Transfer Pricing Adjustments
Audits focusing on compliance with the arm’s length principle in related-party transactions are becoming increasingly frequent, both within international and domestic corporate groups.
In recent years, one of the most controversial aspects of these transfer pricing audits has been determining whether it is appropriate to adjust the profitability of transactions falling below (or above) the median to that median point, even if the result lies within the range of comparable outcomes.
OECD Guidelines occasionally consider that if the price of a related-party transaction falls within the range (the full range, not just the interquartile range), no adjustment should be made, given that “since transfer pricing is not an exact science, there will be many occasions when the application of the most appropriate method or methods will produce a range of figures all of which are relatively equally reliable. In such cases, differences between the figures within the range may be due to the fact that, generally, the application of the arm’s length principle produces only an approximation of the conditions that would be established between independent enterprises. It is also possible that the different points in the range reflect the fact that independent enterprises carrying out comparable transactions in equally comparable circumstances may not establish exactly the same price for the transaction.”
In this sense, using a full range of values in transfer pricing as a reference to determine whether the return obtained by a company aligns with market conditions is fully admissible. In fact, accepting any position within the range of values obtained in the economic analysis as valid is standard practice.
However, in professional practice, it is customary to use the interquartile range as a benchmark to eliminate the effects of extreme results. This practice is also explicitly reflected in paragraph 3.57 of the Guidelines.
The OECD considers that when it is possible to distinguish among various points within the range, “adjustments should be made to the point within the range that best reflects the facts and circumstances of a particular controlled transaction (paragraph 3.62 of the Guidelines).”
In commercial operations between two independent companies, remuneration normally reflects the functions performed, the risks assumed, and the assets used by each company; therefore, in related-party transactions, these same variables will determine the applicable point within the range in each case.
The Spanish Tax Agency (AEAT) has published a note “on various issues regarding the arm’s length range in transfer pricing matters,” where Section 5 outlines how the most appropriate point within the range must be selected.
The AEAT establishes that, starting from the premise that an arm’s length range exists, the Tax Audit cannot issue a tax assessment if the transfer pricing value declared by the taxpayer falls within that range. Conversely, if the conditions of the related-party transaction fall outside the range determined by the Tax Authorities, and the taxpayer fails to demonstrate that they comply with the arm’s length principle or lie within an arm’s length range, the Authorities will adjust the transaction.
Regarding the specific point in the range to which the adjustment should be made, ONLY if comparability defects persist will an adjustment to the MEDIAN be appropriate; however, the Tax Authorities must explicitly cite the existence of such defects.
This adjustment to the transfer pricing median, which the Tax Audit commonly applies almost automatically, is precisely what the National High Court (Audiencia Nacional) considers improper (SAN of March 6, 2019, February 4, 2021, and November 19, 2022).
In other words, to resort to the median, comparability defects must exist within the sample, and the burden of proof lies with the Tax Audit. If such defects are not substantiated, the adjustment must be made to the interquartile point closest to the margin obtained by the taxpayer.
This increasingly frequent conflict between the Tax Audit and taxpayers regarding transfer pricing requires taxpayers to maintain a robust transfer pricing policy, backed by an economic study sufficiently justified to withstand Tax Authority scrutiny, thereby avoiding double taxation scenarios unintended by the tax system.
At UHY Fay & Co, we have a specialized Transfer Pricing team capable of advising you during tax audit proceedings as well as in designing and implementing an appropriate transfer pricing policy within your corporate group.
For further information, please contact us:
- Inmaculada Domecq, Tax & Legal Partner: idp@uhy-fay.com
- Ángela Rodríguez de Tembleque, Transfer Pricing Partner: art@uhy-fay.com
