07.06.

2013

Argentina: Tax Court Case Provides Guidance on Application of Functional Relationship Concept for transfer pricing analysis
Milton Gonzlez Malla, Manuel Val Lema and Pablo Godoy, Ernst & Young, Argentina
Akapol S.A. (the taxpayer) exported goods to its independent and exclusive distributor in Uruguay. Argentine Federal Tax Authorities considered it as related party transaction by applying the concept of functional relationship. However, the Argentine Administrative Tax Court ruled in favour of the taxpayer and provided guidance on application of the Functional Relationship Concept for transfer pricing purposes. Before we discuss the facts of the case and tax court ruling, it is essential to understand how related parties is defined under Argentine Income Tax Law (ITL). Argentine related parties' definition Transfer Pricing rules in general, are applicable to transactions between related parties. Several countries also include as part of the transfer pricing test, the transactions with unrelated entities located in tax havens. Noticeably, certain South American countries, starting with Argentina, also include the so-called functional relationship concept. OECD Transfer Pricing Guidelines are applicable to controlled transactions, which are defined in its glossary as Transactions between two enterprises that are associated enterprises with respect to each other. As per the same glossary, two enterprises are associated enterprises with respect to each other if one of the enterprises participates directly or indirectly in the management, control or capital of the other enterprise and /or the same persons participate directly or indirectly in the management, control or capital of both enterprises. Argentine related parties definition adopts a similar concept when the ITL defines that two parties are related if they are subject, in a direct or indirect way, to the direction or control of the same person. However, the ITL goes beyond this OECD concept when said definition also states that: or by means of their share in the equity, the level of debts, the functional influences or any other kind of influences, one person has the decision power to orientate or define the activity or activities of the other person . The first term of the definition is usually called economic relationship meanwhile the second portion is the so-called functional relationship. In this regard, the Argentine Tax Authorities General Resolution 1122/01 included in one of its annexes several points under which the related party criteria is considered to be configured. It is worth mentioning that said list is not an exhaustive one because it includes terms like among others. The case of Akapol S.A. In a recently announced Tax Court Case of Akapol S.A., the Argentine Administrative Tax Court provides some guidelines regarding the concept of Functional relationship.[1] The facts of the case and ruling of the tax court are summarized in following paragraphs. Facts of the case The taxpayer had an exclusive distribution agreement signed with an independent company located in Uruguay. Under this agreement, the foreign entity was entitled to the distribution rights in certain countries of the finished products exported by the taxpayer. Argentine Tax Authorities assessed a Transfer Pricing adjustment by arguing that the export price agreed by the taxpayer with its exclusive distributor was lower than the price in comparable uncontrolled transactions. The Tax Authorities concluded that the relationship between the taxpayer and its foreign counterpart fall under several points
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of the related parties definition stated in General Resolution 1122/01 (General Resolution), such as: The Uruguay entity was an exclusive distributor of the taxpayer. Thus the arrangement satisfies point (e) of the General Resolution which reads as follows: e) A person has exclusivity as agent, distributor or concessionaire to purchase and sell goods, services and rights on behalf of another person ; Preferential terms, in relation to the exports to other clients, specifically due to the lower prices agreed upon: h) A person agrees with another contract covenants of a preferential nature compared to those granted to third parties in similar circumstances, such as discounts for negotiated volumes, financing of transactions, deliveries on consignment, among others; The taxpayer assumed the expenses related to the advice to be given by the taxpayer to its exclusive distributor and / or to the clients. Accordingly, such arrangement falls under point (l) of the General Resolution which reads as follows: : l) A person bears the losses and expenses of another person ; The agreement stated that the taxpayer would advise its exclusive distributor and / or its clients about advertising, sales systems, stock policies and other aspects, in order to optimize the image of the products and their sales volumes. Such terms of the agreement satisfy point (f) of the General Resolution which reads as follows : f) A person provides another with the technology or know-how which are the basis of his/her/its activities, on which the latter carries out its business; Tax Court Ruling The Tax Court ruling states that General Resolution details a set of assumptions that allow inferring the existence of a relationship, although obviouslythey do not imply the amendment of the concept as defined in the norm (i.e. the Income Tax Law). The key element when dealing with the functional related parties concept is defining, if the situation under study falls or not under said concept, based on the analysis of the capacity of one enterprise to define or orientate the activities of the other one. In this regard, the Tax Court concluded that While there is an exclusive agreement for the purpose of distributing Akapol products, and the Argentine Company assumes the costs related to the ordinary counseling of its exclusive distributor and / or its clients on aspects related to the image of the products and increase their sales volumes , it is not observed the existence of a business relationship that reveals a subordination either directly or indirectly to the direction or control of one over the other, nor the power of decision to guide or define the activity or activities, as required by the tax law. (underlined by us). Therefore, according to the court case, even if a certain identity of business interests is reached by the companies as a result of the exclusive distribution of the products in question, this is not enough to prove the economic conjunction necessary for the purposes of applying the transfer pricing regime, since it has not been proven the ownership by one of these companies for a significant portion of the equity (in Spanish patrimonio) of the other, or the identity of the components of both companies in terms of business direction or profit distribution. It has also not been proven that there had been a substantial participation in the mutual interests, so that there is a common use of the personal, tangible or intangible assets (in Spanish medios) so as to suppose that the decisions of one of the companies are conditioned by the will of the other. Accordingly, because the parties cannot be considered as related parties as defined in the ITL, the transfer pricing rules are not applicable and therefore the assessment is overruled. Impact Although the factual situations detailed in Argentine Tax Authorities General Resolution allow inferring the existence of relationship, they are not absolute ones because they are subordinated to the terms included in a higher rank norm like the ITL. Therefore, the key element in order to consider that a functional relationship is in place is the capacity of one entity to define or orientate the activities of the other entity.
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Authors: Milton Gonzlez Malla is a Partner at Ernst & Young, Argentina. He may be contacted at: milton.gonzalez-malla@ar.ey.com. Manuel Val Lema is an Executive Director of Ernst & Young, Argentina. He may be contacted at: manuel.vallema@ar.ey.com. Pablo Godoy is manager at Ernst & Young, Argentina. He may be contacted at: pablo.godoy@ar.ey.com.

[1] It should be noted that two other adjustments proposed by Argentine Federal Tax Authorities were under discussion in the present Court Case. However, such matters were not related to Transfer Pricing issues.

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