What is Transfer Pricing?
Transfer Pricing are prices agreed between companies belonging to the same corporate group and/or with companies domiciled in a preferential tax regime for the exchange of tangible or intangible goods and services and the provision of services, which must be set under the principle of free competition. These prices ensure that such controlled transactions reflect fair market conditions and comply with the transfer pricing rules in each jurisdiction.
What is Transfer Pricing and what is it for?
They consist of or serve to avoid price manipulation between related parties, establishing the allocation of value as if they were independent parties. This is crucial for the correct transfer of goods and services between related entities, ensuring that such transactions are subject to valuations that reflect the real market value. Transfer Pricing adjustments are made to align the prices of intercompany transactions with the market value and to avoid tax evasion in accordance with local regulations and international tax standards.
Objectives
The objective of a proper transfer pricing assessment is to ensure that related-party transactions are carried out in accordance with the arm’s length principle. This allows to facilitate the transfer of assets, among other types of transactions, and to prevent tax evasion or avoidance. In addition, prices agreed between controlled parties must consider the transfer of market value and comply with transfer pricing guidelines established by international bodies such as the OECD. This approach also ensures that transactions are subject to correct valuation in accordance with each country’s tax regime.
Features
The characteristics of the Transfer Pricing treatment have been implemented in various countries through local regulations. The OECD Transfer Pricing Guidelines have established common aspects for companies of the same corporate group or person and the transfer of profits between them through these prices, respecting the transfer pricing rules established locally.
Importance
Avoid tax base erosion and the artificial transfer of profits
Transfer Pricing ensures that multinational companies do not use intercompany transactions to shift profits to jurisdictions with a lower tax burden, which could erode the tax base of the countries where the profits are generated. This is crucial to ensure that multinational companies pay taxes fairly and contribute to the tax coffers of the countries in which they operate, while respecting each country’s tax regime. Lower tax rates in certain jurisdictions should not be misused to reduce the overall tax burden.
Prevent tax disputes and litigation
Correct Transfer Pricing reduces the risk of disputes and litigation between multinational companies and tax administrations. Having clear policies and proper transfer pricing documentation to support transfer pricing improves transparency and provides legal certainty to both companies and tax authorities, avoiding costly legal proceedings and protracted disputes. Complying with global and local tax regulations is crucial to prevent legal complications in such transactions.
Promote transparency and accountability
Transfer Pricing contributes to transparency in the way multinational companies report their transactions between related companies and with companies domiciled in a preferential tax regime. This enables assessment and monitoring by tax authorities and other regulatory bodies, and helps ensure that companies are properly accountable. Transactions, including those involving relevant intangible assets, must be transparent and properly accounted for.
Facilitate the exchange of information between jurisdictions
They require Transfer Pricing documentation and specific reporting, which encourages the exchange of information between tax administrations in different countries. This allows for greater cooperation and collaboration between jurisdictions to address issues related to profit allocation and aggressive tax planning. In this regard, Master File and Country by Country Report are fundamental to achieve this transparency.
Establish a framework for responsible tax planning
Transfer Pricing provides a framework for multinational companies to plan their taxes responsibly. By taking into account international standards and guidelines, companies can structure their operations in a manner consistent with arm’s length principles, avoiding questionable or abusive tax practices. Correct Transfer Pricing ensures that companies engaged in intra-group transactions maintain responsible tax behavior. In summary, Transfer Pricing (TP) is essential to ensure fairness and transparency in the taxation of multinational enterprises. By properly pricing transactions between related companies, it avoids tax base erosion, prevents tax disputes, and promotes accountability and international tax cooperation.
Benefits of Transfer Pricing
When properly applied, they offer several benefits and advantages for both multinational companies and tax authorities. Some of these benefits are:
Regulatory compliance
Transfer Pricing enables multinational companies to comply with the tax regulations and legal requirements of the different countries in which they operate. This helps to avoid penalties, fines and litigation related to tax evasion. In this sense, Transfer Pricing adjustments, proactively performed by taxpayers or applied by tax authorities, are essential to ensure regulatory compliance.
Equitable distribution of benefits
They ensure that the income and profits generated by the economic activities of a multinational enterprise are allocated fairly and appropriately among the different tax jurisdictions in which it operates. This helps to avoid tax base erosion and the artificial shifting of profits to jurisdictions with lower tax burdens.
Transparency and consistency
Transfer Pricing promotes transparency and consistency in the way multinational companies value transactions between related companies. This facilitates the understanding and evaluation of economic and tax operations by tax agencies and reduces the risk of disputes and litigation.
Certainty and legal certainty
Advance Transfer Pricing Agreements (APA’s) provide legal certainty and security to both multinational companies and international tax authorities. By establishing in advance the methods and terms for transfer pricing, the risks of transfer pricing disputes and litigation are reduced, which is essential for the tax administration of each country.
Administrative efficiency
Such pricing facilitates more efficient management of tax obligations related to transactions between related companies. By implementing appropriate policies and documentation, companies can simplify reporting and comply with documentation requirements established by tax authorities.
Prevention of double taxation
By establishing fair and equitable transaction prices between related companies, Transfer Pricing helps prevent international double taxation. This prevents the same transaction from being taxed twice in different tax jurisdictions. In summary, Transfer Pricing offers significant benefits in terms of regulatory compliance, equitable profit sharing, transparency, certainty, administrative efficiency and avoidance of double taxation. By ensuring that a correct assessment of intragroup transactions properly reflects the economic market value of such transactions, they contribute to a fairer and more balanced tax system both domestically and internationally.
