Issuing reports as a result of the work of the BEPS Action Plan resulted in a major update of the OECD Guidelines applicable to transfer pricing for multinational enterprises and tax administrations (“OECD Guidelines”) in 2017. The different jurisdictions in Latin America have focused efforts in adapting their regulations to this new reality, however, most have focused their efforts on the adoption of the Action 13 “Revisiting the transfer pricing documentation”, issue we discussed in previous publications (See publication Adoption of Master File, Local File and Country by Country Report on the regulatory framework of Transfer Pricing in Latin American countries) .
With respect to actions related to economic substance, the trend has been to build on the OECD guidelines rather than developing specific local regulations. On this last point, one of the most important changes is related to the incorporation of a precise delimitation of the transaction, explained in Section D, Chapter I of the OECD Guidelines, as part of the implementation of the Arm’s Length principle. This concept demands a thorough review of the transaction in order to obtain a sufficiently clear understanding of it to allow an analysis of appropriate comparability, since a superficial review of the transaction could result in an incorrect transaction definition that would result in the wrong selection of comparable transactions or companies and therefore incorrect transfer pricing analysis by the taxpayers. This incorrect analysis could, in their process of self-determination, lead them to apply incorrect transfer pricing adjustments in their tax returns and the tax authorities to errors in their actions to oversight and control.
The exact definition of the transaction involves clarity in the context in which the transaction was made, implying that the taxpayer must identify the parties involved in the transaction, and their interaction with the global value chain of the business: (i) trade and financial relations; and (ii) relevant economic circumstances. This implies a broad understanding of the industrial sector of the taxpayer and the factors that affect it, including business strategies, markets, products, their supply chain, and the key functions performed, the tangible assets used and the risks assumed as important.
In order to be able to define precisely the transaction, although the identification and clear understanding of the context is vital, it is necessary to analyze the economically relevant characteristics of the transaction or the comparability factors, which can be categorized as follows:
Functional analysis (functions performed by each of the parties, taking into account the assets used and risks assumed):
Characteristics of the transferred property or services provided:
Other elements to be considered are: losses, government policies, and savings from the location of activities, established workforce, and synergies, among others.
The precise delimitation of the transaction will allow performing the adequate search for the appropriate comparable transactions, to apply correctly any of the transfer pricing methods. The challenge of taxpayers in Latin American countries will be able to locate, with the limited information available and considering the above, the most appropriate comparable transactions that allow them to evaluate their compliance with the Arm’s Length principle.