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Introduction to transfer pricing in Spain
Transfer pricing rules
- The Spanish’s transfer pricing (TP) legislation is in the Corporate Income Tax Act (Spanish CIT) Article 18. Other related rules and legislation along with this are based on the arm’s length principle as per Article 9 of the OECD Model Tax Convention on Income and Capital, ie it follows the OECD Guidelines.
- The TP rules apply to Spanish taxpayers, including Spanish branches of overseas companies and there is a self-assessment regime, i.e. the burden of the proof is on the taxpayer to confirm its transfer pricing meets the standard or to adjust its tax return accordingly.
- The filing of transfer pricing documentation with Spanish Revenue is mandatory above certain thresholds which in some cases are complex as they are related to turnover of the group, type of assets involved in the transactions, etc.
- Thus, penalties are imposed for the lack of preparation of such transfer pricing documentation despite in practice, taxpayer managed to complete the documentation along the tax audit process and other penalties are imposed based on the lack of proper income/expense imputation rather than lack of Master/local file.
- A taxpayer usually prepares the TP documentation upfront as the deadline to supply the Revenue with the documents is just 10 days.
- The OECD’s Master File and Local File concept is accepted, used and included in our TP legislation and practice. In addition, for larger groups (over €750m) Spain has also implemented CbCR (Country by Country Reporting).
- The Spanish’s transfer pricing rules follow the OECD Guidelines. The Guidelines, updated in July 2017, are mentioned in Spanish legislation as well as in most of the Spanish Revenue rulings, opinions and even sentences issued by Revenue special tax tribunals (TEAR/TEAC), and they must be used for interpretation of the arm’s length principle.
- The OECD has also released further guidance both through the current mechanism of issuing reports but also related to the BEPS actions and those have been expressly and implicitly accepted and applied by the Spanish Revenue.
- The Spanish Revenue has not issued either Manual nor guidelines regarding providing guidance for Revenue official or Inspectors on its view of transfer pricing matters, at least that has been publicly available.
Transfer pricing methods
- The most appropriate pricing method should be selected on a transaction by transaction basis, providing the most reliable measure of an arm’s length result in each case. The current OECD methods, namely the comparable uncontrolled price, resale price, cost plus, transactional net margin, and profit split methods are all accepted but the method used must be in line with the functional and risk profile of the entity. Other methods can also be used if justifiable and appropriate.
- There is no set hierarchy as the Spanish legislation currently refers to the 2017 OECD Guidelines and BEPS Actions 8-10 Final Reports published by the OECD on 5 October 2015. In practice, however, a ‘natural hierarchy’ may be said to favour the comparable uncontrolled price method.
- Spanish Revenue requires taxpayers to make computational adjustments in cases where transactions are not on an arm’s length basis, and the taxpayer is potentially advantaged in respect of Spanish tax.
Transfer pricing documentation
Preparation of transfer pricing documentation
- The Spanish Revenue accepts the OECD transfer pricing documentation model based on the Master File and Local File (BEPS Action 13) approach. This approach is considered best practice in Spain.
- Spain has also introduced CbCR regulations which are effective for fiscal years starting on or after 1 January 2016 for groups with revenues over €750m.
- Despite there are no specific requirements regarding the language, in practice, the documentation is prepared in Spanish. If prepared in English or any other language, a tax auditor may request a translation into Spanish. The documentation ought to be available by the end of the discretionary period for filing the CIT return.
Informative return on related parties and tax havens
- Taxpayers are required to file the information return on related-party transactions and tax havens (Form 232) when the overall amount of their related party transactions with the same related party exceeds EUR250,000 at market value.
- In the case that the overall amount of related transactions does not exceed EUR250,000 but the amount of the specific transactions of the same type carried out exceeds EUR100,000, these transactions must be reported. The specific transactions are as follows:
- Transactions performed by personal income tax taxpayers in economic activities to which the objective assessment method is applicable, with entities in which the taxpayer him/herself or his/her spouse, ascendant and descendant relations, either individually or overall, own 25 percent or more of capital stock or shareholders’ equity
- Business transfer transactions
- Transactions for the transfer of shares or equity-like instruments not listed in regulated markets
- Transactions for the transfer of real estate
- Transactions in respect of intangible assets.