Comparison databases
The Company relies on three main databases for the performance of the services provided: S&P Capital, RoyaltieRange, Veritrade.
- S&P Capital IQ: It is a comprehensive software for the centralized management of corporate taxation of multinational companies. The Capital IQ database covers more than 62,000 public companies and 4.4 million private company profiles.
- Royaltyrange: This database contains information on contracts related to royalty payments, commissions, intangibles, goodwill, among others. It collects information on actual transactions and contractual agreements between companies worldwide. This information covers a wide range of industries and sectors, which allows to obtain relevant and comparable data for analysis and valuations in the PT field.
- Veritrade: It is a database that specializes in providing data and statistics related to international trade. This database focuses on Latin American trade and is mainly used to analyze the imports and exports of different countries in the region, as it compiles data from customs and other reliable sources to provide accurate and updated information on foreign trade.
Full competition principle
The arm’s length principle is one of the fundamental concepts in the determination of transfer pricing between related companies. According to this principle, transactions between related companies should be valued as if they were transactions between independent parties operating under free and competitive market conditions. In other words, the arm’s length principle establishes that prices or conditions agreed in transactions between related companies must be consistent with those that would have been agreed between unrelated parties in similar circumstances. This is because economically affiliated companies have the ability to influence the prices and terms of transactions between them, which could lead to artificial profit transfer and tax evasion. The objective of the arm’s length principle is to ensure that Transfer Pricing adequately reflects the economic value of transactions and that revenues are fairly allocated among the tax jurisdictions involved. This helps prevent tax evasion and ensure that multinational companies pay taxes based on their actual economic contribution in each country where they operate.
OECD-approved methods
The OECD has developed and officially endorses five main Transfer Pricing methods, which are widely accepted by member countries and used in practice. These methods are as follows:
- Comparable Uncontrolled Price (CUP) Method
- Resale Price (RP) Method
- Cost Plus Method (CP):
- Profit Split Method (PS):
- Residual Profit Split Method (RPSM):
- Transactional Net Margin Method (TNMM):
It is important to note that the selection of the appropriate Transfer Pricing method depends on the particular circumstances of each case and requires a detailed analysis of the functions, assets and risks of the parties involved, as well as the availability and reliability of comparable data.
OECD Transfer Pricing Guidelines
It is important to note that the OECD Transfer Pricing Guidelines are not binding, but are widely accepted and used as a reference by many countries in the development of their tax regulations and in the resolution of disputes related to this study. Each country may adapt and interpret these guidelines according to its national tax legislation.
List of OECD guides
- OECD Transfer Pricing Guidelines: You can access the updated OECD guidelines at the following link: Click Here
- OECD Transfer Pricing Documents and Publications: On the OECD website, you can find a variety of technical documents, reports and publications related to Transfer Pricing. You can explore these resources at the following link: Click Here
How Transfer Pricing Works
Transfer Pricing is an accounting and tax practice that determines the costs of goods and services exchanged between divisions, subsidiaries or entities controlled by the same parent company. This mechanism is applied both domestically and internationally and seeks to ensure that transactions reflect a fair market price. The correct implementation of Transfer Pricing helps prevent tax manipulation and ensures fairness in the distribution of income and expenses within a company. Transfer Pricing rules establish the basis for their correct application. Profits from those transactions are subject to potential reviews by the tax authorities.
Transfer Pricing in Taxation
Transfer Pricing is fundamental for international tax compliance. Tax authorities require transactions between related parties to be conducted as if they were between independent third parties, following the arm’s length principle . This helps prevent tax evasion and ensures that companies pay fair taxes in the jurisdictions where they operate. Profits from such transactions are subject to review and must be properly reported in the Informative Affidavit.
What Does Transfer Pricing Analyze?
Transfer Pricing analysis includes several key components:
- Functional Analysis: Evaluation of the functions performed, the assets used and the risks assumed by each entity involved. It is essential to determine the appropriate Transfer Pricing according to the valuation methods.
- Economic Analysis: Comparison of intercompany transactions with similar transactions between independent parties to determine fair prices. The use of comparables between independent parties is crucial.
- Documentation and Compliance: Preparation of detailed reports justifying Transfer Pricing policies and demonstrating compliance with tax regulations. Transfer Pricing documentation is essential to avoid penalties.
Transfer Pricing and the Tax Authorities
Transfer Pricing is defined by the tax authorities as the prices of goods, services or intangibles exchanged between related parties. Guidelines established as part of the regulatory framework of the income tax law require that these prices reflect those that would have been agreed between independent parties in comparable circumstances . Companies must provide extensive documentation to demonstrate compliance and avoid penalties. Related party transactions must be accurately disclosed in the relevant Local File and Informative Affidavit. Other levels of transfer pricing documentation or obligations to be filed are the Master File and Country by Country Report.
Transfer Pricing and Market Value
The arm’s length principle, or arm’s length principle, is central to Transfer Pricing. This principle states that transactions between related parties should be conducted as if they were between independent parties, ensuring that prices reflect fair market conditions . This is crucial to avoid manipulation of taxable income and ensure tax fairness. Correct Transfer Pricing, or in any case, Transfer Pricing Adjustment applied proactively by a taxpayer prior to its tax closing, are vital to maintain consistency with local and international regulations on such matter.