In the practice of transfer pricing in Latin America, one of the main challenges is the limited availability of local comparable companies with publicly available financial information. Given this reality, OECD guidelines permit the use of comparables from foreign markets, such as the United States or Europe.
However, this approach requires rigorous analysis: differences in economic conditions between jurisdictions (including country risk) can significantly affect the comparability of transactions.
According to Chapter III of the OECD Guidelines, these differences must be evaluated as part of the comparability analysis, and adjustments will only be appropriate when they have a material impact on the results and can be quantified with reasonable reliability.
Why might a country risk adjustment be necessary?
The arm’s length principle requires that the terms of transactions between related parties reflect those that would have been agreed upon between independent parties under comparable circumstances.
In this context, an investor operating in emerging economies such as Peru, Colombia, or Chile faces risks (political, inflationary, exchange rate, and regulatory) distinct from those present in developed markets.
These differences can influence the expected profitability of operations. However, it is important to note that not all differences justify adjustments: the OECD emphasizes that these should be applied only when they improve comparability and can be technically substantiated.
In some cases, it may even be preferable to identify more suitable comparables rather than apply complex or unreliable adjustments.
Relevant economic factors in country risk analysis
For a comparability adjustment to be accepted by tax authorities, it must be based on objective criteria and consistent methodologies. Key factors include:
- Macroeconomic conditions: economic stability, inflation, and the country’s growth.
- Political and regulatory risk: regulatory changes or institutional uncertainty.
- Access to financing: cost of capital in the local market.
- Market development level: size, competition, and maturity of the sector.
- On a practical level, these factors are typically incorporated using tools such as:
- Yield spreads (EMBI): to estimate the sovereign risk premium.
- Cost of capital models (CAPM): which factor country risk into the expected rate of return.
However, the application of these methodologies must be consistent, transparent, and replicable.
The stance of tax authorities
Tax authorities have significantly increased the level of sophistication in their audit processes. In this context, it is increasingly common to question foreign comparables that do not adequately reflect local market conditions.
However, it is not only the absence of adjustments that is questioned: adjustments that lack technical justification or whose methodology is not sufficiently reliable or verifiable may also be rejected.
Therefore, a robust analysis must clearly document:
- the existence of relevant economic differences,
- the methodology used to quantify them, and
- the specific impact of the adjustment on the results.
A technically incorrect adjustment can be riskier than making no adjustment at all
Conclusion
The use of international comparables is an accepted practice in Transfer Pricing. However, their reliability depends on a rigorous comparability analysis.
The incorporation of country risk must be evaluated on a case-by-case basis, ensuring that any adjustment applied is material, technically sound, and reasonably quantifiable, in accordance with the OECD Guidelines.
In this way, not only is the economic reality of the transactions reflected more accurately, but the defense of the analysis is also strengthened in the face of potential tax audits.
Does your Transfer Pricing documentation adequately reflect country risk?
At TPC Group, we have specialists in economic and financial analysis who apply comparability adjustments in accordance with OECD standards, ensuring that your studies withstand tax audits and minimize tax contingencies.
Source: OECD CHAPTER 3