Transfer Pricing Rules in the Republic of Tajikistan: Impact on Financial Transactions and the Financial Sector

The new Tax Code of the Republic of Tajikistan (hereinafter, the TCRT), which includes transfer pricing provisions (hereinafter, the TP Rules), entered into legal force on 1 January 2022.

The provisions of TCRT Chapter 33 “Transfer Pricing” entered into legal force on 1 January 2023, requiring multinational enterprises and tax administrations to observe the principle of concluding agreements on an arm’s-length basis in accordance with international TP standards. A survey of the general provisions of the TP Rules is presented in B1’s publication A Review of the Transfer Pricing Rules (TP Rules) in the Republic of Tajikistan.

This alert includes a survey of how the TP Rules are being applied in the tax control of financial transactions and companies in the financial sector.

Please note that our comments are based exclusively on our interpretation of the TP Rules, public sources and information available to us after the TP Rules entered into legal force as well as our experience and knowledge of international TP principles.

Financial transactions and financial sector companies

Pursuant to Article 225 of the TCRT, a transfer pricing agreement is one that includes “a transaction or series of transactions whose objective is to provide or acquire property or services, carry out deals with intangible or tangible assets or issue loans.” It can be concluded on the basis of this article that the TP Rules apply to various types of transactions for the provision of financial services as well as transactions with loans that may be conducted by both non-financial and financial sector companies, so that taxpayers must comply with the TP Rules.

Note that, under part 11 of Article 21 “Arm’s-Length Prices” of the TCRT, the provisions of Article 21 and Chapter 33 of the TCRT do not apply to the operations of credit financial institutions, including loans they obtain.

Article 2 of the TCRT defines a credit financial institution and credit institution as follows:

• A credit financial institution is a credit institution or Islamic credit institution conducting operations stipulated in the law of the Republic of Tajikistan on the basis of a license of the National Bank of Tajikistan (NBT).
• Credit institutions are legal entities (banks and non-banking credit institutions, including microfinance institutions) conducting, on the basis of an NBT license, all or some banking operations.

Currently, publicly available information sources do not contain explanations and positions of the Tadjik tax authorities as to whether exception of the TP Rules (stipulated in part 11 of Article 21 of the TCRT) apply to all types of intra-group transactions or only to banking transactions conducted on the basis of an NBT license.

At the same time, in considering the TP Rules, one should note the category of transactions consisting of financial services rendered by the afore-mentioned institutions, as defined in Article 2 of the TCRT:

• Financial services (for purposes of value-added tax) are services of a credit institution, Islamic credit institution or other organizations in the list approved by the NBT in coordination with the Ministry of Finance of the Republic of Tajikistan and the authorized government agency.

It follows from this definition that financial services may be rendered not only by credit financial institutions and credit institutions but also by other organizations in the list approved by the NBT. However, the provisions of part 11 of Article 21 of the TCRT in the version available on the date of this alert do not include exemptions from the TP Rules for any organizations except credit financial institutions, e.g., insurance companies, investment funds, trustees, brokers and dealers as well as professional securities market traders. Consequently, under a formal interpretation of part 11 of Article 21 of the TCRT, it may be concluded that financial services rendered by organizations other than credit financial institutions and credit institutions may be subject to the TP Rules.

Therefore, Tajik tax authorities may, pursuant to Article 41, part 3, clause 6 of the TCRT, carry out various forms of tax control, including TP, with respect to such financial institutions.

A more detailed review by types of financial transactions and financial market sub-sectors follows.

Loans, borrowings, guarantees and cash pooling

The TCRT does not establish a methodology for verifying the arm’s-length level of the prices of loans, borrowings, guarantees, cash pooling and other financial transactions (financial lease: leasing, factoring and forfeiting) for tax purposes.

We also note that, pursuant to Article 230 of the TCRT, if a loan issued or guaranteed by one party exceeds 50% of the book value of the other party’s total assets, the parties are deemed related parties for tax purposes, and, consequently, if other requirements of part 1 of Article 225 of the TCRT are met, transactions between these parties must comply with the TP Rules.

Therefore, it may be assumed that, for purposes of verifying the arm’s-length level of prices in these transactions, the Comparable Uncontrolled Price method (hereinafter, CUP[1]) will be most appropriate, corresponding to international practice in the TP sphere.[2] At the same time, it does not contradict the arm’s-length principle stipulated in the TCRT, which applies in accordance with international TP standards.[3]

When performing benchmarking studies of arm’s length of prices established in such transactions and identifying comparable transactions, taxpayers should be guided by the general principles for concluding arm’s-length agreements stipulated in Article 226 of the TCRT.

In verifying the arm’s-length nature of agreements in accordance with international practice, one of the key parameters impacting the interest rate or remuneration of the parties to a financial transaction will be the credit rating, which, in its turn, reflects the credit history and solvency of borrowers and principals of bank guarantees.

