applied. According to the Bulgarian CITA (article 43), the positive difference between expenses on interest and income from interest is not tax deductible when it exceeds 75% of the accounting financial result before all expenses on interest and income from interest. One of the key points is that in order to check the entity’s compliance to the thin capitalization rule, the tax payer should summarize interest arising from transactions with every party (related & non related). The only exceptions are:
- unrelated parties where one of them is a bank or a leasing company;
- credit institutions, which do not fall under this regulation at all; and
- situations in which the owners’ capital exceeds at least three times the debt capital
The significant “trap” when testing an entity’s thin capitalization is when there is a cross collateral loan. In this case the interest occurring is added to the total amount of interest arising from the other transactions.