Taxation. From a tax point of view, the OECD recommends the so called Arms Length Principle when dealing with transfer price aspects,

University Degree Business and Administrative studies

Index

1. Transfer Price

1.1 Introduction

1.2 Concept

1.3 Uses

1.4 Arm’s Length Principle

2. Argentine legislation

2.1 Evolution of Norms in Argentina

2.2 Export and Import Operations

2.3 Economic relation and operations subjected to transfer price control

2.4 Transfer Pricing Methods

2.5 Comparability

2.6 Documentation Required

2.7 Transfer Pricing Penalties

3. Mercosur and Argentina

3.1 Evolution of Norms in Argentina

3.2 Income Tax

3.3 Transfer Pricing

3.4 Agreements for Double Taxation Relief

3.5 Off-Shore corporations in Mercosur

3.6 Simplification for small income tax payers on certain taxes

3.7 Conclusion

4. Executive Summary

1.Transfer Pricing

1.1 Introduction

A great percentage of the international trade is represented by transactions between related parties, usually multinational corporations that transfer stock or services among their business units, which are located in many different countries.

When this business units obey to a common commercial strategy, operations can be plan in order to locate the income source in those fiscal jurisdictions where the tax burden is lower, avoiding this way, that benefits be generated in high income tax countries.

The countries that integrate the Organization for Economic Cooperation and Development (OECD) have actively worked in the search of a legal mechanism that would provide a solutions to this phenomenon, with the aim that tax authorities be able to fairly apply their taxes on the income that has been produced in their own fiscal jurisdiction.

This has been the origin of many guidelines elaborated by the OECD to establish norms that allow the adjustment of transfer prices between related parties to neutralize the shift of the place where the income was originated. 1

1.2 Concept

A transfer is a price set by a taxpayer when selling to, buying from, or sharing resources with a related person. A transfer price is usually contrasted with a market price, which is the price set in the marketplace for transfers of goods and services between unrelated persons. Multinational companies use transfer prices for sales and other transfers of goods and services within their corporate group.

To understand this concept better, the OECD considers two corporations to be related when one of them participates directly or indirectly in the administration, control or capital of the other; or if same persons participate directly or indirectly in the administration, control or capital of both corporations. 2

1.3 Uses

The economic reason for which transfer prices are charged, is to be able to evaluate the performance of entities that belong to a group. When charging prices for goods and services transferred within group, managers of those entities can take the best decision in choosing between buying or selling goods and service from or outside the group.

On the other hand, the transfer price is often used, incorrectly, to denote the shift of taxable income from one business unit located in a high tax jurisdiction to another business unit of the same corporation, located in a low tax jurisdiction, through incorrect transfer prices that aim to reduce the tax burden of the main corporation.

Transactions within a firm are not set at open market prices, because they integrate other specific products/services, which permits the company to manipulate prices and increase costs, adapting them to get the most benefits on high income taxes countries.

The price set in these kind of transactions between parts of a group are not the consequence of the functioning of the free market; for purely fiscal reasons, they are divert from those that would have been set by independent corporations in an analog situation.

1.4 Arm’s Length Principle

From a tax point of view, the OECD recommends the so called “Arm’s Length Principle” when dealing with transfer price aspects, according to which, related entities should carry out their operations between them in the same conditions as if they had made them with independent parties in market conditions.

In this sense, almost every country, included Argentina, have provisions which give tax authorities enough powers to adjust transfer prices when they are diverted from this principle.

It establishes that all adjustments should be made with regardless to any type of contract and intention by the parties to avoid the tax.

This provisions to fight tax avoidance have the purpose of dissuading companies on their attitude of translating income to related companies in foreign territory. This, through the sub or overset of the international transaction price.

The OECD understands at the moment, that the base of the arm´s length principle is the same treatment for multinational and independent corporations.
Taking this as reference, when relations between two related parties have different conditions than those that would have been agreed on between two independent corporations, the benefits obtained by one of them could be taxed.