Various tools and methods may be used for purposes of establishing credit ratings, e.g.:

• Information about the credit rating assigned to a borrower by rating agencies (e.g., S&P, Moody’s, Fitch, Expert RA, ACRA and other)
• Methodologies of international rating agencies
• Analytic tools in the databases of information and price agencies or on the platforms of international rating agencies, e.g., PVTCO Calculator, developed by Refinitiv Eikon for calculating a company’s credit rating on the basis of its financial indicators; Moody’s RiskCalc by Moody’s Analytics, which provides for assessing a borrower’s indicative stand-alone credit rating on the basis of its financial indicators, industry and country; S&P technological solutions on the S&P CAPITAL IQ platform (e.g., CreditPro, CreditModel and PD Model), providing for the assessment of a borrower’s credit rating using quantitative methods of solvency assessment
• In-house methodologies of multinational groups of companies for the assessment of credit ratings

In order to obtain information essential for identifying comparable transactions and determining the arm’s-length ranges of interest rates and fees, taxpayers may use the databases of international information and price agencies, such as Refinitiv Eikon and Bloomberg, as well as regional databases, such as Cbonds.

When verifying the arm’s-length level of transfer prices in financial transactions, taxpayers must take into account the provisions of articles 194 and 224 of the TCRT—in particular, those regulating the deduction of interest expenditures:

• A taxpayer may deduct actually paid interest for every loan in the period under review, but no more than triple the amount of interest accrued (subject to accrual) using the NBT refinance rate effective in the tax period.[4] This restriction applies to interest payments under financial lease agreements, among other things.
• The maximum amount of interest expenditures is also assessed in compliance with thin capitalization rules, under which, if the ratio of average credit to average authorized capital exceeds two, the permitted interest deduction in the period is restricted.[5]

Based on the above, one can set out the following procedure of analyzing interest rates for purposes of transfer prices in financial transactions:

1. Determination of the arm’s-length ranges of interest rates on the basis of a TP method
2. Comparison of the results of a benchmarking study with the TCRT’s requirements concerning the adjustment of interest expenditures with respect to:

• restriction in terms of the refinance rate
• compliance with thin capitalization rules

Under the TCRT, taxpayers must also draft documents confirming the arm’s-length nature of transactions carried out by a taxpayer under a transfer pricing agreement. The documentation should include the basis for using a TP method(s).

The tax authority, in coordination with the authorized government agency in the financial sphere, may establish requirements for simplified TP documentation for the following taxpayers and certain types of transactions:[6]

• Distributors
• Taxpayers with a low volume of transborder operations
• Medium-size business entities
• Intragroup services
• Provision of loans
• Technical services

At the same time, under part 6 of Article 229 of the TCRT, simplified rules of TP documentation do not apply to royalty, licensing fees, R&D agreements and other intangible assets..

Transactions with securities, derivative instruments[7] and foreign exchange transactions

As far as we understand, neither the TCRT, nor the Instruction on the Taxation of Actors on the Securities Market[8] includes special provisions determining the methodology for verifying the arm’s-length nature of agreements for transactions with securities, derivative instruments and other types of foreign exchange transactions (e.g., TOD, TOM, Spot and FX Swap). Therefore, for such transactions, taxpayers are entitled to apply the arm’s-length principle in accordance with international TP practice:

1. Using the standard calculation models developed by the international information and pricing agencies Refinitiv Eikon or Bloomberg
2. On the basis of prices for the security on the securities market, e.g., the composite bid price of an over-the-counter security (Refinitiv Eikon Composite bid) or the average closing price (Bloomberg generic mid/last)
3. With the help of formulas for calculating the estimated price of securities, e.g., bonds or bills of exchange
4. As the estimated price of securities calculated by an independent appraiser
5. General TP methods, e.g., CUP

In order to verify the arm’s-length level of prices used in specific types of FX transactions, one may use public data of foreign currency exchanges or, if the latter is unavailable, the quotations of OTC market participants available in databases. Such data may, for example, be information on the exchange rates used for transactions with different pairs of currencies: TOD, TOM and Spot or FX swaps.

Banking sector

Banking sector participants typically carry out the aforementioned types of transactions as well as such operations as:

1. Interbank loans and deposits, REPO, Islamic REPO and transactions conducted in accordance with the principles and standards of Islamic financing
2. Various types of services (middle- and back-office services, HR, marketing, IT support, consulting, etc.)
3. Transactions with intangible assets (transactions for the supply of software licenses, trademarks, etc.)

As stated above, pursuant to part 11 of Article 21 of the TCRT, the provisions of Article 21 and Chapter 33 of the TCRT (the TP rules) do not apply to the operations of credit financial institutions.

However, as stated above, it can be asserted, on the basis of publicly available information, that the TP Rules do not apply to the operations of credit financial institutions—in particular, intra-group banking transactions -carried out by such institutions on the basis of an NBT license.

Consequently, intra-group transactions executed not on the basis of an NBT license and do not directly come under the category of banking operations of credit financial institutions may potentially be subject to the TP, e.g., various types of intra-group services and transactions with intangible assets.

