Taxpayers should ensure they have the documentation necessary to electronically file the new transfer pricing information return. Additionally, taxpayers should review the guide and follow the procedures outlined to ensure that they comply with the transfer pricing rules.

El Salvador's Tax Administration (TA) recently updated the technical specifications for the electronic filing of the transfer pricing information return, Form F-982 v4, Report of Related Party Transactions. This new version replaces the paper form that was filed in previous years. The TA also updated the General Orientation Guide (DG-01/2018) on the tax treatment of transactions with related parties.

Changes to Form F-982 v4

Form F-982 v4 consists of three windows in which the taxpayer must include information on related-party transactions, supporting documentation and the economic analysis of the transactions.

The changes to Form F-982 v4 require taxpayers to report the following information:

• Whether related-party transactions were analyzed on a transactional or aggregate basis
• Who the tested party is
• What types of comparables were used (e.g., internal or external)
• What profit-level indicator was used
• Whether a profit margin, percentage or price was tested
• Whether global or segmented financial statements were used, if financial information was used in the analysis
• Whether a single value or a range of values was tested
• Information on the comparables or interquartile range of comparables
• The result of each transaction and whether each transaction was at arm's length
• The amount of transfer pricing adjustment, if applicable

Taxpayers must file Form F-982 v4 electronically through the TA's website under the option of "Online Services DGII." The technical specifications for electronically filing are on the website.

In accordance with such specifications, before filing Form F-982 v4, taxpayers must prepare and maintain the documentation or the transfer pricing report that supports the information requested in the Form F-982 v4.

Article 124-A of the Tax Code requires taxpayers to file Form F-982 v4 if the related-party transactions equal or exceed US $571,429 annually. Taxpayers must file the form within three months of the end of the tax year. If a taxpayer fails to file Form F-982 v4, Article 244 literal (l) of the Tax Code establishes a penalty of 0.5% of the taxpayer's equity, as reflected on the taxpayer's balance sheet, minus any surplus on the revaluation of assets, or at least three monthly minimum wages of a single employee.When there is no balance sheet, or it is not possible to determine a taxpayer's equity, a penalty of nine minimum wages of a single employee applies.

General Orientation Guide on transfer pricing

The TA updated the General Orientation Guide (DG-01/2018) to facilitate the tax treatment of transactions carried out with related entities,¹ when determining transfer prices, withholding taxes and non-deductible costs and expenses.

The guide includes important elements for tax auditors to consider when complying with the established provisions regarding their review and opinion on transfer pricing.

The guide replaces Guide No. DG-001/2012 issued on March 21, 2012.

Comparability adjustments: Adjustments for accounting effects

Adjustments for accounting effects are intended to enhance accounting consistencies. The adjustments are made to income and/or equity reflected in the financial statements.

Comparability adjustments: Economic adjustments (working capital)

Economic adjustments are made to the financial information of the comparable companies to determine their results under the conditions of the tested party. Such adjustments are applied to accounts receivable, accounts payable, inventories and property, and plant and equipment.

The TA allows taxpayers to use different formulas for the working capital adjustments as long as the formulas are consistent with the adjustment's purpose. The adjustment calculations must be described, illustrated and justified as part of the transfer pricing documentation.

Also, the guide requires taxpayers to perform the transfer pricing analysis on a transactional basis. The application of a global analysis (i.e., taxpayer's total results), however, is allowed whenever a transactional analysis is not possible because the transactions are closely related or there is insufficient information.

The TA establishes that the transfer pricing analysis may include databases and public information from national or international institutions or entities if this information is obtained from reliable sources.

The guide also indicates that information on foreign currency should be converted into US dollars using the exchange rate in effect on the transaction date.

Transfer pricing methods

The guide establishes that taxpayers may use the technical methods included in the Tax Code and the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines). However, the description and application of the method indicated in Article 199 of the Tax Code, "the Market Price Method," have been eliminated.

It also contains a detailed description of all the traditional methods and the methods based on the operating results described in the OECD Guidelines, including the approaches on the total contributions and residual analysis as part of the profit split method.

