Tax authorities in Romania are monitoring your nearshoring activities! Transfer Pricing and the Profit of the Upstream Company are in focus

Functionally speaking, opening a Near-Shoring Centre is not rocket science. Still, if you do not comply with Romanian and European legal and tax demands, you may end up closed by authorities.

Today, I will only focus on the legal and taxes aspect that will insure proper operations in Romania.

I see more and more the Insourcing Strategy being embraced. Companies can keep inside, away from any replication risk, the idea, the knowledge, basically their future. They can work around, be agile, produce an MVP and build a roadmap from there. They use volume subcontracting after the launch, after the initiative is public.

If you are either Insourcing your R&D or expand your Delivery capabilities in Romania, you need to tackle two problems for the new Company; Transfer Pricing and subsequently the Profit of the Upstream Company.

In a further article, I will detail the way of work, with a focus on the processes and MO. I will also build and share a cost structure that you can use and populate with your own data.

Usually, there are two types of operations when you start a near-shoring business:

• Insourcing Strategic Development

• Expand your operations in Romania as a Software Development Company

 

The two approaches are having pretty much identical legal challenges, as we are speaking of sister companies (having similar ownership).

Actually, a situation that I see more and more is insourcing the R&D, as you realize that your company is bleeding huge amounts of knowledge to third-party software development and consulting companies. No matter how strong your non-disclosure clauses are, you are working with people, at the end of the day. If this person are involved in the future in a similar project for your competition, they will be naturally accelerated resources, as they’ve been there, done that, and know the way through. No NDA can stop that, there’s nothing illegal about being smart or experienced. On top of that, some small text clauses may allow your subcontractor/partner to use knowledge, people, or code in an area of the world that looks benign to you today.

Anyway, using the insourcing strategy, companies can keep inside, away from any replication risk, the idea, the knowledge, and basically their future. They can work around, be agile, produce an MVP, and build a roadmap from there. They use volume subcontracting after the launch after the initiative is public.

In finance and taxes wise, in both cases, we are encountering a Cost Plus recommended model that has two main challenges:

• Transfer Pricing
• Profit of the Upstream Company

Let’s assume that we are using Cost Based Pricing, the simplest pricing method in which a standard markup (profit margin) is added to the cost of services:

Cost Base Pricing is when a Company sets a price at a percentage above the cost it incurs to manufacture the products or to provide the service. It can be also called Cost-plus pricing or Mark-up pricing.

 

Transfer Pricing Compliance is used to describe aspects of intercompany pricing arrangements between related business entities and, in our case, applies to intangible services and finance transfers.

To approach TP with zero risks and maximum transparency, you can choose to use the Cost-Based Transfer Price method. In this model, the problem is the amount of markup to allow the upstream division to earn a profit on the transferred product or service.

Don’t forget, if you are buying from your own company at prices that are way over your home market, you risk being associated with money laundering!

According to this methodology, all the direct and indirect costs have to be monitored, and reported and the company must earn a profit on the transferred product or service.

Selling underneath costs is ILLEGAL. Selling under the minimum Mark-up is money laundering. Selling way over the maximum Mark-ups is, again, money laundering.

 

Tax authorities in Romania are monitoring intragroup transactions, looking for a minimum acceptable markup. In the services sector, the mark-up should be between 12 and 15%. Software development is considered a hi-value added services industry, the average markup is 23%. Companies that offer low-added-value services can go down to 5%, this is absolutely not the case for IT Industry.

Always take into consideration that all the costs have to be allocated, to smooth the prices, you can consider a depreciation period for the initial investment that can go up to 36-60 months.

Keep this in mind: minimum 12% Mark-up on ALL the costs, maximum 40%(ish)!

 

Godspeed with your business in Romania!

What is the legal perspective?

Romanian Law. Local Law Guide

 

According to Art. 11 par. (4) of the Romanian Fiscal Code, point 5 (row 9): "When establishing the market price of services in transactions between affiliated persons, the tax authorities shall first examine whether the independent persons, with appropriate behavior, would have concluded such a transaction under the conditions established by the affiliated persons, taking into consideration the usual tariffs for each type of business or standard tariff in some areas such as transport, insurance. Where there are no comparable charges, the cost-plus method is used."

According to Art. 11 par. (4) of the Romanian Fiscal Code, point 5 (row 1/b): "The cost-plus method, is based on the increase of the principal costs with a profit margin corresponding to the taxpayer's field of activity.

The starting point for this method, in case of the transfer of products, goods, or services between affiliated persons is represented by the costs of the manufacturer or the service provider.

These costs are determined using the same calculation method as the person who makes the transfer also basing its pricing policy on independent persons. The amount added to this cost will consider a profit margin that is appropriate to the taxpayer's business.

In this case, the market price of the controlled transaction is the result of adding the profit to the cost.

If products, goods, or services are transferred through several affiliated persons, this method, the profit that increases will be applied separately for each stage, considering the role and the concrete activities of each affiliated person. The supplier's costs in a controlled transaction will be duly established by reference to the profit margin used by an independent supplier in comparable transactions."

Considering the above provisions, in situations where Romanian taxpayer records losses from providing services to affiliated persons, such situations often come within the scope of investigations conducted by the authorities to determine compliance with the market value principle in the generally expected context of the applicability of the cost-plus method for determining pay for services. 

The OECD Guidelines, to which the Romanian legislation refers, also recognize that "[...] affiliated companies, as well as independent companies, may experience real losses either because of high start-up costs, adverse economic conditions, inefficient or other legitimate commercial reasons. However, an independent company would not be prepared to bear losses for an indefinite period. An independent company recording recurring dangers will eventually end up doing business on these terms."