Professional traders (financial market participants)

Based on the provisions of the TP Rules, it can be concluded that transactions conducted by professional market traders,[9] e.g., stock-exchange traders, are not exempted from the TP Rules.[10]

Therefore, when conducting controlled transactions, e.g., brokers/dealers’ transactions, as well as providing various types of intra-group services, companies in this segment of the financial market must comply the TP Rules.

In international TP practice, for purposes of verifying the arm’s-length prices applied in intra-group transactions of professional traders (market participants), various TP methods may be used, depending on the actual circumstances of a particular transaction as well as the distribution of functions, risks and assets between the parties of the transaction. As a rule, the key and most common methods are the Comparable Profits Method (CPM) and the Profit Split Method.

Insurance market

The TP Rules do not include any special provisions on controlled insurance or reinsurance transactions. Therefore, standard TP methods or a combination of them may be used in analyzing such transactions.

In particular, the general provisions of the TP Rules, e.g., the use of the CUP method as well as the CPM method, may be applied to insurance and reinsurance transactions. For example, in order to assess the arm’s length nature of the overriding commissions paid by the reinsurer to the ceding operation, one may assess the return on costs and compare it with the arm’s-length range of return on costs of companies performing comparable functions to those of ceding operation.

Consequently, when conducting controlled transactions, e.g., insurance/reinsurance, as well as rendering various intra-group services, companies in this segment of the financial sector must comply with the TP Rules.

Investment funds

Controlled transactions conducted by investment funds are not exempt from the TP Rules.

In practice, the main intrag-roup transactions of investment funds are, as a rule, conducted in two key directions:

• Provision of investment consulting services. The CPM is the most common method of validating the arm’s-length level of remuneration in these transactions
• Asset management for which remuneration is paid in the form of a management fee and a performance fee. The CUP method may be used to validate the arm’s-length nature of fees.

Consequently, investment funds must comply with the TP Rules when conducting controlled transactions, e.g., the provision of investment consulting/asset management services.

Other intragroup services

Financial market participants may also undertake various types of transactions to render or acquire services (e.g., middle- and back-offices, HR, marketing, IT support services and licensing of intangible assets, etc.)

Article 2 of the TCRT includes the following definitions of services for tax purposes:

• Services are any activities for remuneration, for cash, as well as free of charge services that do not constitute the supply of goods or performance of work and include, among others:

- trading activities
- financial services and
- the lease of tangible and intangible assets.

When conducting such intra-group transactions, taxpayers operating on financial markets must also comply with the TP Rules.

As mentioned above, credit financial institutions may potentially not be exempted from the TP Rules in such transactions, since, as a rule, standard intra-group services, examples of which have been given above, are not categorized as banking transactions that require a NBT license.

An appropriate TP method as well as necessary actions to assess arm’s-length prices applied under such transactions must be determined on an individual basis.

Note that, under Article 229 of the TCRT, a tax authority in coordination with the authorized government agency in the financial sphere may establish requirements for simplified TP documentation for transactions including:

• Intra-group services
• Technical services

Permanent establishments (PE) of a nonresident (representative offices)

The TCRT also establishes criteria for setting up a PE of a non-resident (foreign company or non-resident individual) in the Republic of Tajikistan.

The operations of a non-resident, irrespective of whether it has been registered with the tax authorities or not, give rise to a PE. The PE of a nonresident is deemed a legal entity for tax purposes in the Republic of Tajikistan and must pay taxes to the budget as stipulated in the TCRT.

Pursuant to the TP Rules, transactions are deemed cross-border operations if they are conducted between two:

• Residents and involve entrepreneurial activities carried out via a PE outside Tajikistan by one or both residents and
• Non-residents, except where a transaction involves operations conducted via a PE in Tajikistan by both non-residents

Most often, services are provided to independent clients through branches and representative offices by international financial or insurance groups. At the same time, in accordance with the TCRT, the registered representative office or branch of a foreign company is deemed to be the PE of a nonresident.[11]

The PE of a foreign legal entity conducting operations in the Republic of Tajikistan, in addition to the profit tax is also subject to net profits tax at the tax rate of 15% for the tax period.[12]

How can B1 help?

The B1 team stands ready to provide support in working out the following issues related to the intragroup financial transactions and transactions of financial institutions:

• Analysis of ongoing transactions involving companies in the Republic of Tajikistan as well as diagnostics and assessment of TP risks
• Development of in-house regulations for the interaction of structural units in the process of implementing the methodology for determining the arm’s-length level of interest rates and remuneration, development of a methodology for determining the arm’s-length level of interest rates and remuneration as well as a methodology for determining credit ratings
• Development of a TP model involving companies from the Republic of Tajikistan and implementation procedures
• Compilation of TP documentation templates
• Performance of benchmarking studies with regards to the arm’s-length level of interest rates and remuneration in controlled transactions
• Provision of TP consultations and recommendations when new transactions are concluded involving companies from the Republic of Tajikistan
• Completion of surveys of arm’s-length prices in large groups of transactions with derivatives and forward contracts using the B1FinBench automated solution