Transfer Pricing under Increased Scrutiny: Interest Expenses Enter Profitability Analysis in Tax Audits

Is an operating profitability test sufficient to verify the arm’s length nature of transfer prices for a contract manufacturer that receives financing from a related party? This question was addressed by the Regional Court in Pilsen in its judgment of 9 February 2026.

Background of the Dispute

The claimant, a contract manufacturer within a German group, obtained a non-purpose loan from its parent company in the amount of CZK 138.6 million, bearing interest at 4.45% p.a., to finance its day-to-day operations. In 2016, the company reported a positive operating result; however, due to interest expenses, it ended the year with an overall loss.

In the transfer pricing analysis performed using the Transactional Net Margin Method (TNMM), a dispute arose regarding the appropriate profitability indicator. The claimant relied on an operating profit margin excluding financing costs (EBIT), whereas the tax authorities considered profit before tax (EBT) to be the relevant profit indicator. The claimant argued that interest constitutes a financial expense from an accounting perspective and that the OECD Guidelines require only operating items to be taken into account. In contrast, the tax authorities emphasised that the loan had in fact financed the company’s operating activities and that an independent enterprise would have reflected the interest costs in its pricing.

Court Decision

The Regional Court sided with the tax authorities. It held that while the OECD Guidelines generally recommend considering only operating items, they expressly allow non-operating items to be taken into account were warranted by the circumstances of a particular case. The Court found that such circumstances existed in the claimant’s case because:

• The loan was used to finance ordinary business operations rather than investments;
• The interest expenses had a significant impact on the company’s overall financial result;
• The claimant did not incorporate the interest expenses into its transfer prices, despite being aware of them in advance; and
• An independent enterprise would have included such costs in its pricing in order to avoid creating conditions leading to its own loss.

The Court further emphasised that the behaviour of an independent enterprise is not determined by the accounting classification of costs, but rather by economic considerations aimed at generating profit. It is difficult to imagine that an independent enterprise would set its prices solely on the basis of operating costs while disregarding financing costs.

Practical Implications

Where intercompany financing is used to fund operating activities, the tax authorities may use EBT instead of EBIT when testing overall (or transactional) profitability and may require transfer prices to cover interest expenses as well. This is particularly relevant for companies performing limited functions and assuming limited risks. Czech tax authorities place emphasis on the economic substance of transactions rather than on the accounting classification of costs.

More than in many other areas, transactions of this type require an individual assessment of the specific facts and circumstances of each case. If you have questions regarding the setting of transfer prices or the selection of an appropriate profitability indicator, please do not hesitate to contact us.