TP disputes and developments in Latin America: trends to note
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TP disputes and developments in Latin America: trends to note

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The insights of senior tax practitioners of Deloitte on recent practice in Argentina, Uruguay, Peru, and Colombia indicate an increasing amount of transfer pricing audit activity and a need for early preparation by taxpayers

International taxation issues have been a top priority on the political agenda in recent years. The transfer pricing (TP) audit environment in the Latin American jurisdictions is very active, with no indication that this pace is slowing down. Tax authorities are putting the tax practices of multinational corporations under great scrutiny as they are gaining more experience in identifying and assessing international taxation risks.

Argentina

In the above context, the Argentine tax authority has struggled to deal with the increasing quantity and complexity of intercompany transactions. An increase in the activities of the tax authority in terms of TP scrutiny has been perceived. There is a tendency towards conducting audits across several industries, as opposed to the customary primarily targeted industries, such as automotive, pharmaceutical, and agrobusiness. This article reviews a recent tax law case of significance in this area.

Based on the above, the Argentine tax office considered the following as it attempted to improve the comparability in a manufacturing and export segment for a consumer products company:

  • Marketing expenses and royalties – the tested party does not incur similar expenses but "the companies used as comparables do”, so the office proceeded to deduct from their operating profits the charges for such concept;

  • Distribution expenses – borne by the tested party and the comparable companies, so no adjustment was made; and

  • Withholding tax on exports and taxes on credits and debits – the only expenses incurred by the tested party but not the comparable ones.

The local tax authority applied the transactional net margin method and used the total operating income/costs and expenses as a profit level indicator.

In relation to the expenses of a commercial nature of the manufacturing segment, the accounting expert witness did not indicate that the tested party assumed costs for advertising, R&D, and marketing for sales abroad based on an analysis of the evidence. Therefore, the tax bureau’s policy of removing those expenses from the selected comparable companies to obtain an appropriate degree of comparability of the transactions was considered adequate.

The taxpayer argued that it is contrary to any business logic to assume that a company with a functional profile such as that of the tested party and that makes fewer commercial efforts (in its exports to related companies) should obtain a profitability equal to that obtained by an independent company that makes greater efforts.

Based on the above, the Tax Court agreed with the tax office’s position on the elimination of the advertising expenses of the comparable companies. In this regard, it is expected that a manufacturing company that does not incur marketing expenses, because it does not conduct marketing functions, obtains a lower result than if the company carried out a commercial deployment leading to the sale of its products.

The Tax Office accepted the elimination of the withholding tax on exports and taxes on credits and debits of the tested party, as those expenses are incurred only by the tested party but not by the comparable companies.

In view of the above, taxpayers must pay attention to acceptable comparability adjustments to improve comparability, and particularly in a loss scenario.

Country-specific economic circumstances shall be taken into account for TP comparability purposes. For instance, in 2023, Argentina’s annual inflation topped 211%, the highest since the early 1990s; the Central Bank imposed restrictions on foreign currency access for the private sector; and there was a sharp devaluation of the Argentine peso.

In this uncertain context, multinational companies doing business in Argentina must evaluate alternatives to justify their results, and the economic adjustments will be crucial. Based on this, taxpayers should prepare a defence file to be able to shift the burden of proof to the Tax Office in TP audits.

Uruguay

Uruguay continues to have a significant level of audits, with the most controversial aspects being:

  • Limited-risk entities with losses;

  • High costs for intercompany services; and

  • Royalty payments for the use of brands or technology.

It is important to note that the benefit test for services is often requested even though it is not part of the TP documentation requirements, and not having it available creates difficulties when defending a payment abroad. In addition, there has been a thorough review of TP benchmark analysis and a clear preference for local comparables, which are reasonably available in the case of Uruguay, although they do not always have enough information in the notes of the information reported to carry out a complete comparability analysis.

In the past two years, Uruguay has not had judicial rulings on cases related to TP; however, there have been audits where the taxpayer decided to litigate, so it is expected that new case law will be produced in the coming months and will provide useful insights for future reference to taxpayers and the tax administration.

Peru

TP audits have been intensified in Peru. Although these audits cover different industries, special attention is paid by the tax administration to taxpayers that carry out commodity purchase and sale operations with related parties abroad, including taxpayers that import agricultural commodities included within the scope of application of the valuation method known as ‘the sixth method’.

It is important to address what the application of the sixth method means for commodities transactions. In this regard, the sixth method refers to valuation rules that apply only to a group of agricultural commodities such as corn, wheat, and soybeans in their different presentations.

According to the sixth method, for goods with a known price – in this case, agricultural commodities – the reference value of the respective commodity exchange (the Chicago Board of Trade or the Kansas City Board of Trade) plus the awards, premiums, and discounts applicable according to each case must be considered. In the case of grain commodities such as those mentioned above, it is market practice to set purchase prices using a formula based on the future price plus applicable premiums.

It is also important to address the problem of verifying the principle of market value for each of the components of the commodity price formula, which is presented in an audit process of companies that import these types of products from related parties. Aspects such as the way in which the price of the commodity futures is set based on the schedule managed by the respective reference commodity exchange, and the existence of broker reports for the various origins, qualities, and trading dates of the good in order to obtain a benchmark for premiums are central issues that have generated controversy in the audit processes.

