Transfer Pricing and Controlled Transactions in Connection with Earnings Management and Tax Avoidance

Abstract

Research background: The way of pricing intra-group transactions (controlled transactions in the terms of transfer pricing) should be in line with the arm´s length principle, whether we consider nationally or transnationally related business entities. If this is not the case, these operations are a tool for earnings management between the companies. It is known that income tax is perceived by businesses as an unproductive withdrawal of own funds without obvious consideration, and therefore managing economic transactions at the level of related-party entities in order to minimize the tax liability is obvious and even expected. Purpose of the article: The aim of the paper is to find out if controlled transactions are used in connection with earnings management and tax avoidance in the selected Slovak company using proxies, which may carry this detection capability (ratios of related party transactions, book-tax differences ratio, and discretionary accruals ratio). Methods: The analytical part of the paper follows the Slovak transfer pricing legislation in force. Following the existing research studies, we test hypothetical relationship between the indicators of earnings management, related party transactions and tax avoidance by applying correlation analysis. We worked mainly with publicly available data from financial statements and notes to financial statements. Findings & Value added: The results indicate that the company managed earnings rather downwards, since the values of discretionary accruals ratio were negative. On the other side, it was not proven that earnings management was carried out purely with the intention of minimizing tax liability.