What are related entities and how to distinguish them when preparing transfer pricing documentation?

From this article, you will learn:

• when we can talk about related entities?
• how to understand the concept of "exerting significant influence"?

What is the Polish definition of related entities? Pursuant to Art. 11a section 1(4) of the Corporate Income Tax Act, we deal with related entities when one entity exerts significant influence on another. But what does this mean? Is it about capital connections? Or maybe personal connections? And what exactly is this “significant impact”?

When defining related entities, the transfer pricing regulations distinguish basically three categories of significant influence:

• through ownership, management or control relationships;
• through the actual ability of an individual to influence key economic decisions;
• through family connections.

Ownership, management or control relationships

Relations between entities are ownership, management or control if one of the entities has in the other at least 25% of:

1. Shares in capital
   We will deal with a direct relationship when, for example, entity 'A' directly holds at least 25% of the shares in the capital of entity 'B'. However, in the case where, for example, entity 'A' holds 25% of the shares in the capital of entity 'B' and at the same time 50% of the shares in the capital of entity 'C', there is an indirect relationship between 'B' and 'C' (through entity 'A' '). This type of capital connections is one of the most common types of connections.
    
2. Voting rights in constitutive or management control bodies 
   In practice, this most often means the presence in the entity's structures of management board members or supervisory board members who sit in at least two different companies.
    
3. Shares or rights to share in profits, losses or assets, or their prospects, including participation units and investment certificates
   It should be remembered that the share in profits may be determined, for example, due to the performance of a given function in the entity or due to the share held by a partner.

An individual's actual ability to influence key economic decision-making

Polish regulations categorising related entities lack a precise definition that would allow us to understand what "the actual ability of a natural person to influence key economic decisions" is. But it seems that the legislator is not only concerned with persons who have formal and legal authorisation to represent the company or persons sitting in control bodies (this situation is also defined in a separate provision discussed above).

This position is confirmed, for example, by the individual interpretation of 20 September 2022, reference number 0111-KDIB1-1.4010.445.2022.3.AND, which states that "actual ability means the ability to influence key economic decisions both by exercising formal functions in the Supervisory Board (e.g. by being an actual member of the Supervisory Board), as well as the real possibility of such influence without formal authorisation”. This understanding of this provision was also indicated in the justification for the regulations being introduced in this area, where the legislator's aim was to enable tax authorities to verify the arm’s length nature of such transactions, which resulted from decisions made by persons without formal authorization in decision-making or control bodies.

Therefore, it can be considered that, for example, a managing director who makes key economic decisions related to, for example, negotiating commercial terms with main contractors, or who decides on the investment directions of the entity, meets this definition. However, taking into account the imprecise nature of this provision (as well as the possibility of various situations occurring in business transactions), each case should be assessed individually.

Family connections

We talk about family connections if there is a marital relationship, consanguinity or affinity up to the second degree between the persons managing the entities. 

So, if, for example, the husband is the owner of company 'A' and the wife is the owner of company 'B', then entities 'A' and 'B' are related entities under the transfer pricing regulations. This means that transactions carried out between these two entities should be consistent with the arm's length principle. 

When determining the group of related entities, it is worth being really precise and using the help of an expert

Transfer pricing regulations broadly define related entities. In addition to obvious situations (such as, for example, one entity owning 100% of the shares in another entity), there may be much more complex and complicated cases that require in-depth analysis and verification. 

Errors or omissions related to lack of due diligence when verifying existing connections between entities may result in incorrect identification of transactions that require preparation of transfer pricing documentation and reporting on the TPR form, and the consequences of such errors may be very serious. Entrusting this task to professionals who deal with transfer pricing on a daily basis will help you avoid this risk.