A letter from the SRS is not a formality

For most companies, contact with the State Revenue Service (SRS) does not begin with a tax audit. It often begins with something far simpler - a letter asking for documents and explanations relating to a particular period, payments or transactions.

At first, this can look like a formality: gather the documents, prepare a short explanation, and send the reply. In practice, however, it is the first response that often determines whether the rest of the communication with the SRS runs smoothly or becomes considerably more complicated.

The SRS does not ask questions without a reason

The SRS does not usually send these requests without a reason. Before it asks anything, the authority has typically already noticed something - in the tax returns, payment data, reports or other available information. Sometimes it is a specific doubt. Sometimes an inconsistency. Sometimes simply a situation the authority does not yet fully understand.

That is why a response to an SRS request is not merely an administrative task. The SRS will not read the explanation in isolation from the rest of the information available to it. It will compare the explanation against the returns, the contracts, the accounting records, the payment flows, earlier explanations, and the actual substance of the transaction.

Why this matters most in transfer pricing

Heightened care is needed where the request concerns transfer pricing or transactions between related companies. In such cases the tax authority often already has a working hypothesis - even if the request itself looks general.

The question may be phrased simply, but in substance it can serve as a test: does the company’s explanation match the data the SRS already holds?

By the time the company receives the letter, the SRS may have far more information than it first appears: data from previous years, financial statements, declarations, industry profitability indicators, benchmarking data and - in the case of larger groups - information received from the tax administrations of other countries.

Intra-group transactions are rarely assessed in isolation. They are read in a wider context - how the transaction fits within the group structure, what functions the parties actually perform, where decisions are taken, where the risks sit, and whether the allocation of profit corresponds to all of this.

If the company answers too generally, adopts the SRS’s view without assessment, or gives an explanation that does not match the contracts, the accounting or the transfer pricing documentation, the consequences can be very practical: an adjustment to the transaction price, additional taxable income, late-payment interest and penalties.

Where problems most often arise

In transfer pricing, problems are rarely caused by a single figure. More often, they arise from a mismatch between what has been written down and what actually happened.

For example:

  • the functional and risk profile described in the explanation does not match the intercompany agreements or the parties’ actual conduct;
  • a company is described as a low-risk distributor or contract manufacturer, but its results do not fit that role;
  • management or service charges are deducted without clear evidence that the services were actually received and provided a benefit;
  • royalty or financing flows do not correspond to where the functions, risks, assets and decision-making genuinely sit within the group;
  • the explanation describes how the group operates today, rather than the situation at the time of the transaction.

What the SRS will compare your answer against

Before sending a reply, it is worth remembering that the SRS can compare the company’s explanation against several layers of information:

  • the tax returns filed;
  • intercompany and external contracts;
  • accounting records;
  • payment flows and bank data;
  • transfer pricing documentation;
  • explanations given previously;
  • financial statements, publicly available information, industry data and comparable indicators.

This is often where the risk appears. Not within a single document, but in the inconsistency between documents.

What to consider before replying

Before sending a reply, it is worth asking yourself a few practical questions:

  • What exactly is the SRS asking - which tax, which period, and which transactions?
  • What might the SRS already have identified in the returns, payments or reports?
  • Does the explanation match the accounting records, the contracts and the actual substance of the transaction?
  • If the matter concerns intra-group transactions - does the explanation align with the transfer pricing documentation?
  • Do the figures and the description used reflect the situation at the time of the transaction?
  • Does the answer contain any assertion that could create additional risk later on?
  • Before sending the reply, is there a legal, tax or transfer pricing angle that should be assessed?

The biggest risk is inconsistency between different sources

In practice, the biggest problems rarely come from the data itself. They arise when the explanation does not match the contract, the accounting, the tax returns or the economic reality.

In intra-group transactions, one further important source comes into play - the transfer pricing documentation. If the SRS receives an explanation that does not square with the functional and risk profile described in the documentation, that alone can become a reason for further questions.

So, before sending it, it is worth reading the reply through the SRS’s eyes: if I had only this letter, the returns, the contracts and the accounting records in front of me, would the explanation be convincing? Does it answer the question? Does it raise new ones?

Answer precisely, completely - and no more than was asked

A good response to an SRS request is not the longest possible answer. It is a precise, complete and consistent answer to the specific question. Part of preparing it is assessing the boundaries of the request. If a particular question, or the documents requested, plainly do not relate to the transaction, period or tax matter the SRS is trying to clarify, it is legitimate to say so. Co-operating with the SRS does not mean an obligation to expand the scope of the review without justification, or to provide information that has no clear connection to the specific request. In such situations, the better course is to clarify the scope properly, rather than automatically handing over everything that is asked for.

It is equally important not to exceed the scope of the request. Volunteering unrequested information, speculative explanations or unnecessary documents rarely helps. More often, it widens the range of questions and provides grounds for further review.

In these situations, precision and consistency are worth more than volume.

The early stage is usually the most favourable for the company

It is often forgotten that the early stage is precisely the most favourable for the company. As long as a tax control or audit has not formally begun, the company usually has more room to explain the situation, clarify the facts and, where necessary and justified, correct inaccuracies in the ordinary way.

A considered response at this stage gives the company greater control over the process. Once an audit has begun, that control usually becomes considerably more limited.

A letter from the SRS should not be treated as a formality. It is often the first sign of how the tax authority views a particular transaction, payment or tax matter.

In transfer pricing cases this is especially important, because it is at this moment that the company’s explanation is first measured against the figures, the contracts and the documentation.

An intra-group transaction is not a problem in itself. But it must be explainable. And the explanation must match the documentation, the contracts, the accounting and the economic reality.

Where an SRS request touches transactions with related parties, it is usually worth involving a tax and transfer pricing adviser before the reply is sent - not once the matter has already grown into a review or an audit.