- To conclude, even if the total amount of the related transactions did not exceed EUR250,000 and EUR100,000 thresholds, the related transactions of the same type and the same valuation method must be reported if their total amount exceeds 50% of the entity’s net revenues.
Master and local file
- The Master and Local file structures are based on Articles 15 and 16 from the Corporate Income Tax Regulation (Spanish CITR) and should help with penalty protection. Spanish Revenue’s view is that transfer pricing documentation should usually include a background to the company, group structure, industry analysis, key intercompany transactions; key functions, assets and risks of the company, and economic analysis including evidence of comparables.
- Transfer pricing documentation explains the value driving activities and the management of risk in the group and shows that the policies are at arm’s length.
Some risk factors for challenge
- High risk business models include commissionaire and toll manufacturing.
- Limited risk distributor and contract services/ contract R&D arrangements could also potentially be affected, especially where significant people functions are in Spain.
- Companies with persistent losses.
- Intangible transactions and any other licensing payments to low tax jurisdictions
- Business restructurings, or changes in TP model, can also trigger a challenge but needless to say, businesses can evolve, and if the previous TP method no longer appears the most appropriate, it should always be reviewed, rather than being ignored for the sake of maintaining consistency.
- In case of non-applicable tax adjustment, penalties in relation to failed, late or incorrect submission of the transfer pricing documentation are EUR1,000 per fact and EUR10,000 per group of facts, limited to a minimum between the 10% of taxable income and 1% of net income.
- The tax-geared penalty dependent on the transfer pricing adjustment made by the Spanish Revenue may be up to 15% of the additional tax base in addition to the tax due and the interest related with delayed payment of the increased tax.
- Due to there are no specific penalties for CbCR filing and notifications, the penalty regime of the Spanish General Taxation Law applies.
- An enquiry into a tax return by Spanish Revenue may be made up to 48 months from the due filing date of the tax return.
Economic analysis and how to demonstrate an arm’s length result
- Spanish Revenue will expect to see that a search for potential internal comparables has taken place before defaulting to an external database search for comparables.
- Local comparable companies are preferred, whilst Western Europe or Eastern Europe comparable companies can be accepted.
- Note that where databases are used, contrary to popular understanding, despite there is no specific requirement that the interquartile range be used, in practice it will often be calculated as a means to eliminate outliers, given that incomplete information will always be an issue in external database searches.
- Note also that Spanish Revenue is not permitted to use 'secret comparables'. There are also no published TP 'safe harbours' or norms in Spain, and the key is always the facts and circumstances of the specific case.
Advance Pricing Agreements (APAs), dispute avoidance and resolution
- Advanced Pricing Agreements (APAs) are written agreements between a business and Spanish Revenue to govern the appropriate transfer pricing method for a forward-looking period. The average time taken to negotiate them is 39.4 months.
- APAs can be affected by rollback provisions whether the Spanish revenue right to undertake a tax audit has not expired or a definitive assessment was not performed in the APA transactions.
- Spain has an extremely extensive treaty network, and the Mutual Agreement Procedure (MAP) will often be available. However, on average MAP cases take nearly more than three years to resolve.
- There is no charge for APA or MAP, unlike in many countries, but Spanish Revenue may refuse to accept a case, for example where it is deemed insufficiently complex.
- It is Spanish policy to allow for arbitration in the event that agreement cannot be achieved, and it will seek to include such a provision in its tax treaties. The EU Arbitration Convention is available, and Spain has ratified the OECD Multilateral Instrument (MLI), hence where the other country (treaty partner) has agreed, arbitration should be available to eliminate double taxation.
- As regards exemptions from inclusion in the Form 232, the following transactions are exempt:
- Transactions taking place between entities forming part of the same consolidated tax group;
- Transactions performed by Economic Interest Groupings and Joint Ventures (unless ruled by the Article 22 of the Spanish CIT); and
- Transactions taking place within the framework of a takeover bid or public offering.
