Multinational enterprises (MNE) in Mexico and Latin America are more frequently carrying out relevant operations of income, costs, and expenses for reimbursement concepts with related parties, hence, it is important to document these transactions properly according to their real substance for transfer pricing (TP) purposes in order to avoid future tax contingencies.
A reimbursement transaction between related parties represents an expense incurred by one of the related parties, generally with an independent third party, in benefit of a second related party. Therefore, the first related party requests the reimbursement of its expense with the independent third party to its related party.
Reimbursement transactions are generally part of intra-group services, since according to the definition of the OECD Transfer Pricing Guidelines for MNEs and tax administrations (OECD TP Guidelines), they may represent an activity for which an independent enterprise would have been willing to pay or perform for itself.
In accordance with Chapter VII of the OECD TP Guidelines, concerning the special considerations for intra-Group services, it is not of interest to an MNE to incur unnecessary costs, therefore, the activities or services involved should be identified properly, and the associated costs should also be allocated in accordance with the arm’s-length principle.
Generally speaking, in Mexico and Latin America, for TP purposes, the income, cost, and expense reimbursement operations with related parties are analysed only conceptually, that is, based on the idea that these operations with related parties are considered to be reimbursements, since they are called as reimbursements in the accounting records. Therefore, under that premise the TP analyses are proposed under two conceptual perspectives:
(1) Applying the comparable uncontrolled price method, explaining in the case of revenue operations, that the company has information from independent third parties that allows it to corroborate that the amount invoiced corresponds to what they subsequently requested as a reimbursement to its related party. In the case of expenses, the company has information that allows it to corroborate that the amount invoiced by independent third parties to the related party as an expense, corresponds to what its related party billed. However, it is most certainly that this information is not always available due to administrative circumstances.
(2) Referring to Chapter VII of the OECD TP Guidelines, explaining generically and more particularly for costs and expenditures, why these reimbursements:
- Correspond to a service received, or if an independent party had to carry out the activity to be reimbursed by itself or to resort to a third party to do so (paragraph 7.8);
- Do not constitute stewardship activities (paragraphs 7.9 and 7.10);
- Are not duplicated with other related and third-party expenditures (paragraph 7.11); and
- The market value is not higher than the costs and expenses incurred by the providing related party, since the intra-group service in question does not constitute the normal or recurring activity of said provider, and it is offered occasionally (paragraph 7.36).
It follows that the key in terms of TP so that a reimbursement operation in general can be treated as such, is that it corresponds to an occasional activity, additionally, its value should not be representative since it is considered a sporadic support from one related party to another, outside of their normal activities.
Despite the above, in Mexico and Latin America, the MNE carry out, with greater frequency, reimbursement operations that are recurring, for significant amounts and under the argument that the supplier related party is not normally engaged in the activity involved and characterise the transaction as a reimbursement for accounting purposes.
This could expose a risk in this matter since the transaction amounts are representative and the operations are frequent, it would lead to questioning whether these operations are not correctly characterised and whether it may appear, as part of the functional analysis, that these are routinary activities or part of the business functions of the entity that provides this service, since they represent administrative and negotiation efforts.
In this case, Chapter VII of the OECD TP Guidelines recognises a modality of intra-group services called low added value, which are defined as those services that (paragraph 7.45):
- Are of a supportive nature;
- Are not part of the core business of the MNE group;
- Do not require the use of unique and valuable intangibles and do not lead its creation; and
- Do not involve the assumption or control of substantial or significant risk by the service provider.
This form of low value-adding intra-group services has a simplified approach in the OECD TP Guidelines, however, it is not applicable in all tax jurisdictions of the OECD members, until it is incorporated into their tax legal framework.
Therefore, in order to comply with the arm's-length principle and avoid fiscal contingencies, it is recommended that companies review whether their reimbursement income, costs and expenses operations with related parties, are in fact a reimbursement for occasional activities. Otherwise, they could be treated, as an option, as low value-added intra-group services, with a profit margin of income or to be characterised as a different transaction.
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