In the context of international taxation, transactions with jurisdictions considered tax havens—or countries with low or no taxation—are one of the main focuses of attention for tax authorities and corporate compliance teams. This is because such transactions carry a high risk of tax base erosion, manipulation of results, and transfers of profits to locations with artificial tax advantages.
Unlike many transactions between related parties in jurisdictions with comparable tax regimes, transactions with companies domiciled in tax havens often require a more rigorous analysis of transfer pricing, not only because of their international nature but also because of the potential misuse of structures to shift tax bases without any real economic activity to support it.
What is meant by “tax havens” in transfer pricing?
While the definition may vary depending on local legislation, in many countries tax legislation defines tax havens or low- or no-tax regimes as those countries or territories that meet one or more of the following criteria:
- Low or no effective taxation on global income,
- Lack of legal or administrative transparency,
- Limited or non-existent exchange of tax information,
- Absence of substantive real economic presence.
This definition aligns with the criteria that various tax administrations adopt to identify jurisdictions that require special treatment from a transfer pricing perspective. Given the possibility that companies may use these locations to artificially reduce their tax burdens, legislators and regulatory bodies have stepped up their monitoring of these transactions.
The arm’s length principle and its application in transactions with tax havens
International transfer pricing standards, such as those established by the Organization for Economic Cooperation and Development (OECD), require that transactions between related parties be valued in accordance with the arm’s length principle. According to the OECD Guidelines, such transactions must reflect the conditions that would have been agreed between independent companies in comparable circumstances, without the tax context unduly influencing the pricing.
This approach is particularly critical in transactions with tax havens, where the presence of extreme tax rates or the absence of taxes increases the risk of profit shifting to jurisdictions with lower tax burdens. Transfer pricing guidelines applicable to transactions between related companies with operations in tax havens require a careful assessment of comparability, functions performed, risks assumed, and assets used, in order to justify that the agreed prices are consistent with the market.
Documentation requirements and enhanced enforcement
Local transfer pricing rules, as in many jurisdictions in Latin America and other countries, require that all transactions with related parties or entities located in tax havens be documented and justified, regardless of their amount. This includes the obligation to file local and master documentation (Local File and Master File) supporting the pricing policy applied and demonstrating the arm’s length nature of the transactions.
Some regulations even require a specific information return when payments or transactions with entities in tax havens exceed certain thresholds, with the aim of increasing transparency and reducing the possibility of tax abuse.
In certain tax administrations, such as in Peru, the transfer pricing regulatory framework even expressly provides that transactions to, from, or through low- or no-tax jurisdictions fall within the scope of transfer pricing rules, which means that these cases must not only be documented but are also subject to review and adjustment by the authority.
Most frequent risks in transactions with tax havens
- Presumption of hidden affiliation: In many countries, if a transaction is carried out with an entity in a tax haven, the existence of an effective affiliation for tax purposes is presumed. This means that the authority can review the transaction even when there is no formal affiliation agreement.
- Transfer pricing adjustments: If prices or economic conditions do not align with what an independent company would determine—considering functions, risks, and assets—the tax administration may adjust the values to reflect arm’s length conditions, which may result in higher tax obligations, penalties, and surcharges.
- Requirement for comprehensive evidence: Authorities often require extensive documentary evidence to support the comparability and economic reasonableness of transactions. The absence of reliable comparative studies or detailed functional analysis significantly increases the likelihood of adjustments.
Tools and best practices for proper management
Comprehensive functional analysis: A study that clearly documents the functions, assets, and risks of each party allows you to demonstrate that market conditions were considered in setting prices.
Rigorous benchmarking: The selection of appropriate comparables and the application of OECD-recognized methods are essential to support pricing policy in transactions with parties in low-tax jurisdictions.
Comprehensive compliance documentation: Maintaining a well-structured Local File and Master File not only meets formal requirements but also constitutes a defense in potential audit proceedings.
Preventive risk assessment: Before establishing structures involving low- or no-tax jurisdictions, it is advisable to conduct a tax risk assessment that considers local regulations (including transfer pricing and international audit rules).
Integration between transfer pricing and tax transparency
Transactions with tax havens represent a critical area within the discipline of transfer pricing due to the high potential for manipulation of tax bases and the requirement by tax authorities to justify each transaction with solid evidence. Strict application of the arm’s length principle, in line with OECD international guidelines, and the submission of supporting documentation not only mitigate the risk of tax adjustments but also strengthen the compliance position in the event of any review.
In a global environment where international cooperation is increasing and tax transparency has become a priority for governments, multinational companies must incorporate robust transfer pricing policies into their tax governance that explicitly consider the risks associated with transactions with low- or no-tax jurisdictions.
Source: OECD