In effect, the tax administration is not considering the criteria followed by participants in the grain commodity market for pricing, nor is it specialised enough to apply an analysis of the sixth method that is aligned with the practice of the industry in question, which is leading to very large TP adjustments and impacting the business strategies of multinational groups.

In line with the above, one aspect to highlight is the expectation of the tax administration to have an exact market reference for each component of the price, which, in certain cases, can be very complicated, given the dynamics of the businesses and the trading schedules of the respective product exchanges used as a reference.

In the case of futures, although there are several international exchanges where futures are traded, special knowledge of the business is required to identify the most reliable reference exchange and the price range to consider. The latter is impacted by the date of negotiation and shipment of the goods, for which a futures pricing schedule is considered that includes the date of negotiation of the contract and the date of shipment of the product by the seller in order to have a correct reading of the date of the transaction and thus obtain the correct futures to make the comparison.

In the case of the premium component, there are not always brokers in the markets that provide information or reports on premiums, since contracts can be traded outside trading days, such as Saturdays, or there are markets for which there are no premium publications, such as soybeans from the Bolivian market. Additionally, the broker's premium report may not be available for the date of the transaction; in that case, the report of the date closest to the transaction under analysis should be used.

Therefore, the tax administration faces a very important challenge, as it requires in-depth knowledge of the sector given that it is a very specialised industry in which multiple factors and characteristics impact the formation of its prices. The administration's lack of knowledge is generating distorted analyses and resulting in adjustments without technical and business justification.

On the part of taxpayers within the scope of application of the sixth method, they also face significant challenges to be in a better position in an audit process. In this sense, companies need to implement the necessary mechanisms to be able to maintain periodic and meticulous control of the documentation of the market benchmarks that would support each component of the price for each transaction, which is an arduous task given the large number of transactions under this control.

Colombia

The National Directorate of Taxes and Customs (Dirección de Impuestos y Aduanas Nacionales, or DIAN) in Colombia has struggled to meet its budgeted tax collection targets. Several factors have contributed to this shortfall:

  • Increased government expenditure – higher government spending has strained fiscal resources;

  • Economic slowdown – a general decline in economic activity has reduced tax revenues;

  • The failed Litigation Settlement Act – the legislation did not pass through Congress, impacting potential settlements; and

  • The unconstitutionality of royalty non-deductibility – the declaration that royalty payments in the oil and gas industry are deductible has resulted in a fiscal impact that the executive could not counteract.

These challenges, among others, have intensified the pressure on tax audits, particularly in TP, which remains a significant source of disputed taxes.

As mentioned before, DIAN, like other tax administrations, faces resource constraints and thus prioritises audits of large taxpayers. The goal is to ensure compliance with TP regulations and the arm’s-length principle. To enhance its capabilities, DIAN has engaged in technical exchanges with other tax administrations and the Inter-American Center of Tax Administrations.

Colombia ranks second in Latin America, after Argentina, in the number of TP audits, with nearly 1,000 conducted since 2017. In 2022 alone, effective tax collections from TP audits reached approximately $500 million, nearly ten times the figure from 2017. This highlights the importance of TP as a key focus area for tax disputes.

DIAN is expanding its audit team and decentralising operations from Bogotá to include major cities, anticipating an increase in the number of audits. These audits have significant implications for taxpayers, as disputes can result in taxes owed, inaccuracy penalties equal to 100% of the tax, and delay interest, which can double the tax liability every 2.5 years at current interest rates (around 30%). Given that disputes can take 10 to 12 years to resolve, the total liability can reach up to 600% of the original tax assessed.

A section of the Colombian Tax Code provides that penalties for inaccuracies may be voided if there is a reasonable difference in interpretation. Given the inherently subjective nature of TP, this is particularly relevant. Human judgement plays a crucial role in selecting methods and comparable criteria, making differing opinions common.

Recent court rulings have increasingly focused on the substance of TP issues rather than mere formal compliance. Key considerations in these rulings include:

  • The use of controlled or loss-making comparables;

  • The appropriateness of the selected TP method;

  • The classification of foreign exchange gains or losses as operational;

  • Quantitative screening of comparables for R&D activities; and

  • Adjustments to the tested party.

Taxpayers are now more frequently using expert witnesses to support their positions in TP disputes. Given the complexity of TP methodologies, expert opinions provide judges with valuable technical insights, which are gaining importance in these cases. In terms of court rulings, taxpayers seem to be obtaining more favourable outcomes.

Final thoughts on TP audits in Latin America

The TP audit landscape in the Latin America region is becoming increasingly sophisticated, placing greater pressure on taxpayers to invest in internal and external tax advisory resources. Adequate preparation and compliance are essential, as the burden of proof in TP falls on the taxpayer. Proper documentation and adherence to regulations are crucial to minimising exposure to penalties and lengthy disputes.

The goal is to walk into a TP audit with confidence, trusting that all your preparation will set you up for success. Planning ahead allows for a much stronger position rather than waiting until you receive notice of an audit. All the preparation you take allows you to enter your TP audit with clarity and confidence, and in a position of strength.

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