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New wave of tax audits could be triggered by specific P&L reporting of intra-group expenses with management, consultancy services and royalties in Romania
article published on 14 November 2024
In an increasingly complex and strictly regulated tax environment, even the management of intra-group transactions is becoming more important, especially for multinational companies.
With the introduction of new regulations, such as the separate itemization of expenses for management and consultancy services and respectively for royalties in the profit and loss account under MFP Order 2649/2023, the Romanian Tax Authorities aim to increase transparency and most likely improve the tax risk analysis on the basis of which companies are selected for tax audits.
Moreover, at the moment, the Chamber of Deputies is currently debating a draft law (i.e. no. 820/2023) proposing to tighten the conditions for the deductibility of expenses for management and consulting services purchased from non-residents classified as artificial transactions, with the imposition of significant penalties – non-deductibility of the full amount of the expenses and fines equal to twice the amount of the deductible expenses for such expenses.
At the same time, recent years have also shown a significant share of litigious cases at the level of the Courts of Appeal and the High Court regarding the deductibility of expenses for management and consulting services, highlighting in many cases the subjectivity and aggressiveness of the tax authority in investigating these transactions.
All these measures and trends demonstrate what may even be considered an “exaggerated” interest from the Romanian Tax Authorities.
In the following, we try to analyze the context and impact on multinational companies. We will also explore the risks and challenges that the new legislative changes pose for taxpayers and how companies can prepare themselves for potential tax audits.
Introduction of separate reporting lines for expenses with intra-group management, consultancy services and royalties
By the Order of the Ministry of Public Finance 2649/2023, the Romanian Tax Authorities introduced the obligation to report separately the expenses related to management services, consultancy services and royalties in the Profit and Loss Account (form F20), with the individualization of the values derived from intra-group transactions (screenshot included below):
This measure aims to bring more transparency to expenses considered to be at risk and to facilitate the monitoring of these flows by the Romanian Tax Authorities. The main goal is of course to increase the visibility of expenses that may raise questions of deductibility and transfer pricing risks.
One immediate effect of these changes is that intercompany transactions become much easier for Romanian Tax Authorities to identify and analyze without even having to visit companies at their premises.
In addition, considering also the availability of SAF-T reporting information for large and medium taxpayers as part of risk analysis, the Romanian Tax Authorities can access details at supporting document/invoice level and thus could request specific explanations.
As a result, those companies that reported management and consulting services expenses on the newly introduced lines in the Profit and Loss Statement form filed for FY 2023 can expect questions or even a tax audit with a specific topic of analyzing intercompany services. In our practical experience, if intercompany consultancy and / or management services expenses exceed 2.00% of turnover, the likelihood of receiving questions or having a tax audit in the following period increases exponentially.
Moreover, we also expect those with royalties exceeding 8.00% of the turnover may likely be targeted by the Romanian Tax Authorities for a corporate income tax audit.
Differences between management, consultancy and support services
Unfortunately, accounting legislation in Romania does not provide specific definitions for management, consultancy and support expenses, leaving companies to rely on general financial reporting principles. This lack of clarity can lead to confusion in the correct classification of these expenses and the risk of disclosure errors, especially in the context of new regulations requiring separate reporting of these services.
In addition, there is often the problem of compliance with the principle that the economic substance of a transaction must take precedence over its legal form, which further complicates the application of correct accounting treatment.
Thus, we now try to present the main characteristics of the three distinct categories:
Management services are those activities that involve coordination, supervision and strategic decisions at the beneficiary level. These include, for example, long-term planning, financial control and general supervision of a company’s operations. In practice, these services are more closely scrutinized by Romanian Tax Authorities.
In contrast, consultancy services refer to external expertise provided in various areas of strategic interest to the company, such as operational, sales, technical or business strategy, without directly involving the coordination of company activities. They are easier to document, but the need for them for the local business must be clearly justified.
Finally, support services are related to core operational activities and include assistance in areas such as IT, accounting, marketing or human resources. They are necessary for the day-to-day running of a company and can be considered to bring less added value than consultancy or management as they are not related to the functions that directly generate added value for companies.
Confusion often arises when support services are wrongly labeled as ‘management’ and reported as such even in intercompany service contracts, thus attracting the attention of Romanian Tax Authorities.
Therefore, it goes without saying that from now on, companies must be careful how they classify these services in order to avoid the risk of a tax audit arising for this reason and for no reason.
Tax risk analysis – will it be enhanced by inclusion of a separate criteria of weight of intra-group expenses with management and consultancy services in total turnover?
The separate classification and reporting of management and consultancy expenses in the statutory accounts will most likely have consequences for the way Romanian Tax Authorities shape the risk profile of taxpayers and it would not be a surprise if this element is already added in the tax risk analysis that Romanian Tax Authorities do in order to select those taxpayers to initiate a tax audit.
Thus, if a local company, part of a multinational group, declares high values for these services in terms of turnover, the Romanian Tax Authorities may suspect an attempt to reduce the tax base in Romania.
This carries with it a risk of triggering a tax audit, which once triggered for such a reason, can push tax audit teams towards an aggressive approach. The result of such a potential highly aggressive audit is the denial of the deductibility of expenses, usually leaving taxpayers to defend their position in court.