If the transfer prices are not establish in accordance with the arm´s length principle, the tax obligations of the related companies would be different, as well as the income tax obtained by the involved countries. Nevertheless, other factors such as, different legislations, price and changes control, could also lead to a distortions.

source: “Manual de Fiscalidad Internacional”, by Teodoro Ezquerro

“International Tax Primer”, by Michael McIntyre

2. Argentine Legislation

2.1 The evolution of Norms in Argentina

In the year 1943 the law for income taxes incorporated the international conceived postulates of the OECD, specifying that branches and other permanent establishments from foreign corporations had to be considered as independent units in order to determine the amount of argentinean income subject to tax. Later, in 1977, the law incorporated the arm´s length principle, when it defined that operations between a local corporation of foreign capital and the foreign party that directly or indirectly controls it would be considered as carried out between independent parties, whenever the conditions were identical or similar to the market normal practices between independent entities.

To better appreciate the normative evolution, it is possible to distinguish three stages:

Stage Previous to the sanction of the Emergency Law 23.697

The explanation about the arm´s length principle was long and comprehensive, because it didn´t make any references about a certain type of operation. Every legal act between a local corporation of foreign capital and a foreign party that directly or indirectly controls it needed to be adjusted to the normal market practices carried out between independent entities.

The arm’s length principle did not cover the transactions carried out with a party that belonged to the same economic group but didn’t hold a dominant position, this is, operations with another corporation that is under the control of the same third party.

The generality of the definitions and the mechanisms that the law provided to make the compliance of the arm’s length method possible, referred particularly to three kinds of transactions: the transfer of technology, loans, and imports and exports.

Transfer of technology and loans: for both cases, the concrete application of the open ...

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Transfer of technology and loans: for both cases, the concrete application of the open market principle depended on the controls that state organisms independent from the fiscal administration made.
Exports and Imports: the control of prices for operations between related parties adopted the pattern of the external wholesaler price, in the place of origin for the imports case, plus transport and insurance costs, and in the place of destination for the case of the exports, in order to determine the argentinean source income corresponding to those operations.

Stage between September 1993 and December 1998

Such a rigid system was not proper for the enormous mobility of capital that globalization brought with, impulsing the competence to attract capitals.

The law 23.697 of economic emergency incorporated provisions that aimed to deregulate the economy, affecting, among other aspects, the controls established by the previous law in relation to the transfer of technology and to the loans that local corporations of foreign capital received from their foreign controllers.

Nevertheless, the arm’s length principle was not modified, as well as the provisions for operations of imports and exports.

Adoption of transfer pricing methods

With the reform incorporated by the law 25.063, the argentine income tax was adapted to the needs of an open and globalized economic world, through the adoption of the worldwide income criteria for argentinean residents, and the incorporation of the OECD methodology of transfer prices.

Perspective of the changes

There were no modifications on the essence of the arm’s length principle, whose postulates remain in the article 14 of the Income Tax Law (LIG). The assertion of the prices of transnational operations is mandatory in case of transactions between related entities, and also for those carried out with parties addressed in jurisdictions of low or null taxation, even when no economic relation is verified. A wide definition of “economic relation” has been adopted.
Article 15 also contains the same methods for transfer pricing as the OECD, but it doesn’t mention any preference on which of the five methods has to be used. Instead, it adopts the “most appropriate and adequate” criteria, in a similar way to the United States legislation. But this criteria has an exception, consisting of a sixth method of mandatory application for exports of commodities through intermediaries.
In addition, some basic concepts were incorporated from the OECD Guidelines such as the definition of comparable operations and the announcement of the elements or circumstances to be taken into consideration.
Finally, the reform meant important changes in the effects of adjustments that could correspond to transfer prices, determining that the differences in tax matters should be added to the tax results.

source: “Manual de Precios de Transferencia en Argentina”, by Cecilia Goldemberg

2.2 Export and Import Operations

The way to determine the Argentine source income from imports and exports between independent corporations is established in the Income Tax Law, this is, for those cases where no relation can be verified.

