The Local Transfer Pricing Report is an essential tool to inform the Tax Administration about all transactions with related companies. This report must include among other specific details such as the amount of the transactions, the transfer method used, the median, the lower and upper quartiles, the profit, the adjustments made and an exhaustive functional analysis of the company. Complying with these regulations is essential to ensure transparency and fairness in transactions between related companies. However, the preparation and presentation of this Report is not risk-free. The following are the main challenges and audit risks associated with the Local Transfer Pricing Report.
Selection of Comparables and Transfer Method
The selection of comparables and the transfer method used in the Local Transfer Pricing Report are critical components that can generate significant audit risks for the Tax Administration. The selection of comparables should be based on sufficient information to demonstrate that they are the most appropriate and do not require additional adjustments.
For example, in the importation of goods, it is common for the Tax Administration to prefer the application of the Net Transactional Margin (NTM) instead of the Comparable Non-Comparable Price (NCPC). This implies that ad hoc comparables must be identified to support this approach. To mitigate this risk, it is vital to have comprehensive documentation including detailed invoices and their associated debit and credit notes, the settlement analysis of each transaction showing the formula and pricing, documentation of each element of the formula and the technical characteristics of the goods purchased. In addition, information on comparables with similar level of detail should be available.
Services received are another focus of interest for the Tax Administration, which based on the description of the transaction, the country of residence of the service provider and the amount of the transaction, may request a wide range of documentation to understand the operation. To mitigate these risks, it is essential to have complete documentation including signed contracts with suppliers, price records, service orders, minutes, budgets and general service controls.
IT Services and Loans
IT services require a more detailed explanation, as it is necessary to demonstrate the correlation between contracts, service orders, invoices, compliance reports, certifications and valuations. Without this complete documentation, Peruvian Tax Administration may question such transactions, especially if they are services that by their nature are provided on a continuous basis and lack the detail indicated above.
Loans, both received and granted, are of special interest to Peruvian Tax Administration. It is necessary to demonstrate that the interest rates are at market value; to this end, it is essential to have detailed information to support the use of interest rates and any special situations related to the transaction. Key elements that must be supported include an analysis of the type of loan or credit classification, currency, date, the term or amortization period and the debtor's country of residence. Without this information, Peruvian Tax Administration may consider that the interest rates applied are not adequate and proceed with adjustments and/or penalties.
Inconsistencies in Documentation
Any inconsistency between the different reports submitted to the Tax Administration may raise suspicions and trigger a thorough audit. Peruvian Tax Administration, in its power of audit, will thoroughly analyze every aspect of the reports to ensure that the transactions and their terms adequately reflect market realities. Discrepancies between the details of the transactions and the functional analysis presented may lead to questions, so the contracts will be examined in detail to verify that the agreed terms are consistent with the transfer prices declared.
The annual report and the company's organization chart are key documents that Peruvian Tax Administration will use to understand the organizational structure and internal relationships of the group. Similarly, the organization and functions manual is crucial to identify and confirm the functions, assets and risks assumed by each entity within the group. Inconsistencies in these documents may indicate a lack of consistency in the transfer pricing strategy.
To mitigate the risks noted, contributors should conduct a thorough review of all reports, contracts and documents related to transactions and transfer pricing to ensure that there are no inconsistencies between them, and ensure that all transaction details are clearly documented and consistent with the functional analysis presented.
Profit Margin and Interquartile Range
The correct determination and justification of profit margins in related party transactions is crucial to avoid adjustments and penalties by the tax authorities. If the profit margins reported by the taxpayer are outside the interquartile range and adequate justifications are not provided, showing for example that there is no tax loss, Peruvian Tax Administration may have an element of questioning that leads to a specific audit on these points.
To mitigate any associated risks, it is essential to maintain detailed documentation to justify the reported profit margins. This includes economic analyses, transfer pricing studies and any other evidence supporting the taxpayer's position.
Adjustments Made
Proper justification and documentation of transfer pricing comparability adjustments is critical to avoid misinterpretations by the Tax Administration, which could consider them as attempts at price manipulation.
To mitigate these risks, it is crucial to have detailed documentation to support the comparability adjustments made. This includes explaining the reasons why each adjustment was deemed necessary and how these adjustments improve the reliability of the results and their comparability.
It is essential to specify the accounting accounts involved in the adjustments, describing their nature and the calculation applied. For example, if adjustments are made to operating expenses, detail what specific expenses were adjusted and how the amount of the adjustment was determined.
Transactions with Low or Zero Tax Jurisdictions
Transactions with companies located in low or no tax jurisdictions are subject to particularly close scrutiny by the tax authorities who will seek to understand the context of such transactions. This special attention is due to the perception that such transactions may be used to artificially shift profits to jurisdictions with lower tax burdens. This includes inquiring into the commercial reasons behind the choice of suppliers in these jurisdictions and how such transactions fit into the company's business model. In addition, they may request working papers demonstrating the calculations performed and justifying the selection of the method as the most appropriate for the specific circumstances. Additionally, they may require an accurate breakdown of the goods purchased from each country, providing evidence that the prices paid are consistent with market values.
To mitigate these risks, a clear and robust justification of the business rationale for selecting suppliers in low or no-tax jurisdictions should be provided. This may include cost-benefit analysis, logistical advantages or access to specific products or services that are not available in other jurisdictions. In addition, it should be demonstrated how operations with these suppliers bring value to the company, including the presentation of market research, supply chain analysis and operational efficiency assessments.
Conclusion
The Local Transfer Pricing Report is a critical tool to ensure transparency and fairness in transactions between related companies. However, the preparation and presentation of this report presents a number of risks and audit challenges. The selection of appropriate comparables, justification of profit margins, documentation of comparability adjustments and accurate functional analysis are essential to mitigate these risks. It is also crucial to maintain consistent and detailed documentation to support all transactions and ensure compliance with tax regulations.
