Reducing tax uncertainty in Latin America through APAs

We are living in a time of high global instability, when most multinational companies will need to review their strategic plans, reconsider their investment and supply chains across countries, and possibly move back from global to regional structures. In the post-COVID-19 world, online sales, remote working and nearshoring of supply chains will be at the heart of business investment decisions.

Corporate taxation will not be exempt from the consequences of this post-COVID-19 pandemic world. It is likely that all these changes in the way that multinational companies operate their global businesses, together with international tax and transfer pricing (TP) trends, will bring higher uncertainty in the tax and TP field. This is especially expected in those regions and countries where it is not possible to agree ex-ante with the relevant tax administrations on the attribution of the business profits/losses to the corresponding jurisdictions.

Latin America has traditionally been a region of high uncertainty for TP purposes, not only because some countries in the region do not apply the OECD Transfer Pricing Guidelines (e.g. Brazil) but also because the countries that do accept those guidelines, do not always apply them in a consistent and orthodox manner. Furthermore, although the volume of international inter-company flows has grown consistently and vigorously in recent years, almost no APAs have been signed between taxpayers and tax administrations to ensure certainty on the TP methodology used in specific inter-company transactions. This has contributed to an increase in TP litigation, both within the region and among European and North American-capital exporting countries such as Canada, Spain and the US.

An essential factor in the search for tax certainty from a TP standpoint is having the practical ability – as opposed to the theoretical ability – to execute an APA before making an investment, because this is the sole means of ensuring that a company's TP policy will not be subject to challenge at a later date, resulting in potential fines or assessments that could affect cash flow.

APAs are agreements between a taxpayer and one or more tax authorities concerning an appropriate TP methodology that will apply to a group of transactions for a determined time period.

A key exception to the general situation in the region, where despite continuous international efforts, it is still not possible to obtain certainty through an APA, is the case of Chile. In the country, the tax administration has only started to grant APAs in the last few months. By inviting companies to submit APA applications, the Chilean tax authority is sending a message to international markets that the jurisdiction respects its TP regulations and applies them in conformity with the OECD Transfer Pricing Guidelines. In addition, the level of sophistication in TP is increasing, which is a relevant consideration for companies that face more complex TP issues. Although an agreement with the Chilean tax authorities in the context of its APA programme is not binding on other countries in the region (e.g. Peru, Colombia, Argentina), it does increase the taxpayer's credibility and serves as an excellent 'letter of introduction' in other countries in the region, in the event that the TP policy of the group is called into question.

Most multinational groups have standardised TP policies, whereby the same policy tends to be applied consistently in all the countries within a region, assuming that the overall functional and risk profile is similar. In this context, the signing of a bilateral APA involving Spain and Chile, for example, would likely provide some degree of legal certainty in the case of potential challenges by other jurisdictions in the region.

Some additional advantages for multinational taxpayers of signing APAs with Latin American countries, such as Chile or Mexico, are the following:

• APAs provide an opportunity for the relevant tax administration and the taxpayer to consult and cooperate in a spirit of reaching agreements;

• APAs can avoid long and expensive TP audit processes and possible litigation that may result in the event of an adjustment to the price of transactions between related parties;

• Bilateral APAs eliminate the possibility of double taxation;

• Unilateral APAs, although not binding on another jurisdiction, can help reduce the amount of audit scrutiny given to specific inter-company transactions; and

• TP teams in the tax authority that manage APAs are experts in their fields, whereas in the audit process, the responsible officials may not have the necessary experience or knowledge to address TP issues.

Other potential advantages of entering into APAs relate to timing and cash flows. A TP audit can start at any time and demands time and resources from the company that might not be readily available, potentially distracting the company from its core business, if extensive information must be obtained from operating teams. Furthermore, a TP audit may generate penalties and legal and advisory fees that have a significant impact on cash flows. In the case of an APA, the company selects when to begin the process based on availability of time and resources. An APA will obviously require a commitment of time and resources, but it will likely yield better outcomes, as the taxpayer has greater flexibility with regard to planning and preparation.

From the tax administrations' perspective, signing APAs can also be very advantageous by enabling them to perform better risk assessment. Indeed, by reaching agreements with taxpayers that are willing to cooperate with the tax administration, and that disclose in detail their business operating model and their TP policies, tax administrations are able:

• To get a better understanding of how multinational taxpayers operate and determine their allocation of global profits (or losses) among their different affiliates, which ultimately allows tax administrations to better assess their compliance with the arm's-length standard; and

• To concentrate and focus scarce tax audit resources on taxpayers that present a higher risk profile (e.g. using low-tax structures or concealing real substance, etc.)

Based on the above, in order to increase the level of tax certainty and confidence of potential investors in the region, the Latin American jurisdictions should consider actively promoting the negotiation of APAs. At a time when countries are looking to differentiate themselves to attract foreign investment, the ability to align local regulations and tax administration to international compliance standards may provide competitive advantage for specific countries in the region.

Click here to read the entire 2020 Deloitte/ITR Transfer Pricing Controversy guide