INSIGHT: Seven Sets of Challenges With a Single Fundamental Solution—Understanding Taxation and Transfer Pricing in Uruguay

Uruguay beckons. The nation has been attracting foreign investment due not only to its robust domestic marketplace, but also to its ability to service customers and affiliates from Brazil and Argentina. Meanwhile, the nation is also in the throes of implementing a wide swath of new transfer pricing regulations. Although the new regulations are modeled on Action 13 of the Base Erosion and Profit Shifting (BEPS) initiative from the Organization for Economic Cooperation and Development (OECD), there are some significant variations in local practice. Overall, investors in Uruguay need to familiarize themselves and address certain “local” transfer pricing peculiarities and associated challenges.

Challenges: Uruguay’s Local ‘Flavors’

Look first to the challenges. Uruguay’s national tax authority, the Dirección General Impositiva (DGI), oversees the taxation of international companies doing business in the country. In a number of areas multinational corporations (MNCs) need to pay particularly close attention to DGI requirements to avoid added assessments, penalties, or other difficulties.

Note that none of these issues is insurmountable—they can and should be dealt with proactively. Areas deserving close review and attention include:

• Documentation: A key element in today’s global transfer pricing environment is the need for contemporaneous documentation. Transfer pricing legislation has been applicable in Uruguay since July 2007, predating the OECD’s BEPS project. Although, local legislation is based on OECD guidelines, there are significant differences, which must be evaluated when preparing the transfer pricing documentation.

It is important to highlight that the transfer pricing report, and the corresponding form, must be filed with the DGI no later than nine months after the fiscal year end if the taxpayer’s transactions with related parties for the year analyzed exceed the threshold of $6.2 million (UYU 201 million for FY2018). If the transactions do not exceed this threshold, taxpayers have no obligation to file the transfer pricing documentation but nonetheless must retain the supporting evidence justifying the prices used and the analysis performed.

• Functional analysis: The functional analysis that the taxpayer performs should address the functions, risks, and assets that correspond to the reality of the business in Uruguay. Applying the principle of substance over form, the DGI will attempt to corroborate that the company’s functional analysis included in its transfer pricing analysis represents the actual substance of its business in Uruguay.

• Comparables: The issues relating to comparables are particularly nuanced in an Uruguayan context. Characteristics and practices requiring awareness include:

o Global comparables: Both taxpayers and DGI have historically generally relied on global comparables for transfer pricing analysis. There are special provisions for import and export transactions of goods in which prices can be determined through transparent markets, stock exchanges, or similar information. Uruguayan legislation states that when information exists regarding transparent markets or other similar information exists, those prices should be used as comparables for prices in related party transactions.

Although the use of global comparables is generally accepted, it is important to recognize that the DGI encourages the use of local comparables.

o Strict application: The DGI looks for comparables that are very similar to the related party transaction in both functions and product. Therefore, it makes sense to focus the comparable search to address the assets, risk, and functions performed by the product or service in the particular related party transaction, as opposed to an analysis simply based on similar industries.

o “Secret” comparables: What makes this analysis even more challenging is the DGI’s use of comparables that it cannot share. The DGI has access to the full spectrum of information on taxpayers doing business in Uruguay and will use such private confidential information to develop its comparables. The trouble for taxpayers is that DGI provides no access to this information because DGI cannot, and will not, share business’s private confidential information from such unrelated businesses.

• Allocation: If a company has two or more distinctive lines of business, a segmentation of the financial information should be performed to justify the profitability of each line. Costs and administrative expenses should be accurately allocated to each activity, according to the actual economic substance of each of the segments. In addition, proper support of the segmentation of financial information should be maintained to avoid controversies with the taxing authorities.

• Losses: DGI takes particular note of affiliates of the MNCs generating year-over-year losses. DGI is likely to perceive such losses as raising a “red flag” requiring further investigation. Authorities will then perform a rigorous functional analysis of local companies that perform similar activities and are generating a profit, and then propose an assessment based upon such local comparables.

It should also be noted that local tax authorities have little sympathy for episodic business losses. When a key customer defects, a critical employee leaves, or a fire or tornado disrupts operations, legitimate losses often ensue. In such cases, it is important to have proper support of the adjustments to the financial information considered in the transfer pricing analysis. Nonetheless, the DGI will often levy an assessment as though the company had remained just as profitable as in the past, leaving it up to the taxpayer/company to show why a lower assessment is appropriate. Note that this habit is common to many of the world’s developing economies.

• Related parties: Uruguay takes an expansive view of related parties. For example, any interactions between any two businesses with two or more shared directors on their boards are considered related party transactions. Moreover, if an MNC agrees to confer exclusivity to a local company, Uruguayan regulations on transfer pricing deem this a related-party relationship. Though this legislative approach is not common in the rest of the world, it is similar to the practices of Uruguay’s neighbor to the south, Argentina (as are many other elements of Uruguay’s tax administration).

• Country-by-country reports: In 2019, the DGI began requiring taxpayers within large multinational groups and with consolidated revenues exceeding 750 million euros to file an annual country-by country-report (CbCR), again largely in line with the OECD guidelines. However, Uruguay’s CbCR requirements are both demanding and well-specified, so that any company that meets these revenue thresholds needs to put substantial effort into making certain it clearly understand the CbCR requirements. Some companies may initially balk, not wanting to share intimate details relating to global and local operations, but not only are the fines substantial, but failure to comply can lead to business interruption, or even in some situation cessation of all operations.

How to Respond

Simple in concept but demanding in execution—all that’s needed in response to any of the above challenges is to recognize the need for strong local “flavor” to any Uruguayan transfer pricing strategies and accompanying documentation. Responding successfully to DGI challenges means taking the particular provisions of the Uruguayan transfer pricing legislation into account and making best efforts to develop an optimized and defensible approach.

Working with a team that is knowledgeable about local rules and practices is key. Those practitioners who are closest to the market will be familiar with the types of companies operating in the country and can help, often forensically, develop appropriate ranges or quartiles for comparability. Similarly, those practitioners who are familiar with local legislation as well as the review and local audit practices will know the proper terminology and tone to obtain good results in the local environment.

Though investing in Uruguay presents enormous opportunities, doing business In Uruguay also introduces MNCs to significant local transfer pricing-challenges. But with attention to detail and a concerted effort to develop Uruguayan-specific transfer pricing policies and related documentation—such challenges can be overcome.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

The views expressed are those of the authors and do not necessarily reflect the views of Ernst & Young LLP or any other member firm of the global Ernst & Young organization.

Martha Roca is a tax managing partner, Marianella Capoano is a senior manager, and Rafael Garcia and Natalia Olid are senior consultants in transfer pricing with Ernst & Young Sociedad Civil in Montevideo, Uruguay. Carlos Mallo is a senior manager, National Tax, transfer pricing with Ernst & Young LLP in Washington.