Corporate Loopholes: Billions Drained from Czech Republic Through Transfer Pricing

Corporations are drawing billions out of the Czech Republic, not merely from dividends, but via the cunning ruse of transfer pricing. Firms are set to transfer over 300 billion crowns abroad this year from dividends, a share of taxed profits. However, multinational corporations are siphoning off even more billions annually by selling goods or providing consultancy and licenses, often in IT, to their Czech companies at artificially inflated prices.

An attempt often drives this scheme at tax optimization, confirms the Financial Administration, which has spotted an increase in these illegal practices this year. “We are increasingly encountering the creation of purposeful structures and chains between related parties, typically in advertising and artificially increasing their prices. We are also dealing more frequently with complex cases with optimization schemes aimed at diverting profits from the Czech Republic through the transfer of intangible assets and subsequent licensing,” says Tomáš Weiss, a spokesperson for the Administration.

A classic example of misuse is transferring a trademark to a company linked by ownership abroad. The Czech company sells its trademark to a foreign-related party at a price significantly lower than its market value. The foreign company then concludes a licensing agreement with the Czech company to use this trademark, thus granting the Czech company the right to continue using it in the Czech Republic.

However, the Czech company pays fees significantly above the market price to its foreign sister for this. Furthermore, even after selling the trademark, it continues to ensure and finance its maintenance and appreciation, for example, through expenditure on marketing, even though the trademark is formally legally owned by a foreign company.

“We are witnessing a diversion of profits abroad, resulting from an undervalued purchase price for the sale of the trademark and an overvalued amount of subsequently paid licensing fees. The result is a decrease in corporate income tax collection,” summarizes Weiss. Profits are typically diverted to countries with low-income taxation from licensing fees, such as Cyprus.

While all transactions between related companies should take place at arm’s length, according to law, and under market conditions as between entities that are not capital or personally connected, those who violate this risk not only additional tax plus a penalty but in extreme cases even criminal prosecution for the company’s statutory bodies. The Financial Administration has controlled transfer prices for ten years. While it mainly examined large multinational corporations in the past, according to court expert Martin Koldinský, it is now increasingly focusing on medium and small businesses.