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Luis Ocando |
In the Central America and Dominican Republic region, the question is not whether transfer pricing regulations will be adopted, but the standards that such regulations will follow and the mechanisms whereby those regulations will be implemented.
On June 4 2007 a uniform transfer pricing model law was approved in Managua by the Committee of Ministers and Secretaries of Finance of Central American countries, Dominican Republic and Panama.
Though not yet published for public comment, this model would apply to taxpayers and economic groups operating throughout the region and intends, as expressed by Nicaragua's finance minister, to develop a legal tax framework that regulates transactions between related companies and especially those that form part of the same multinational group.
Given two major free trade agreements that would have a significant economic impact are coming into force (the Central America Free Trade Agreement (CAFTA) and eventually with the European Union), the countries of the Central America region require a reform of their tax systems and the incorporation of a transfer pricing regulations which follow international standards in order to provide legal certainty to the foreign investor.
Countries such as Honduras and El Salvador have established their own definitions of transactions between related parties, and how to deal with them from the tax perspective. However, the provisions are not clear and appear not to follow the general principles of the OECD.
In the particular case of El Salvador, there is a peculiar definition of comparability established under section 199-B of the Tax Code, which specifies that the market price for inter-company transactions conducted by a local company with a related party abroad must be compared to the price that three independent parties use in transferring the same type of good or service from [to] El Salvador to [from] the same country of destiny [origin].
To date, neither Honduras and El Salvador, have issued the corresponding regulations that taxpayers should follow to fulfil the obligations. Accordingly, although there are domestic transfer pricing regulations in place, taxpayers do not have compliance guidelines. To this end, whereas some of the Latin American jurisdictions provide for the filing of annual tax returns, other require documenting transactions with a transfer pricing study, which must be available to the tax authorities, if required.
In addition, on January 1 2007 section 281 of the Dominican Republic Tax Code was amended and established its own transfer pricing rules stating that the fiscal authorities are able to determine Advance Pricing Agreements (APAs) for certain industries, such as the all-inclusive-hotels and the pharmaceutical industries. Though the rules are not completed, the tax authorities plan to issue specific regulations to clarify application of the new transfer pricing rules to the various types of transactions.
In Costa Rica, there are no official transfer pricing rules. However, based on an internal resolution, the tax authorities encourage its tax auditors officers to adjust any income derived from intercompany transactions, when the tax resulting thereof would be lower than the hypothetical tax that would have resulted from an arm's length transaction. The validity of that ruling could be questionable since it is based on domestic provisions that were not originally enacted to regulate transfer pricing (in other words the substance over form principle and imputed income rules).
The Central America transfer pricing model
It is expected that the Central America transfer pricing regional model will be based on OECD guidelines in a way of being consistent with the international standards as well as with most of the Latin American countries that have adopted transfer pricing provisions.
Some of the most important issues that the model may be expected to include are the following:
Definition of the arm's length principle: For instance, including in the model the arm's length principle definition established by the OECD would be a conservative way of ensuring consistency with the international consensus of the business community and tax administrations around the world. More importantly, it could lead to reduce the risk of double taxation;
Definition of related parties: A uniform definition of associated enterprises would provide certainty especially in cross-border transactions conducted within the Central America region;
Transfer pricing methods: For assessing the arm's length principle, it may be expected that the model would take into consideration the use of both traditional transaction methods and transactional profit methods. Experiences from other countries such as Mexico in the application of methods may be considered as a basis. A peer review of such nation's transfer pricing legislation and practices performed by the OECD [Peer Review of Mexican Transfer Pricing Legislation and Practices, released by the OECD 1/07/05] showed that Mexico is challenged by taxpayers' extensive use of profit-based transfer pricing methods when transaction-based methods may be more appropriate. Thus, advancing in imposing a hierarchy of methods in the model would put the Central American region a step ahead in the implementation of its own transfer pricing practice;
Comparability: For applying the arm's length principle in comparability, besides establishing the definition of comparable transactions and the factors determining comparability, a key factor is the use of comparables. The lack of acceptable third-party data in Latin American countries often obstructs the enforcement of transfer pricing requirements. Due to the limited number of independent companies that could be used as comparables in each of the countries in Central America, it is foreseeable that eventually Central America routinely will accept foreign countries as comparables. Countries such as Mexico frequently confront with practical difficulties in applying comparability analyses as the report of the OECD said, which among others include the lack of available public company data; the practice among taxpayers of generally employing foreign comparables (mostly US comparables); and the lack of transactional information on third parties, which makes hard the comparison between third parties and the taxpayer under review;
APAs: Regulation on APAs (unilateral, bilateral or multilateral) may also be included, especially when the experience over the past years has evidenced that its use among the multinational enterprises has increased in some mature practices. In addition, an equitable access to APAs for all taxpayers would also be a good approach, not limiting its use only to specific sectors;
Documentation: Recommendations for documentation may be useful in the model in order to provide guidance for each tax administration to take into account in developing procedures. In addition, general recommendations, both flexible and reasonable, would be useful to assist taxpayers in assessing its inter-company transactions satisfying the arm's length principle and hence facilitating tax examinations. Special care should be taken into account with the burden of proof given that the region is composed by different jurisdictions;
Annual information return: Furthermore, a particularly useful provision is the requirement of filing an annual information return that details related-party transactions as implemented by most of the Latin American countries with transfer pricing requirements.
The condition of the narrow transfer pricing provisions current in some of the Central American countries has resulted in considerable uncertainty and varying interpretations of the implications in the local markets. Hopefully, the regional model would provide a uniform technical guidance and procedures to assist in the implementation of the transfer pricing rules in each country.
However, some important issues remain to be considered, including when the model will be adopted, how it would be implemented in its local tax provisions, and how the regulation of administrative approaches to avoiding and resolving transfer pricing disputes will be handled. An appropriate implementation of the regional model may be an important step for regional economic integration to provide a leveled plain field for foreign investors that view the different countries of Central America and Dominican Republic as a single market.
Luis Eduardo Ocando (luis.ocando@pa.ey.com) Panama City
