Post by José Alonso Aquino, Associate – Peru
As part of its ongoing efforts to enhance regulatory efficiency and foster a business-friendly environment, the Peruvian government has introduced significant updates to its transfer pricing framework. These changes aim to align Peru’s Income Tax regulations more closely with internationally recognised practices, providing greater clarity and security for businesses operating in cross-border transactions.
Transfer pricing, a critical tool for preventing tax avoidance in related-party dealings, is particularly relevant in today’s globalised economy. With the adoption of new methodologies and provisions, Peru is taking important steps to ensure compliance with the OECD guidelines while addressing the unique complexities of intangible assets and alternative valuation methods.
What is Transfer Pricing?
Transfer pricing refers to the methods and practices that tax authorities impose for determining the value of transactions between related parties or with residents of low taxation countries. This gain special importance in cross-borders intracompany transactions, were tax avoidance schemes can be applied. Many countries have implemented the Organization for Economic Co-operation and Development (OECD) guidelines to set forth an arm’s length principle and prevent distortion of taxable income through low-cost tax jurisdictions.
Income Tax Regulation for Transfer Pricing
The Peruvian legal framework has adopted the OECD guidelines for a long time, even using them as an interpretation source. As a general rule the value of transactions between related parties or with residents of low taxation countries must be determined by the following methods to ensure a price that reflects an agreement between unrelated parties:
- Comparable Uncontrolled Price (CUP): comparison between prices charged in a controlled transaction and comparable uncontrolled transactions. This is the most straightforward method.
- Resale Price (RP): assessment of gross profit margin of reseller that acquired goods by a controlled transaction to determine if it is comparable to the gross profit that could be obtained in an uncontrolled transaction. Frequently used for the valuation of resale of goods without any further processing.
- Cost Plus (CP): adding to the cost of providing goods or services in a controlled transaction an appropriate mark-up creating a profit margin that reflects market conditions. Commonly used for the valuation of semi-processed goods or services.
- Profit Split (PS): assessment of distribution of combined profits obtained in one or more controlled transactions to determine if it was done in the proportion in which it would have been assigned in market conditions. This method mostly considers non-unique contributions made by the related parties like costs, sales, assets and risks.
- Residual Profit Split (R-SP): like the PS method but the profits made from intangible assets are separated from the combined profits distribution. Then such profits are distributed considering the contributions to such intangible assets under market conditions. Mainly used for the valuation of unique contributions made by the related parties.
- Transactional Net Margin (TNM): comparison of profits made in controlled transaction and comparable uncontrolled transactions, based on profit level indicators that consider assets, sales, costs, expenses, cash flows and other variables.
These are the methods expressly included in the OECD guidelines which can be divided in the ones that are applicable to common transactions (CUP, RP and CP) and the ones that apply to complex transactions (PS, R-SP and TNM). Either way both require comparable uncontrolled transactions or profits gained by similar business models under market conditions. Therefore, to cover other methods that adequately represents better the economic reality behind transactions, the guidelines allow the application of alternative methods.
Until 2016, the Peruvian regulation did not permit the application of alternative methods, forcing taxpayers to only apply the OECD main methods. Even though nowadays the relevant statute includes an express authorisation to apply alternative methods, the tax authority has been reluctant to allow it considering that the main methods have priority over any alternative method.
Alternative Methods for Intangible Assets
From 1 January 2025, transactions that by their nature or lack of comparable uncontrolled transactions cannot use the main methods will be able to apply alternative methods if (i) the price follows what would been agreed in an uncontrolled transaction and (ii) represents better the economic reality behind the transaction.
This new regulation specifically authorises the application of the following methods to determine the value of transactions involving stocks not listed in any stock exchange or trading venue:
- Discounted Cash Flow (DCF): estimates the value of an investment using its expected future cash flows.
- Relative Valuation Model: compares a business entity’s value to that of its competitors or industry peers through financial ratios, such as price-to-earnings (P/E) or EV multiple (EV/EBITDA).
- Net Asset Value: determined by subtracting the business entity’s liabilities from its assets. Both liabilities and assets valuation are adjusted to market conditions.
- Appraisal Value: appointed appraiser inspects, studies and analyses the qualities and characteristics of the stock to establish its value.
In the case of other intangible assets, the new provision allows the application of the same methods used for stock of closely held companies, but additionally allows the Multiperiod Excess Earnings Method (MPEEM). Like DCF, MPEEM quantifies cash flows discounted to present value but focuses on the ability of certain intangible assets to generate them. That is why MPEEM is frequently used for the valuation of patents, trademarks, customer relationships & databases, among others.
Restrictions on the alternative methods
It is important to flag that the new provision restricts the application of alternative methods with the following conditions:
- DCF method can only be applied if (i) seller holds less than 5% of the stock of the legal entity whose stock are being transferred, or (ii) net income accrued in the previous taxable year by the legal entity whose stock are being transferred not exceed 1700 Peruvian Tax Units (UIT) (estimated of US$ 2’328,458.00). These requirements can be changed by decree.
- Prepare a technical report supporting the price of the transaction and includes the minimal information required in the regulation.
Conclusion
The express inclusion of more internationally recognised methods for transfer pricing in the Peruvian statutes is a step forward to create a secure and inviting legal framework for investors and businesses. By explicitly including alternative valuation methods for intangible assets and closely held stocks, the Peruvian government has created a more adaptable framework that better reflects the economic realities of modern business transactions.
These updates are particularly noteworthy as they offer businesses operating in Peru the ability to address the complexities of transactions involving unique or hard-to-value assets. This aligns Peru more closely with neighbouring jurisdictions, such as Chile, Argentina, and Colombia, which are more flexible in accepting alternative methods.
While there are limitations on the alternative methods, the reforms are certainly a step forward in fostering a transparent and predictable tax environment, making Peru a more competitive destination for international investment. Companies are advised to work closely with legal and tax experts to fully leverage these changes while minimising risks.