Transactions between related parties: Prior assessment consultations
Ecuadorian legislation on transfer pricing is closely aligned with the provisions issued by the OECD, although several aspects are adapted for a small country with very variable economic conditions, diverse taxpayers, and still in a plan of formalisation and tax culture in its taxpayers.
Ecuador adopted the Advance Pricing Agreements (APAs) determined by the OECD as an advance analysis of the operations subject to the transfer pricing regime to which the Tax Administration is exposed: the operations, methods, comparables, critical assumptions and relevant adjustments to remedy by common agreement the complex problems that such operations could create in a changing and dynamic business environment.
These agreements have been called "prior assessment consultations", which have been in force since 2014. The following is a summary of the general requirements that must be met for this procedure before the Internal Revenue Service:
- Designation of administrative authority to which the application is made
- Name and surname of the appellant, and tax identification number of the taxpayer he represents
- Address for notifications
- Details of operations subject to valuation, including names of related parties, approximate annual amount, country of residence, and type of operation
- Conditions for which they are considered related parties
- Identification of the tax regime, jurisdictions and tax rate to which the related parties are subject
- Methodological proposal by the contributor that includes: chosen method of analysis, chosen comparables, profitability indicator, and sources of information.
- For margin methods, indicate the results for the last fiscal year in respect of: full competition range, median, and result
- Details of the search made in databases to obtain comparables
- Copies of contracts, agreements or arrangements on which the transactions subject to valuation are based
- Balance Sheet and Income Statement of the last fiscal year of the consultant and its related parties
- The critical assumptions, facts or circumstances that may economically affect the valuation of Operations, whether or not they are under the control of the taxpayer
- Signature of the appearing party.
Once this procedure has been entered, the Tax Administration is empowered to carry out the information requests or additional reviews that it considers necessary in order to issue its resolution within a period of two years from the date of acceptance of the query. Once the resolution of prior assessment of transactions between related parties has been received, it will take effect in: three subsequent fiscal years, the current fiscal year and the previous fiscal year, provided that the income tax return has not been filed.
Although this ruling exempts the presentation of a Comprehensive Report or Transfer Pricing Annex in the terms established for the approved operations, taxpayers who are under the protection of a previous valuation must (in the month of June of each year) present a Report of application of previous valuation consultation before the IRS, detailing:
- The operations carried out in the period under protection of the approved methodology.
- Prices or profit margins obtained from the transactions, obtained from the operations of each year of application of the query.
- Behaviour description of the critical assumptions established in the methodology, and compliance with them.
- Methodological application description of the results of the year.
In the event of non-compliance with what is established, or having a variation in the facts or circumstances and the critical assumptions under which the operations were analysed within the previous valuation, the valuation resolution will be ineffective, which leads us to ask ourselves what will happen in this year 2020, in the face of an external factor that generated many changes in the economic and negotiation conditions between related parties due to the effects of the COVID 19. It is the responsibility of each taxpayer to validate the changes and notify the Tax Administration, so that through a modification or new consultation new results are obtained, to avoid contingencies before the control agencies.
Taxpayers in Ecuador have not seen as an alternative to carry out the previous valuation of their operations among related parties, based on fears of reflecting information to the control agencies, which could generate contingencies to the current management. In addition, due to the time taken to carry out the procedure , the circumsatnces in some businesses or sectors could have considerably varied, and the time invested in the process would be lost.
However, it must be taken into account that this analysis not only validates Transfer Pricing operations, but it is an indispensable step where taxpayers need to request an increase in the percentage of deductibility of expenses for royalties, technical, administrative and consulting services performed among related parties (which may only be deductible up to 20% of the taxable base), plus such expenses on an annual basis. However, with the prior assessment, they can request that this percentage be increased and the non-deductible expenses and the income tax value be optimised.
The benefits of the prior valuation consultation can only be applied to transactions subject to analysis by the Internal Revenue Service; therefore, it is important that all transactions with related parties in progress, and even those that are intended to be carried out, are included .
It is important to remember that the query must be taken into account until the last business day of March of each year, with the aim that the ruling is intended to be applied to the said exercise. The success of this process depends on carrying out an adequate analysis and supporting the transfer pricing study, so that the review by the Tax Administration is simple and supported, resulting in the approval of the transactions, or a higher deductibility limit of royalty expenses , technical, administrative and consulting services.