A perspective on the evolution of transfer pricing regimes in Latin America
Background
Transfer pricing regimes make their formal appearance in Latin America in the 1990s, where, as a result of the liberalization process of the economies, signing of trade agreements and negotiation of treaties to avoid double taxation it became urgent to establish a control system that would allow the taxation of multinational groups arriving in the countries of the region to exploit competitive advantages such as abundance of natural resources, labor, logistical advantages, etc. The country with the most experience in the region is Mexico, whose regime is now 30 years old (25 years if one considers 1997 as the beginning of the regime, when it was fully established with rules in addition to the mere imposition of the arm’s length principle). The last country in the region to align itself with this regime is Brazil, which in April of this year announced the modification of the current transfer pricing system based on pre-established profit margins, to an OECD regime (see table 1).
Current Status
Since its establishment, almost all the countries in the region have followed the recommendations issued by the Organization for Economic Cooperation and Development (OECD) and have applied to the best of their ability the arm’s length standard and the rules derived from it. The Inter-American Center of Tax Administrations (CIAT) in its databases estimates that up to 87% of the countries in the region have reasonably robust regimes on the matter and in general terms, few countries have not incorporated specific provisions (Barbados, Guyana, Trinidad)-.
Having made this point, it can be seen that in the region: 1) The arm’s length principle regulates transactions between related parties (even domestic ones, as in the case of Peru, Colombia or Mexico), 2) The application of transfer pricing methods is required and, consequently, the application of comparability analysis to support the taxpayer’s choice regarding the construction of reference parameters or ranges, 3) sanctions for non-compliance are established, 4) The filing of information returns on intercompany transactions is required (including those derived from Action 13 of the BEPS plan; master file, local file and country by country report), 5) The possibility of negotiating advance transfer pricing agreements is enabled, 6) there are information exchange agreements and 7) disputes regarding this matter have reached administrative courts.
It should not be overlooked that transfer pricing regimes have been influenced by the implementation of the OECD’s action plan to combat tax evasion and profit shifting (the BEPS plan, for the acronym in English of action plan vs. base erosion and profit shifting) in its actions 8-10 (alignment of transfer pricing with value creation) and 13 (country-by-country reporting and transfer pricing documentation). Little by little, either through national courts, amendments to the law or even through administrative provisions, the interpretation of the regime has been regulated, adapting it to the recommendations of the plan. Some relevant controversies that account for the activity in the courts of the region are, for example, Mexico vs. Beverage Distributor (Federal Court of Administrative Justice, 5378/16-17-09-2/1484/18-S2-08-04, regarding the deductibility of marketing and advertising expenses and their connection to trademarks), Colombia vs. Sony Music (Administrative Contentious Chamber, 4th Section, 20641) regarding the adequate delineation of operations, choice of entity to be analyzed, deductibility of services and establishment of ranges, Argentina vs. Nike (Tax Court, File 24.495-I) regarding the deduction of royalties for the use of trademarks, technical assistance and commissions.
Where are we heading?
In general terms, Latin American countries have made significant efforts to operate their domestic transfer pricing regimes, in some cases even proposing ad hoc alternatives to their situation, as in the case of the Argentine sixth method, or instituting simplified regimes such as the maquila regime in Mexico. Clearly, the instrumentation of the regime is not simple and straightforward. Problems of a practical nature such as the lack of information at the national level to apply the arm’s length standard, the shortage of financial resources, infrastructure and human capital, the inexperience of administrative courts or the proliferation of aggressive tax planning schemes making use of intercompany operations- hinder the operation of the regime. And of course this has an effect on tax collection, recent studies indicate that countries like Mexico (where there are more than 60,000 registered subsidiaries of multinational companies according to data from the Ministry of Economy) lose around half a point of GDP in taxation (less moderate estimates calculate even up to 1.5% of GDP).
In this situation, the governments of the region have reached an impasse while awaiting the results of the negotiation of the OECD’s unified approach proposal (pillars 1 and 2), but preliminary estimates indicate relatively modest increases in collections (in our firm’s estimate up to a maximum of 1,884 million dollars for México), which will necessarily lead to rethinking the organization of the transfer pricing areas of the national authorities and to make a greater investment in human capital, training and infrastructure, and it may even be necessary to think precisely about a redesign of the regime to discourage aggressive tax planning via transfer pricing. (for example, requiring independence between transfer pricing advisors and tax auditors, or incorporating the recommendations derived from Action 12 of the BEPS plan regarding reportable schemes, including transfer pricing, as Mexico did in 2020). Likewise, greater support to key taxpayers through programs such as the International Compliance Assurance Program (ICAP) could also make a substantial contribution to improving the regime’s results.
At this point, it is worth pondering the very important contributions to the region made by CIAT, which actively provides training to tax administrations in the region (particularly by developing practical guides such as the “transfer pricing cocktail” or the manual on international tax planning control, as well as the contributions that the joint collaboration platform (OECD, UN, IMF, WB) has made through its practical guides on comparability and documentation , or even providing audit capacity through initiatives such as tax inspectors without borders.
Recommendations
A maxim frequently used in the regime is: “the greater the functions, assets and risks, the greater the return”. Consequently, if the countries in the area expect to benefit from their respective regimes, it is imperative that they invest aggressively in the training of their transfer pricing control departments without the risk of seeing their revenue diminished. Of course, the use and improvement of information exchange mechanisms and the professionalization of the administrative courts must be short-term objectives to achieve the efficiency of the regime, which is destined to be a bastion of collection for the countries of the continent.
*I appreciate the collaboration of Daniela González, José Chamorro and Esteban Ollervides in the realization of this article.
1 Jesús Aldrin Rojas. Managing Partner. QCG Transfer Pricing Practice.
2 Jansky, Petr, Palansky Miroslav. Estimating the scale of profit shifting and tax revenue losses related to foreign direct investment (2019). International Tax and Public Finance. ONU-Wider 2019.
3 Rojas, Jesús Aldrin, Chamorro Gómez, José. Una nueva era de tributación para la economía digitalizada. International Tax Review, 2021
4 Joint Collaboration Platform, OECD, UN, IMF, WB. Practical guide to address the difficulties associated with the lack of comparables in transfer pricing analysis.
5 Joint Collaboration Platform, OECD, ONU, FMI, BM. Practical Guide for the Implementation of Effective Transfer Pricing Documentation Obligations in Developing Countries.
