A great percentage of the international trade is represented by transactions between related parties, usually multinational corporations that transfer stock or services among their business units, which are located in many different countries. When this business units obey to a common commercial strategy, operations can be plan in order to locate the income source in those fiscal jurisdictions where the tax burden is lower, avoiding this way, that benefits be generated in high income tax countries.
The countries that integrate the Organization for Economic Cooperation and Development (OECD) have actively worked in the search of a legal mechanism that would provide a solutions to this phenomenon, with the aim that tax authorities be able to fairly apply their taxes on the income that has been produced in their own fiscal jurisdiction. This has been the origin of many guidelines elaborated by the OECD to establish norms that allow the adjustment of transfer prices between related parties to neutralize the shift of the place where the income was originated.
A transfer is a price set by a taxpayer when selling to, buying from, or sharing resources with a related person. A transfer price is usually contrasted with a market price, which is the price set in the marketplace for transfers of goods and services between unrelated persons. Multinational companies use transfer prices for sales and other transfers of goods and services within their corporate group.
To understand this concept better, the OECD considers two corporations to be related when one of them participates directly or indirectly in the administration, control or capital of the other; or if same persons participate directly or indirectly in the administration, control or capital of both corporations. he economic reason for which transfer prices are charged, is to be able to evaluate the performance of entities that belong to a group.
When charging prices for goods and services transferred within group, managers of those entities can take the best decision in choosing between buying or selling goods and service from or outside the group. On the other hand, the transfer price is often used, incorrectly, to denote the shift of taxable income from one business unit located in a high tax jurisdiction to another business unit of the same corporation, located in a low tax jurisdiction, through incorrect transfer prices that aim to reduce the tax burden of the main corporation.
Transactions within a firm are not set at open market prices, because they integrate other specific products/services, which permits the company to manipulate prices and increase costs, adapting them to get the most benefits on high income taxes countries. The price set in these kind of transactions between parts of a group are not the consequence of the functioning of the free market; for purely fiscal reasons, they are divert from those that would have been set by independent corporations in an analog situation.
From a tax point of view, the OECD recommends the so called "Arm's Length Principle" when dealing with transfer price aspects, according to which, related entities should carry out their operations between them in the same conditions as if they had made them with independent parties in market conditions. In this sense, almost every country, included Argentina, have provisions which give tax authorities enough powers to adjust transfer prices when they are diverted from this principle. It establishes that all adjustments should be made with regardless to any type of contract and intention by the parties to avoid the tax.
This provisions to fight tax avoidance have the purpose of dissuading companies on their attitude of translating income to related companies in foreign territory. This, through the sub or overset of the international transaction price. The OECD understands at the moment, that the base of the armi?? s length principle is the same treatment for multinational and independent corporations. Taking this as reference, when relations between two related parties have different conditions than those that would have been agreed on between two independent corporations, the benefits obtained by one of them could be taxed.
If the transfer prices are not establish in accordance with the armi?? s length principle, the tax obligations of the related companies would be different, as well as the income tax obtained by the involved countries. Nevertheless, other factors such as, different legislations, price and changes control, could also lead to a distortions. In the year 1943 the law for income taxes incorporated the international conceived postulates of the OECD, specifying that branches and other permanent establishments from foreign corporations had to be considered as independent units in order to determine the amount of argentinean income subject to tax.
Later, in 1977, the law incorporated the armi?? s length principle, when it defined that operations between a local corporation of foreign capital and the foreign party that directly or indirectly controls it would be considered as carried out between independent parties, whenever the conditions were identical or similar to the market normal practices between independent entities.