How to ensure compliance with the arm’s length principle in loans between related companies
In the Peruvian context, financial transactions between related companies, such as intra-group loans, must comply with the arm’s length principle established by SUNAT and the OECD Guidelines. This means that the terms of these transactions must be comparable to those that would be agreed between independent parties in similar circumstances.
Importance of Intra-Group Legal Agreements
The first step in any transfer pricing analysis is to review the legal agreements governing transactions between related companies. It is essential that these agreements accurately reflect the agreed conditions and that the conduct of the parties is consistent with the provisions. Discrepancies between what was agreed and what was executed may lead to questions from SUNAT and possible tax adjustments.
Determination of Borrowing Capacity at Market Value
It is crucial to assess whether the amount of the intra-group loan is in line with what an independent entity would be willing to lend or receive. This involves analyzing the borrower’s borrowing capacity, considering factors such as its capital structure, financial ratios, and market comparables. Excessive indebtedness may result in the loan being recharacterized as a capital contribution and the interest becoming non-deductible.
Establishing Market Value Interest Rates
The interest rate applied should reflect market conditions and consider the borrower’s risk profile, the characteristics of the underlying asset, and the economic environment. For example, properties with stable income and located in prime areas may justify lower interest rates compared to development projects with higher risks.
Transfer Pricing Documentation
Proper documentation is essential to support the application of the arm’s length principle. It should include detailed information on the transaction, a functional analysis of the parties involved, a comparability study, and the methodology used to determine the interest rate. Poor documentation may result in tax adjustments and penalties by SUNAT.
Conclusion
Compliance with the arm’s length principle in intra-group loans is essential to avoid tax risks and ensure the deductibility of interest. Proper planning, supported by solid documentation and market analysis, is key to complying with Peruvian regulations and international guidelines.
For more information and specialized advice on transfer pricing, please contact TPC Group.
Source: DLA Piper