Exports

Income derived from the export of goods is considered totally as Argentine source, and establishes that when a price is not accorded, or if the accorded is below the current open market price at that time in the place of destination, it should be adjusted to that value in order to determine the value of the exported goods. It also adds that the Tax Administration, in certain circumstances, can also establish the value of the exported goods by taking the price of those goods in the place of origin as reference.

Imports

The income derived from imports is considered as foreign source income. Nevertheless, it presumes that there is net income of Argentine source for the foreign exporter when the sale price is superior than the open market price of the good in its place of origin plus necessary costs. It also establishes that the Tax Administration, in certain circumstances, can also establish the value of the goods by taking the price of those goods in the place of destination as reference.

The article remarks that when it is necessary to apply the open market price in the place of origin/destination, and, for any reasons, it is not public, can’t be obtained or there are doubts about its correspondence to analog or identical goods than the one exported/imported, then the provisions provided about transfer prices between related parties should be taken as reference for the determination of the price.

Article 8 of the Argentine Income Tax Law

2.3 Economic relation and operations subject to transfer price control

The application of the arm’s length method proceeds for any type of operation, whatever its purpose is, that takes place between two persons or entities economically related. The situation can imply many different cases, but it is evident that it’s not the legal form of the persons/entities what determines the possibility of identifying the source of the income, but the decision-making power of a dominant corporation over its business units.

The economic relation is considered to exist when under any form, or by any reason, the control by a party over the other/s can be verified.

Operations subjected to transfer price control

In Argentina, the application of the arm’s length principle and the transfer price methods, is established for transnational operations made between related parties and for transactions with resident parties of jurisdiction of low or null taxation, even when none economic relation can be verified between the parties.

Source: “Manual de Precios de Transferencia en Argentina”, page 17 - Cecilia Goldemberg

2.4 Transfer pricing methods

The legislation of Argentina contains in the fifth paragraph of its Income Tax Law, provisions regarding the methods to be used in order to determine whether transactions between related parties satisfy the arm’s length principle.

In fact, Article 15 of the Income Tax Law stipulates that the methods to be used are those that are most appropriate based on the type of transaction considered, similarly to the United States policy. In that regard, the mentioned Article stipulates that the applicable methods to do that are the comparable uncontrolled price, resale price between independent parties, cost plus, profit split, and transactional net margin methods.

The Tax Administration implemented this provision by issuing regulation indicating, on a general and theoretical basis, that the most appropriate method to determine whether transfer prices are consistent with normal market practices between independent parties shall be the one that best reflects the economic reality of transactions, and the regulation includes some of the factors to be considered for this purpose.

It indicates that the best method shall be the one that:

- Is most compatible with the business and commercial structure.

- Has the best information for an appropriate justification and application.

- Provides for the most appropriate degree of comparability between related and unrelated transactions and the enterprises involved in such comparison.

- Requires the lowest level of adjustments to eliminate the differences between comparable facts and situations.

The methods adopted by the legislation of Argentina to verify transfer pricing, stipulated in the above mentioned Article 15, are similar to those set in the OECD Transfer Pricing Guidelines. The statutory methods and their definitions are as follows:

Comparable uncontrolled price: the method establishes an arm’s length price by reference to sales of similar products made between unrelated persons in similar circumstances. It is usually the preferred method when such comparable sales exist, because it is the only one that analyses prices (the remaining methods analyze information related to gross and net profit), contrasting directly the price of the transaction with its comparable one.
It is of relevance to mention that the argentine legislation in matters of transfer pricing, has set some patterns in order to make the transactions and entities involved in the operations comparable. The legislation says that with the aim of adjusting the existing differences, the following has to be taken into consideration:

- Payment Term
- Negotiated quantity
- Advertising
- Intermediation costs
- Transportation and insurance
- Physical and content nature
- Differences on the date of the considered transactions

In conclusion, it is the ideal method for testing prices between related parties, but despite that, it suffers from some technical limitations that decrease its application field, specially on those operations that don’t involve commodities, making it difficult to find ideal and homogeneous transactions for each case.
Resale price: this method sets the arm’s length price by subtracting an appropriate markup from the price at which the goods are ultimately sold to unrelated parties. The paradigm case for its application is the sale by the taxpayer of its manufactured goods to a related party acting as a distributor, followed by a resale to unrelated customers without any further processing of the goods. The appropriate markup is the gross profit, expressed as a percentage of the resale price, that distributors typically earn from similar transactions with unrelated parties.

