Transfer Pricing and Its Tax Effects

December 12, 2023

Transfer Pricing has become more important for Tax Administrations due to the dynamics of the markets, generating important commercial relationships among companies from different jurisdictions. Given that the legislation of each country determines the tax obligations of its taxpayers, as well as the incentives for investments, depending on its economic environment; the differences in the established conditions may generate undue tax benefits, affecting the tax collection of the countries involved. Therefore, the Organization for Economic Cooperation and Development (OECD), an international economic organization, provides tools to protect tax collection through the 15 actions proposed in the BEPS (Base Erosion and Profit Shifting) project.

According to the aforementioned, actions 8, 9, 10, and 13 of the BEPS project propose guidelines to prevent mispricing among companies from different jurisdiction with a certain degree of economic relationship (related parties) to the detriment of the tax authorities. For example, in an international transaction between related companies, the parties may misprice, inflating the cost in the country with a high tax rate, thus reducing the overall tax burden. Due to this scenario, the domestic legislation of each country establishes adjustments to the taxable base of those transactions that are not at market value, resulting in higher taxes for the taxpayer.

The concern of the Tax Administrations to combat the BEPS effects has led the countries of the region to incorporate in their domestic legislation the OECD Transfer Pricing Guidelines, which Paraguay and Brazil were the last ones to align themselves with this standard. It should be noted that each country will establish the mandatory conditions for its taxpayers to be subject to the Transfer Pricing regime to consider transactions with non-domiciled and local companies (in regimes with a lower tax rate within the country) and/or companies located in tax havens. Thus, each jurisdiction establishes fines or penalties for errors, omissions, and/or non-compliance with Transfer Pricing obligations, which may significantly affect the economic situation of a company.

On the other hand, tax planning schemes represent a potential risk for Tax Administrations. Although multinational groups should consider the Transfer Pricing legislation in their tax planning, not only focused on ensuring compliance with the Arm’s Length Principle but also as part of the business expansion strategy, these schemes may allow tax fraud scenarios. Therefore, there is an important international cooperation between governments and international organizations to fight tax fraud, including our country. Likewise, it should be noted that some Tax Administrations have identified high-risk schemes in their tax audit processes, providing an informative catalog for their taxpayers. Due to new situations that require the creation of mechanisms in international tax law, these will have to establish a balance between measures to protect tax collection and incentives for taxpayers in their international transactions.

As measures to mitigate the tax effects, some Tax Administrations allow making advance agreements, which establish the criteria for pricing transactions within the Transfer Pricing scope, providing certainty to the companies on the tax position of their transactions.

Likewise, due to the proximity of the closing of the fiscal year 2023, risks should be mitigated through a preliminary Transfer Pricing analysis, which will allow us to evaluate the main characteristics of transactions, making it possible to regularize the supporting documentation, such as the execution of contracts. Likewise, a prior analysis will allow for the evaluation of the functions, risks, and assets used in the transactions, which is essential to select the evaluation method according to the documentation and information available. In addition, the results of the Transfer Pricing analysis will be available before the fiscal closing, allowing it to adjust voluntarily with the least impact on the business, contributing to the financial and operational stability, which would not be possible if the Tax Administration had adjusted it.

Finally, the tax Transfer Pricing effects must be considered in the tax planning of local and multinational groups due to the penalties arising from the lack of supporting documentation or non-compliance with the established guidelines, which may affect the operability of the business and its growth.