The arm's-length range

The guide allows the use of the interquartile range as the acceptable or arm's-length range when applying the transfer pricing methods. The guide sets forth the methodology for its calculation. The TA is authorized to adjust any value outside of the arm's-length range (or acceptable ranges) to the median of this range.

Steps to apply the transfer pricing methodology

When applying any transfer pricing method, taxpayers should verify:

• They conducted transactions with related parties and that the transactions have economic substance.
• The transactions have a benefit and are necessary for the economic activity or business.
• The transactions are duly documented.
• The transactions are duly registered.
• The taxpayer withheld the applicable tax.

The guide also allows taxpayers to apply the steps recommended in the OECD Guidelines for the comparability analysis.

The appendices to the guide include examples to facilitate the identification of related or domiciled parties incorporated or located in countries, jurisdictions, states or territories with preferential tax regimes, regimes with low or zero taxation or tax havens. The appendices also include examples on how to perform the comparability analysis, application of adjustments for accounting purposes, adjustments to eliminate differences and economic adjustments.

Income tax withholding: Withholding for equity payment or crediting

Taxpayers should withhold tax on income in accordance with the provisions of Articles 72 and 73 of the Income Tax Law. The guide clarifies that the withholding tax stipulated in Articles 72 and 73 of the Income Tax Law will not apply if an exemption in Article 74-B applies.

Income tax withholding: Loan withholding

The guide establishes that taxpayers should withhold tax on loans in accordance with Article 74-A of the Income Tax Law. Taxpayers should apply the withholding tax to loans, unless the conditions established in numerals 1 through 5 of Article 74-A apply or the exemptions in Article 74-B apply.

Deduction of losses, interest, commissions and other payments

The guide establishes that taxpayers may not deduct losses incurred from operations conducted by related parties or entities resident in countries, states or territories with preferential tax regimes, or low or null tax regimes or tax havens.

In addition, taxpayers may not deduct interest, commissions and any other payments derived from financial operations when the lender is a related party residing in El Salvador that has not declared them as taxable income. Taxpayers also may not deduct payments that exceed the result of applying the average lending rate plus four additional points to loans if the lender is a related party or resident in countries, states or territories with preferential tax regimes, low or no tax regimes or tax havens.

Tax auditor obligations

The guide establishes that external tax auditors must note on the tax report that the prices or amounts agreed between the related parties were determined at arm's length.

The guide also establishes that tax auditors must disclose the following information in the notes to the financial statements accompanying the tax report and opinion:

• The nature of the relationship between the taxpayer and other entity as per Article 199-C of the Income Tax Law
• Transaction descriptions and amounts
• Amount of pending balances, including the terms and conditions (e.g., guaranteed or not), the nature of the compensation the taxpayer must provide on settlement and details on any guarantee granted or received
• Allowances for uncollectible debts related to the amount of pending balances
• The expense recognized during the period with respect to uncollectible debts, derived from or related to parties mentioned in Article 199-C

The external tax auditor also must establish whether the transactions comply with the following criteria:

• That the transactions provide a benefit and are necessary to the business activity (deductions must comply with the requirements of law in the case of expenditures)
• That the corresponding withholding tax was applied to the transactions

The guide establishes that the external tax auditor must document the audit in work papers, comprised of schedules and reliable documentation that contain data and information obtained by the external tax auditor in the examination of the tests carried out and the results that support the auditor's opinion.

Additionally, the guide establishes that the external tax auditor's opinion must include the following items to establish whether the transactions with related parties were conducted at arm's length:

• Determination of the market price, including the comparability analysis, adjustments performed, methodology used and supporting documentation
• Determination of whether Form 982 v4 was filed
• Determination of income tax withholding
• Determination of the non-deductibility of losses in transactions conducted by related parties or entities, domiciled in jurisdictions, states or territories with preferential tax regimes, or low or no tax regimes or tax havens
• Determination of the non-deductibility of interest, commissions and any other payment on financial transactions, insurance or reinsurance

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ENDNOTES

¹ Including entities domiciled, incorporated, or located in countries, states or territories with preferential tax regimes (low or no taxation) or tax havens.