From an operative point of view, we can say that:

- With this method less adjustments are necessary than with the comparable uncontrolled price one, because small differences in the goods have a minimal effect over the open market gross margin.
- The consideration of exclusivity in the sale of the good is key for the quantification of the resale margin.
- In general, the function of the corporation is more important to determine the margin than the kind of product/good sold, except when considering intangible goods.
- This method works better when the product commercialized presents a large number of similar factors and characteristics that make it possible to differentiate them from other products.

Concerning Argentine legislation, there are practically no specific norms that clarify aspects referred to the application of this method.
Cost plus: the method uses the manufacturing and other costs of the related seller as the starting point in establishing the arm’s length price. An appropriate amount of profit is added to these costs by multiplying the seller’s costs by an appropriate profit percentage. This percentage is determined by reference to the gross profit percentage earned by the seller in transactions with unrelated parties or by comparable unrelated parties in transactions with unrelated parties.
There are two data elements essential for its application: cost and margin. Both elements are key for the comparison and should be documented. The importance of the cost is given by the necessity of homogeneity in the concepts that build it, and in the case of the margin because it must reward the same functions and risks.
In summary, this method is specially adequate for sales operations of goods of own production when the addressee is a related corporation, whatever the kind of product is. Nevertheless, the difficulties in comparability that arise when margins of independent corporations are taken as reference, makes the application of this method decrease, particularly when goods are manufactured by the seller.
For this method also, as well as for the remaining ones, there are no specific norms in the Income Tax Law or provisions issued by the Tax Administration that clarify aspects referred to its application.
Profit split: under this method, the worldwide taxable income of related parties engaging in a common line of business is computed. The taxable income is then allocated among the related parties in proportion to the contribution they are considered to have made in earning the income.
There are many possible variations of the profit-split method. One variation is to combine it with one or more traditional methods. The traditional methods might be used to allocate average profits from routine activities and the profit split method might be reserved for dividing entrepreneurial profits from the exploitation of valuable intangible property.
Transactional net margin: under this method, the profit margin applicable to transactions between related parties is determined by establishing the profit that would have been obtained by any one of them in comparable uncontrolled transactions, or comparable transactions between independent parties. The transactional net margin method (TNM) operates only over one member of the related relation, which means that when using it, the relative contributions that all members make to the obtention of the income are not taking into consideration. For the purposes of establishing the mentioned margin, a division has to be made, where the numerator is, in every case, the net income of the operation, while the denominator can change according to the methodology applied. The Argentine legislation, as well as the OECD agree on that profitability factors may be considered for the denominator, like return on assets, sales, costs, expenses or cash flow. Curiously, there is no mention about what should be considered as net income.
In conclusion, we can say that the benefits of the method are:
- the net margins are less affected than prices to differences in transactions
- because it operates over one member of the related relation, the use of the method implies that it is only necessary to determine the functions assumed by only one of the related corporations.
Instead, its weaknesses are:
- the net margin could be influenced by some factors that have few if any effects over the prices or gross margins.
- because it only analysis one party, the method could not be considering the rentability of the group as a whole.
- it assumes that a transaction will always be rentable at a net level, which doesn’t always happen between unrelated parties.

It is also important to mention that in the sixth paragraph of the Article 15, there is a rule about the new method for transfer pricing in the case of exports to related parties, involving grains, oil seeds, other products obtained from the land, hydrocarbons and derivatives, and, in general, goods with public prices in transparent markets. The best method to assess the Argentine-source income shall be the trading value of the good in the market on the date in which the goods are shipped, without considering the price that would have been agreed upon with the international broker.

However, if the price agreed upon with the international broker were higher than the effective trading value at the above-mentioned date, the former will be considered as the actual value of the transaction.

