Chile Taxation- Managing Transfer Pricing
Transfer pricing is the exercise of pricing transactions internally between related businesses and/or subsidiaries that operate under common control or ownership. It is an important concept in international taxation since most companies will provide services or goods between related companies. Where we document the profit will determine which company pays the related taxes.
Transfer pricing poses a significant risk to companies who are operating internationally since many countries are looking at these arrangements to ensure that profits are not being shifted to lower tax jurisdictions unfairly.
It is important that companies understand how transfer pricing works in every country they are operating in. Chile is no different and companies with operations in the country need to understand how transfer pricing is defined, what responsibilities they have, and what risks they need to watch for.
What is the definition of Transfer Pricing in Chile?
Chilean Income Tax Law (LIR) defines transfer pricing as: “normal market prices, securities, or returns defined as those that have or would have been agreed or obtained by independent parties in comparable operations and circumstances, considering, for example, the characteristics of the relevant markets, the functions assumed by the parties, the specific characteristics of the goods or services contracted and any other reasonably relevant circumstance”.
In short, the Chilean office wants to ensure that prices set between related parties are based on market rates for similar operations under comparable circumstances.
What is meant by related parties?
In most cases, it is quite clear what is meant by related parties but there are times when it is more ambiguous such as when a company operates through an agency or branch. The Chilean Income Tax Law (ITL) defines related parties based on the following examples –
- when one of the parties is directly or indirectly involved in the management, control, capital, profits or income of the other;
- when transactions are carried out between an agency, branch or any other form of permanent establishment and its head office which is located in another country;
- in transactions where the parties to the agreement are residents, domiciled, or incorporated in a country, territory or jurisdiction that is considered to have a preferential tax treatment (tax haven) in accordance with Art. 41H of the ITL, unless said country signs an agreement with Chile that allows for the exchange of relevant information;
- individuals who are married or are related by consanguinity or affinity up to and including the fourth degree, etc.
When can the Chilean Tax Office challenge the prices set between related parties?
The Chilean tax office (SII) may challenge the prices, securities or returns declared by taxpayers for any cross-border transactions. The tax office can then establish normal market values in accordance with the procedures and methodologies established by law. In addition, the SII may also challenge the prices, securities, or returns set by the companies or establish them if they were not set when there are business reorganizations or restructurings between a Chilean taxpayer and its related counterpart abroad.
In order for the Chilean tax office to challenge the transfer pricing they must summon the taxpayer according to the rules of the ITL. They will use one of the following internationally recognized methods to determine whether the rates are fair: i) Comparable uncontrolled price; ii) Resale price; iii) Cost plus margin; iv) Profit division; v) Net margin trading; vi) Residual methods. The latter will only be applied in case none of the previous methods is applicable.
In short, the Chilean tax office has broad powers to challenge the prices set by companies for all related transactions. The result is that companies need to be able to defend the rates they use between related parties to prove that they are in fact market rates. The only acceptable way to do this is through a transfer pricing report that uses one of the above methods to determine the true market rate.
What are the obligations of companies who enter into agreements with related parties?
Chilean Income Tax Law (LIR) has established certain obligations to which taxpayers domiciled, residents or established in Chile must adhere to –
Corporate reorganizations or restructurings must submit annually the affidavit (AF) Nº. 1970 on transfer pricing. In order to do so, they must meet certain requirements; taxpayers must belong to medium or large companies; or those who, without being included in said segment, have carried out transactions with related parties with no domicile or residence in Chile for amounts exceeding five hundred million pesos, or their equivalent according to the exchange rate; or those who, without being included in the aforementioned segment, have transactions with persons domiciled or resident in a country or territories considered as tax havens or in preferential tax regimes.
In addition, the SII established the obligation for taxpayers to submit another affidavit that complements the information contained in the previous affidavit, called a “Country by Country Report”, contained in Form 1937 of the SII. This affidavit is mandatory for taxpayers who are considered a parent or controlling entity of multinational enterprise groups as regulated in Resolution Ex. Nº 126 of the SII of 2016 and its annexes. The deadline for submitting both affidavits is the last business day of June each year.
Finally, there is a mechanism that allows taxpayers to propose to the SII an advance agreement regarding the determination of the price, value or normal market return for cross-border transactions with related parties. They are called “Advanced Transfer Pricing Agreements” or “APAs”, which must follow the procedure stipulated in the law, accompanied by a Transfer Pricing Report or Study using one of methods set by the tax office.
In short, companies will be required to submit affidavits each year which will need to be completed by qualified accountants. It is not required to submit a transfer pricing study but if a company is reviewed then this will be the first document that the tax office requests to prove the prices that were set between the related parties.
Some companies may choose to enter an “Advanced Transfer Pricing Agreement” with the tax office with the goal of reducing risk should they be audited in the future. This will typically be done by large companies who have substantial transfer pricing between their related entities.
Finally, taxpayers who do not file their affidavit on time will be subject to fines which range from 10 to 50 UTA (Annual Tax Units), around USD$800 and USD$4400. The fine can be increased substantially by between 50% to 300% of the avoided tax if the declaration was considered maliciously false.
Transfer pricing poses a significant risk to companies operating internationally. Each country will be slightly different in what is required for their transfer pricing laws. For this reason, it important that companies understand their obligations.
Companies entering into agreements or transaction with related parties need to set their prices in line with market prices based on “Arms Length Principle”. That is, the prices fixed in such contracts need to be market prices that would have been agreed by independent parties in similar transactions and under comparable circumstances. All transactions need to be supported by a written agreement.
To prove that a price or market value has been fixed according to market rates, companies need to be able to provide the tax office with support of how they came up with those rates in case they are ever challenged. There are certain transactions that have a comparable market as a reference, and in that case, the SII will for the most part will not object to those prices or market values as they are relatively straight forward and easy to determine.
However, when the operations that are more complex or are more subjective because they are between non-independent parties, the SII may dispute their values. It is in these cases that it is important to have a “Transfer Pricing Study or Report” so that the rates chosen can be defended against the Chilean tax office. The report will reflect what an independent third party has agreed should be the value or price in a cross-border transaction with similar characteristics and under similar conditions.
For larger transactions involving high values, it is also recommended to consider the possibility of entering an APA with the Chilean tax office.
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