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Introduction to transfer pricing in El Salvador
Transfer pricing rules
- The transfer pricing (TP) legislation were introduced to the Salvadoran Tax Code since its reform in November 2009, effective as of 2010 fiscal year, in articles 62-A, 124-A, 135 literal f), 147 literal e), 199-A, 199-B, 199-C, 199-D and 244 literal I).
- TP rules in El Salvador are mainly based in the OCDE Guidelines, however, there are some local elements that taxpayers need to address, such as the definition of a related party which include transactions conducted with entities located in preferential tax regimes and domestic transactions among others.
- The General Directorate of Internal Taxes (DGII) issued in 2018, the 'Transfer pricing guide' aiming to facilitate the transfer pricing determination, as well as to address the relevant regulations around transactions between related parties. This document is based on the OECD Guidelines and local regulations.
- Taxpayers must comply with documentation requirements such as the transfer pricing report and the informative TP return.
- The DGII annually issues a guide to facilitate the recognition of preferential tax regimes, listing several countries, states or territories that are considered by the Tax Administration as having low, no taxation or 'tax haven'. Transfer pricing rules also apply to transactions conducted with a subject located or established in any of these territories.
- The Salvadoran transfer pricing rules are not completely aligned with the OECD guidelines. Although OECD guidelines were mentioned previously in the reform of article 62-A of July 2014, in May of 2018 the Constitutional Hall of El Salvador’s Supreme Court of justice issued a judiciary resolution leaving without effect that reform, which includes among others, the reference to the OECD guidelines.
- In March 2018, the tax authority issued the Transfer pricing guide, which is a general orientation for taxpayers required to comply with the TP rules. This guide includes the OECD methods for transfer pricing analysis, comparability analysis process, and recommendations for preparing the TP documentation.
Transfer pricing methods
- The OECD methods are generally acceptable, preferably on a transaction by transaction basis. The most appropriate pricing method should be selected according to the circumstances of each case and taking into consideration the available information, the most appropriate comparability between related and unrelated transactions and that requires the least possible adjustments.
- Acceptable transfer pricing methods include comparable uncontrolled price, resale price, cost plus, transactional net margin and profit split.
- There is a local method used by the tax authority called the 'market price' which is similar to the CUP method but with much more restriction in the number and type of comparable transactions. This method does not accept a range of comparable values and is generally applied to taxpayers that haven´t performed the transfer pricing analysis and do not have the documentation. For taxpayers, this method is inapplicable in most cases.
- There are no self-assessment transfer pricing regimes in El Salvador.
Transfer pricing documentation
Preparation of transfer pricing documentation
- According to article 147, literal C) of the Tax Code, it is mandatory for taxpayers to document the transactions conducted with related parties or subjects located in preferential tax regimes (transfer pricing report) and the pricing analysis. In case of a transfer pricing audit, the documentation must be available for the Tax Administration. Any documentation must be prepared in Spanish and be kept for a period of 10 years.
- The transfer pricing report must be prepared regardless of the transaction amount in the year.
- The documentation must also be available for the external tax auditor prior to 31 May (in case the company appoints a tax auditor).
- When transactions conducted with related parties in a fiscal year exceed USD 571K, taxpayers must prepare the TP informative return prior to 31 March.
- The current Transfer pricing guide of the tax authority refers to the supporting TP documentation that should include: background to the group and the company, the group legal and operative structure, an outline of the key intercompany transactions under analysis, an analysis of the key functions, assets and risks of the company, industry analysis and economic analysis including the comparables supporting evidence.
Master and local file
- To date, El Salvador has not incorporated into the TP legislation the documentation scheme proposed by the OECD in the framework of BEPS. And although the 'Master and Local file' structure is best and standardised practice, there are local elements of the transfer pricing regulation that would be left out and could end in non-compliance with the TP rules.
- Unlike other jurisdictions, the definition of 'related party' for fiscal purposes in El Salvador is broader, including domestic operations, operations carried out with subjects located in preferential regimes, entities with exclusive distribution contracts and foreign supplier that represents more than 50% of purchases. There is also a local method that should be analysed, if applicable.
Some risk factors for challenge
- Services or royalty payments with lack of documentation, benefit test, and materialisation.
- Sale of tangible goods at a unit value below cost (even commodities).
- Business restructurings without taking into consideration an anticipated TP analysis.
- Persistent losses.
- Payments or transactions through low tax jurisdictions.
- Penalties in relation to transfer pricing informative return are derived from failure in submitting the form, submitting it out of the legal term (31 March) and/or referring it without specifications contained in the tax code. In any of these cases, the penalty will be of 0.5% over the equity or capital stock of balance sheet.
- A company may receive mitigation of a penalty if correction is made voluntarily and prior to a review by the tax authority.
- Daily interest may also apply.
Economic analysis and how to demonstrate an arm’s length result
- If there are internal comparable transactions, whether they are accepted or rejected, it is recommended to perform a comparability analysis before resorting to external sources.
- Transactional analysis is preferred over resorting to aggregate or pooled analysis. If an aggregate analysis is used, it is recommended to detail the reasons.
- Comparable companies located in preferential tax regimes could be rejected in an audit process.
- When segmented financial information is used, keep in mind consistency in allocation criteria.
- Quality in a comparable does not rely only on the data base but on a well-performed functional analysis.
Advance Pricing Agreements (APAs), dispute avoidance and resolution
- Advanced Pricing Agreements (APAs) are not applicable in El Salvador.
- There are no exemptions for preparing the transfer pricing documentation, regardless size of the company or volume or transactions.
- There are exemptions for submitting the TP informative return F-982, if the transactions conducted with related parties does not exceed the amount of US $571,429 individually or jointly.
The profit diversion compliance facility (PDCF)
- There are no PDCF rules in force in El Salvador.
Digital services tax
- There is no specific tax for digital services in force in El Salvador.
Local tax authority and taxpayer behaviour
- Since 2012, the General Directorate of Internal Taxes has carried out review processes focused mainly on large taxpayers.
- The economic effects derived from the COVID-19 pandemic will require many companies to re-evaluate their transfer pricing policies and even modify them to adapt it to changes in current value chains and demand behaviors.
- There will be also effects for the tax administration, which could increase the auditing activity of large taxpayers.
- The general rule does not change, transfer prices must behave similarly to prices between third parties. Unfortunately, it is not always possible to have real-time information, but it is recommended that companies analyze their industry on an ongoing basis and collect the information that supports their tax positions. Both gains and losses are expected to be consistent with the arm's length principle.