The method described above shall not apply when the taxpayer effectively proves that the international broker meets all of the following requirements:

It must have an actual presence in the territory of residence, with a commercial establishment where the business is managed, and meet all the legal requirements in terms of incorporation, registration and filing of financial statements. Assets, risks and functions of the international broker must be in accordance with the volumes traded.
Its primary activity should not consist of obtaining passive income or brokering in the trading of goods from, or to, Argentina or with other members of the economically related group.
Its international trade transactions with other members of the same group must not exceed thirty per cent of its total annual transactions.

The conclusion of the above is that the transfer pricing methodology contained in Article 15 of the Income Tax Law establishes no order of precedence for the use of the methods, with the exception of the case described in the sixth paragraph of the mentioned article. However, the taxpayer shall have to indicate the reasons why a given method has been chosen and prove that the mechanism chosen is the most appropriate for the transaction made.

Article 15 of the Argentine Income Tax Law
Transfer Pricing chapter - “International Tax Primer”, by Michael McIntyre
“Manual de Precios de Transferencia para Argentina”, by Cecilia Goldemberg

2.5 Comparability

Decree 1,037 classifies transactions into four categories and references some of the comparability criteria relevant to each:

Financial Transactions: amounts of capital exchanged, guarantees, solvency of the parties to the transaction, interest rates, relevant commissions, etc.
Services: the nature and the recipient's need for such services, whether or not the services include technical assistance or the transfer/use of intangibles.
Tangible goods: characteristics of the products as they relate to the functions performed by the buyer or seller, quality, reliability, availability, and volumes, among others.
Intangibles: the structure of the transaction, exclusivity, restrictions, unique characteristics of the intangibles, duration of the contract or agreement, degree of protection, and the potential capacity of the intangible to generate income.

While considering this classification of transactions, the decree discusses general comparability criteria including the functions, assets employed, and risks inherent in the business activity; contractual terms; and economic circumstances such as competition and other market forces.

The decree also lists specific factors that may give rise to comparability adjustments:

Term of payment: adjustments for differences in payment terms should take into account relevant interest rates, commissions, administrative expenses, and any other financing arrangements.
Quantities: the determination of volume adjustments should use the data from uncontrolled transactions that demonstrate discounts or rebates related to quantities sold.
Promotion and advertising: to reconcile differences arising from different levels of promotion, publicity, or advertising spending, adjustments should consider the relative amounts of promotional expenses incurred.
Intermediation costs: comparisons between controlled and uncontrolled transactions that indicate differences in the prices of goods, services or rights arising from intermediary activities, should reflect adjustments to eliminate these differences.
Reconditioning, freight and insurance: comparability adjustments should take into account costs of reconditioning products for resale and any relevant costs for freight and insurance that represent differences between the controlled and uncontrolled transactions
Content: where applicable, adjustments should quantify differences in prices of goods, rights, or services in accordance with the costs of their production or performance.
Timing: differences in the dates of transactions may necessitate adjustments based on variations in exchange rates or rates of inflation.

Source: “Supplement Transfer Pricing Argentina”, http://www.internationaltaxreview.com/includes/supplements

2.6 Required Documentation

Even though Argentina doesn’t use the same terminology as the OECD for the norms referred to the required documentation, it accepts as a reasonable and good idea to require contributors to produce and facilitate information concerning their transfer prices, because without adequate information, it would not be possible to audit in a useful and consequent way with the legal goals. Besides this, the Guidelines remark that if the contributor do not provide the adequate documentation, it could lead to a favorable presumption for the Tax Administration in its proposal about the transfer price. The effort of the contributor is clearly recognized as important for the effective application of the arm’s length principle and the necessary control by the authorities.

This possible consequence about the lack of cooperation of the contributor or taxpayer can be found in the Argentine law 11.683. The administrative norms mention a number of obligations to be met. Among them, they set the obligation to present a Transfer Prices Report, with an annual frequency, for all contributors.