- The exempted transactions from documentation obligations are the same ones as the Form 232, whereas it also includes the related transactions carried out with the same party which overall amount is lower than EUR 250,000 at market value.
- Groups with income lower than EUR45 million are exempt from preparing a Master file.
- Groups with consolidated revenues in the previous fiscal year lower than EUR750 million are exempt from preparing a CbcR.
Digital services tax
- Spain approved the digital service tax (DST). The Spanish DST consists of 3% tax of gross revenue arising from digital services.
- The tax applies to three main categories of business:
- Online advertising space;
- Intermediary activities (B2B and B2C); and
- Data transfer.
- The DST is not a tax on the online sales of goods, but it applies to revenues earned from intermediating those sales.
- It is relevant to businesses that generate revenues of at least EUR750 million. In addition, the first EUR3 million of Spanish revenues will not be taxable. These thresholds are designed to ensure that smaller businesses and start-ups are out of scope.
- Spain is participating in the OECD discussions on the digitalisation of the economy (BEPS Action 1: Pillar One and Pillar Two proposals).
Tax authorities and taxpayer behaviour
- Unlike the approach of the tax authorities in some countries, Spanish Revenue does not provide any penalty relief via reviews of taxpayer and agent 'behaviour' but repeated tax offences can lead to a significant increase in the penalty to be paid.
- Benchmarks, functional analyses and even transfer pricing policies prepared in previous years are expected to be changed or adjusted when preparing the 2020 transfer pricing documentation (Masterfile and Local files) to avoid comparability mismatches between the previous and the current economic situation as a consequence of the COVID-19.
- Depending on the circumstances of every case, adjustments that might have to be considered are the following: unused capacity; changes in exchange rates; extraordinary expenses; changes in the solvency of entities, etc.
- The value chain and ordinary transactions of businesses may be impacted because almost none of them were designed to resist the effects of the COVID-19 in the economy.
- Relocation or digitalisation of activities, and business restructurings, among others, will have a decisive effect on the value contribution and risk management of various entities within its multinational groups.
- Companies will have to document more deeply the business and economic arguments that support in the future the reasonableness of the added adjustments.
- The new guidance released by the OECD on financial transactions need to be addressed to consider the liquidity problems at many groups due to a reduction or deferral of revenues as a result of the COVID-19.
- Multinational groups tend to operate with limited risk subsidiaries, like contract manufacturers or limited risk distributors and service providers. Their functions are remunerated with a reduced margin on their costs or sales.
- The decrease of revenues and increase in costs that multinational groups have had to face could give reason to question the suitability of these remuneration arrangements.
- In particular, exceptions in transfer pricing policies, or temporary adjustments based on functional and industry analyses may be necessary to help companies to be adapted.
- Reduce, suspend, or relax certain payments and conditions for services or royalties may be another approach to soften the pandemic impact on cash flows’ companies within groups, if this is consistent with the behaviour of independent third parties.
- Inter-company agreements, however, may not contain force majeure clause for extraordinary events, or if they do, they may not be drafted in sufficient detail or suitably adapted to the facts.
- In those cases, it is right for parties to renegotiate the contractual terms to restore balance in the relationship, preserve profitability, or mitigate losses, which is acknowledged in the OECD Transfer Pricing Guidelines and is what independent parties would do in practice.
- To achieve this goal, it is particularly important to analyse accessible contracts between independent parties and document the contract with the new economic circumstances.
- Certain quantitative or qualitative critical assumptions determined by the tax authorities before the COVID-19 outbreak in APAs will be harder to be met by the companies.
- In these cases, the terms of the agreements need to be studied to determine whether they allow adjustments on the occurrence of unexpected events.
- Companies should not lose sight either of the options of approaching the tax authorities to inform the need to add changes in the APAs, or even cancelling them.
- The uncertainty level is going to remain for a long period and makes more useful to seek arrangements for transactions which, due to their technical complexity or quantitative size, are difficult to value from a transfer pricing perspective.