The world is changing and with it, people change their natural and legal status (companies, societies, associations, foundations, etc.), change their personal relationships, and consequently change their social and commercial relationships. With so much change, nothing is certain in life, except for two things that the president of the United States George Washington mentioned in a letter addressed to Jean-Baptiste Leroy in 1789: “… you cannot be sure of anything except death and taxes.”  Tributes and taxes have been with us since very early in history, and their laws, regulations, and doctrine have been evolving through the times, adjusting to all these changes locally and internationally. On this occasion, we will explain the regulations that regulate transactions and prices agreed to between related companies, better known as “transfer pricing.”


What is Transfer Pricing?

The Organisation for Economic Co-operation and Development (OECD) defines transfer pricing as the prices at which a company transmits material goods and intangible assets or provides services to associated companies. (OECD, 2010)

In other words, it is the price that is agreed for any transaction that exists between related or associated companies, these can be both locally and internationally. We can ask ourselves, why should commercial relationships between companies that are related or “sisters” be subject to tax studies and regulations? Because the prices of services or tangible or intangible goods could be different from those that independent companies had agreed upon, which are governed by market forces and their conditions; due to the fact that there is a relationship between the companies, they can manipulate these transfer prices, resulting in a way to be able to pay less.

For example, imagine that a Honduran company sends its profits, disguised by manipulating the price they pay for a service to a related company, to a country where there is low or favored taxation, thus paying less than what should be paid in their country of origin and maximizing its utility or benefit in its entirety or failing to obtain any benefit; same that could be avoided if the prices paid or agreed were similar to those that would exist between totally independent parties.


Transfer Pricing Regulations

The OECD is an international cooperation agency with the objective of coordinating the economic and social policies of its members. In 1963, the OECD Transfer Pricing agreement was approved, which has been reformed and updated over time, the last update is that of 2017. There are currently 36 members of this organization that are governed by the guidelines of the OECD. However, most of the non-member countries have taken these guidelines as a reference to create their own regulations, making the OECD guidelines the standard for transfer pricing practices.

Problems that exist in terms of transfer prices should be analyzed in two ways: (1) in the manner in which multinational companies set transaction values ​​between groups, assigning the tax burden to each of them, as a strategy or tax planning; and (2) following the worldwide consensus on the part of developed and developing countries, whether the evaluation of transfer prices is in accordance with the principle of Free Competition / Full competition, commonly known as “arm’s length”, which the OECD defines as “the price that would have been agreed between unrelated parties, who participate in the same transactions or similar transactions, under the same conditions or under similar conditions, in the open market.” Therefore, tax administrations or studies must evaluate the transactions between related companies as if they were made between independent parties.  In the case that the profits are not similar as if they were between independent parties, the applicable jurisdiction may adjust them and tax the transaction under the terms of the principle of free competition.

Regarding the Principle of Free Competition, it is worth mentioning that there is no real answer about the market value of an international operation. Therefore a margin must be established between the results when making comparisons of a related company and an unrelated one. For example, suppose we have company A, which gives a loan to company B (a company within its same group) and for this loan company B must pay an interest rate of 25%. If, at the time of verification before the World Bank or bank commissions the interest rates of loans between companies have a low of 5%, an average of 10% and a maximum of 15%, we can argue that the rate that A charges to its linked company B is above the corroborated margin and therefore there is a problem with the transfer pricing.

In order to determine the linkage of companies, we can divide it into formal and functional linkage. Formal would be when there is a shareholding, control or dependence of one company with another, and functional is when a group of companies share management boards and have a significant influence on decision making.

There are different methods to determine if the transactions between related companies were in accordance with the market price. However, the OECD guidelines propose five methods of analysis, which are grouped into two categories, traditional methods, and non-traditional methods.

Within the traditional methods we find:

  1. The Comparable Uncontrolled Price (CUP) compares prices for the provision of services or the transfer of tangible or intangible assets (know-how, trademark rights, etc.) that are controlled, with those that are not controlled (in the case of third parties or market price between two unrelated companies).
  2. Resale Price Method (RPM) verifies the price or market value of goods purchased from a related company and subsequently sold to a third party. In this case, the price is not compared, permitting the profits obtained from the sale of the goods to be higher depending on the price at which it was purchased, for example, from distributors, commission agents, etc.
  3. The Cost-Plus Method (CPM) compares the mark-up on costs to produce the goods that the manufacturer or service provider earns from a controlled transaction to a comparable uncontrolled transaction.


Non-traditional methods. In case that traditional methods cannot be applied or because of the complexity of the transaction the following methods apply:

  1. Division of the Benefit of the transaction determines the operating profit (operating income minus costs and operating expenses) that all members of the economic group (related companies) had and compared with the income they would have had in the case of sharing operating profits between independent companies.
  2. The net margin of the transaction determines and compares the sales performance between transactions of related companies and between unrelated companies.


There is a sixth method that is used in Latin America, that of the evaluation of commodities, which is about objects or goods with a known price in transparent markets, stock exchanges or similar; for example, gold, coffee, bananas, among others.

As one can see, due to the constant changes in commercial relationships, the management of groups of companies, economic groups and tax planning around the world, tax laws and regulations must adjust to the reality in which we live, and in the case of transfer pricing regulations, we can argue that it is the present and future of the tax world.


Fernando Gómez.