Contributors required to document their transfer prices

Obligated contributors to document their transfer prices are those that have, during its economic exercise, made international transactions that have to be subject to price control due to the qualification of the counterpart as a related party, and those that are addressed in a jurisdiction that is considered of low or null taxation.

Physical or legal persons that are involved in transactions with related persons or entities constituted, addressed, based or located in foreign countries and that are specifically defined in Articles 69 and 49 of the Income Tax Law.
Physical or legal persons that are involved in transactions with persons or entities addressed, constituted or located in countries of low or null taxation, without considering the existence of a relation.
Residents in the country that are involved in operations with stable establishments located in foreign countries and that are under their ownership.
Residents in the country, holders of stable establishments in foreign countries, for the operations that this establishments make with entities addressed, based or located in foreign countries, in the terms foreseen in Article 129 and 130 of the Income Tax Law.

Documentation Requirements

Obligations for the contributors are defined in the General Resolution 1122/01 and are the following:

Presentation of a biannual income statement, for the first semester of the economic exercise, with information about the operations subject to transfer pricing evaluation made in that period
Presentation of an annual income statement with detailed information about the operations subject to evaluation, and with indication of the complementary adjustment, if any.
Presentation of a comparability analysis report of the transfer prices and the selection of the most appropriate method.
Conservation of detailed information about related parties, the economic group, operations made, functional analysis, search selection of comparable, determination of the most appropriate method and its application, among other data.

2.7 Transfer Pricing Penalties

The Argentine legislation does not provide specific transfer pricing audit procedures in order to verify transfer pricing. As far as the sanctions regarding the manipulation of transfer pricing and in relation to the breach of the rules on documentation, the Tax Procedure Law of Argentina contains some dispositions.

After the enactment of Law 25.795, which was published in 2003 and amended the Tax Procedure Law, specific rules were incorporated for penalties to be imposed as a result of events of non-compliance with the rules governing international transactions, based on the practical experience our country had gained.

The penalty system is since then, the following:

Automatic penalty, without serving prior notice, upon failure to file tax return by the corresponding deadline:

Informative complementary return of import and export transactions between independents: $1,500 (approximately U$S 500) for individuals and $9,000 (approximately U$S3,000) for corporations.

Informative complementary return of transactions with foreign subjects: $10,000 (approximately U$S3,330) for individuals and $20,000 (approximately U$S6,600) for corporations.

Penalty for non-compliance with regulations establishing or requiring fulfillment of formal obligations to assess tax liabilities, and verify and examine compliance by the taxpayers.

Penalty of $150 (approximately U$S50) to $2,500 (approximately U$S830).

In the following cases, the penalty will range from $150 (approximately U$S 50) to $ 45,000 (approximately U$S15,000):

Resisting examination (repeated failure to respond to requests made by the tax authority).
Failure to keep evidence of prices used in international transactions.
Failure to provide data needed to control international transactions.

3. Failure to submit informative returns of international transactions or returns

with information about the taxpayer itself or about third parties as requested by the tax

authority.

Penalties: $500 (approximately U$S160) to $45,000 (approximately U$S15,000). These fines are in addition to those above and the amounts depend on taxpayer’s status and seriousness of the breach.

4. Higher-income taxpayers.

When the taxpayer has an annual income of $10,000,000 (approximately U$S3,333,000) or more, the penalty imposed upon failure to comply with the third request is 2 to 10 times the maximum amount established ($45,000), which shall be added to the rest.

5. Failure to pay the tax

General: 50% to 100% of the tax that was not paid, withheld or collected.
International transactions: 1 to 4 times the tax that was not paid or withheld.

Source: Transfer Pricing Country Profile,

“Manual de Precios de Transferencia en Argentina”, by Cecilia Goldemberg

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1 “El valor en Aduana y el tratamiento de los precios de transferencia a los fines del impuesto a la renta” in Criterios Tributarios- Digital Edition by Barreira, Enrique C.

2 “International Tax Primer”, page 56 - by Michael McIntyre

Income Tax Law, Article 15 - Administracion Federal de Ingresos Publicos