As mentioned above, in our practical experience, if intercompany advisory and management services expenses exceed 2.00% of turnover, the likelihood of a company being highlighted in the tax risk analysis can increase significantly.
In this context, companies need to implement rigorous control over these costs to ensure transparency and justification of services. Without such oversight, the risk of a tax dispute is higher than ever, and taxpayers may have to wait years for a resolution of the contentious case.
Steps to consider for ensuring deductibility of expenses
The tax audits on intercompany consultancy and management services focus mainly on two fundamental aspects:
- the fulfillment of the conditions for deductibility of expenses under Romanian law; and
- the justification that the transfer price paid for these services reflects the market value.
To ensure compliance with the first condition, it is crucial to also integrate the principles set out in the OECD Guidelines, which provide an essential analytical framework for the assessment of intercompany services. It emphasizes the importance of four key tests for assessing intercompany services:
- the actual provision of the services;
- the existence of real benefits as a result of the provision of these services;
- avoid duplication of services with identical locally procured services/in-house resources;
- the identification and elimination from the cost base of services of costs incurred in the interest of the shareholders.
These tests provide an assessment framework that allows companies to clearly determine whether the services received are beneficial and necessary for their activities and complement the legal requirements in Romania to ensure deductibility.
Supporting documents play a key role in this equation, as the Romanian tax legislation does not set out an exhaustive list of admissible evidence to prove the actual provision of services.
Each company should have a varied set of documents, such as acceptance reports, work reports or feasibility studies, to prove the necessity and actual nature of these expenses.
Even though there may be concerns at group level about the costs and resources associated with keeping such appropriate documentation up to date, which can be burdensome, it is now recommended that such documentation should nevertheless be proactively developed for at least 1-2 months every 5 years to set a formal framework that can be detailed in a tax audit context.
In addition, it is essential that the group’s central management is informed of the potential risks that may arise from missing or non-compliant documentation in order to be able to take the necessary action in a timely manner.
Impact of the legislative proposal on the non-deductibility of intercompany management expenses
Looking into the future, we should also mention the legislative initiative on the deductibility of intercompany management expenses incurred by non-residents (i.e. Draft Law No. 820/2023 for the amendment of Article 25 paragraph (4) letter f) of Law No. 227/2015 on the Tax Code).
The current form of the proposed law:
“The following expenses are not deductible:
- f) expenses for management, consultancy, assistance or other services rendered by an affiliated person non-resident in Romania. The deduction of expenses of this nature, on the basis of transactions qualified as artificial according to Art. 11 para. 3, constitutes a contravention and is punishable by a fine equal to 200% of the amount of the deducted expense.”.
may lead to aggressive interpretations by Romanian Tax Authorities and seems likely to explicitly discourage the conduct of these types of transactions, which are often essential to the smooth running of local operations of subsidiaries of multinational groups.
Although adopted by the Senate, this initiative is currently being debated in the Chamber of Deputies, which is the decision-making chamber. Of course, it should be noted that in order to become law, the proposal has to go through the entire legislative process: adoption in the Parliament, promulgation by the President and publication in the Official Gazette.
However, if the law comes into force, many companies that spend considerable amounts on management and advisory services with group entities will have to review the structure of their transactions.
Under the threat of abusive interpretations and significant penalties, the impact on profitability and the tax base may prove substantial, particularly for companies that frequently use these services as part of their group structures.
From a strategic point of view, it could be a winning bet to localize a higher volume of services by employing local staff in the Romanian entity or subcontracting third parties to perform such services.
Thus, these potential limitations on the deductibility of expenses for intercompany management services may bring about a profound review of tax strategies and the way of operating in relation to the Romanian subsidiaries of multinational groups.
Final remarks
The introduction of separate lines for management and consultancy expenses in the Profit and Loss Account is a significant step in the Romanian Tax Authorities’ strategy to monitor intercompany transactions and identify areas of high tax risk.
In this context, it becomes essential for companies to pay particular attention to the correct classification of these expenses in the financial statements. A clear and well-defined structure not only helps regulatory compliance, but also reduces the likelihood of possible consequences.
Taking into account also the “aggressiveness” of the Romanian Tax Authorities in general with regard to expenses with management services, manifested on the one hand by the numerous disputes that have come to court and in which the management services are at stake, and on the other hand the legislator’s intention to issue normative acts eliminating the possibility to deduct such expenses, the need for a detailed analysis of the way these expenses are categorized becomes even more pressing.
It also remains as important as ever for firms to regularly review intercompany transactions and proactively ensure that supporting documentation is complete and robust at least at the level of 1-2 months out of a 5-year period.
Remember however that the transfer pricing documentation scope is only to defend the mark-up. The documentation to defend the cost base is the “Benefit Test”.
ATIPIC Solutions is a 100% transfer pricing dedicated and specialized transfer pricing firm with a culture centered around effectiveness of building reliable transfer pricing documentations though automations and innovation. We work with companies that have as their ERP of choice SAP, Oracle, Microsoft or Scala and we are recognized in the World TP / International Tax Review Rankings.
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