Decrees Add to Transfer Pricing Compliance

Ana Suárez Capel.

April 2009 International Tax Review

New documentation rules in Spain mean that preparing a transfer pricing master file requires a methodical approach.

The documentation requirements for transactions between related parties established by Royal Decree 1793/2008 of November 3 (RD 1793/2008), amending the Corporate Income Tax Regulations (RD 1777/2004), came into force on February 19 2009.

These requirements are based on the Code of Conduct on transfer pricing documentation for group companies in the EU (passed by Resolution of the Council and of the representatives of the governments of the member states meeting within the council of June 27 2006 and published in the Official Journal of the EU C 176 on July 28 2006). When all the member states adopt provisions based on the Code of Conduct, this common source will ensure that the transfer pricing documentation is standardised and partially centralised and, thus, will simplify the transfer pricing requirements for cross-border activities within the EU.

The documentation requirements established by RD 1793/2008 are a set of basic information aimed at providing the tax authorities with sufficient knowledge, so that they can verify that the transactions between related entities have been carried out at a "fair market value", that is, at the value that would have been agreed by and between independent persons operating in a free competitive market, required by article 16 of Royal Legislative Decree 4/2004 of March 5, approving the revised text of the Corporate Income Tax Law (the Corporate Income Tax Law).

RD 1793/2008 structures the documentation requirements in two parts; on the one hand, the documentation requirements corresponding to the group of companies to which the taxpayer belongs (the common standardised information for all the EU group members is referred to as the Masterfile in the Code of Conduct and although RD 1793/2008 does not expressly use this term, it is used in practice to refer to the abovementioned documentation requirements) and, on the other hand, the documentation requirements specifically applicable to the relevant taxpayer.

If you leave to one side the criticisms placed on RD 1793/2008 for the disproportionate documentation requirements imposed on taxpayers to enable the tax authorities to assess and, as the case may be, prevent one of the parties from influencing or possibly influencing the price of a relevant transaction, in practice the degree of complexity of the documentation requirements resulting from RD 1793/2008 depends on the characteristics of the group and on the amounts and features of the transactions carried out.

From a practical perspective, the drafting of the group's Masterfile and of the relevant taxpayer's documentation must follow, in our view, a single methodology of three clearly distinct phases: Functional analysis, Economic assessment and Preparation of documentation.

Functional analysis

In this phase, all the information concerning the business and the organisational, legal and operational structure of the group of companies subject to the analysis is compiled to further assess whether the price of the related transactions is appropriate and consistent with the fair market value.

In this respect, the lawyer in charge of preparing the transfer pricing documentation should carry out a three-tier analysis in which each tier is clearly connected. The first tier would consist of identifying and describing the transactions in which the entities of the group are involved, either with related persons or with third parties. The purpose of the second tier would be to detect the related transactions from all the group transactions identified in the first tier, in order to analyse the nature, amount, flows, functions and risks assumed by the parties to such related transactions. Finally, the third tier would entail identifying the valuation methods already used by the group in the related transactions and analysing the reasons behind such choices.

In this phase, existing contractual documentation relating to the relevant transactions, as well as any other relevant documentation is analysed, including any information provided by the persons responsible for each of the entities of the group. This phase is probably the most detailed and time consuming. Moreover, this first phase requires close collaboration between the lawyer and the people in charge of the financial, legal and general management departments of the group entities.

Although the outcome of this phase is mainly descriptive, its importance is paramount since its results will serve as a basis, a source of information and necessary precedent for the subsequent two phases.

Economic assessment

In this phase, the fair market value of the related transactions identified in the functional analysis above is ascertained.

For the lawyer in charge of preparing the transfer pricing documentation, the economic assessment of the related transactions can be carried out, in brief, in three different ways, depending on the source of the relevant information and the economic analysis to be carried out, pursuant to the valuation methods for related transactions set out in article 16.4 of the Corporate Income Tax Law. These methods are the standard OECD transfer pricing methods, that is, the comparable uncontrolled price method, the cost plus method, the resale price method, the profit split method and the transactional net margin method.

The first alternative allows for the economic valuation analysis to be prepared and carried out by the relevant group by its own means. Another alternative is for such valuations to be requested and provided by external analysts. And, finally, the use of both alternatives may be combined.

Undoubtedly, the choice of the alternative to be used will depend on the group under analysis. In all cases, the lawyer will be responsible for including the analysis carried out and results obtained within the transfer pricing documentation to be prepared in accordance with RD 1793/2008 (as a part of the next phase concerning the preparation of the documentation).

The group companies themselves are in the best position to know the features and particularities of their market and have the best access to the necessary information and relevant comparables pertinent to their business. Consequently, in our view the third alternative would be the best option, as it is more comprehensive and reduces costs. Indeed, ignoring the people in charge of the entities under analysis at the time of the economic assessment is a mistake that could ruin a high quality analysis already carried out or the possibility to carry out an analysis at a low cost using the experience and files of the group companies' staff. Therefore, the alternative we usually follow is to plan the assessments and economic analysis to be carried out, assigning to this task the most efficient people or entities in terms of price and quality. Conversely, and to the extent that this requires external services for the most particular or specific assessments -regarding which the group's staff tend to have less experience-, regular economic analysis suppliers for clients may easily be incorporated into the relevant working groups, benefiting from their experience and previous knowledge.

Notwithstanding this, many clients prefer the second alternative, hence to outsource the economic assessment work which will then be included by the lawyer in charge into the transfer pricing documentation. The reason is that through this alternative, the preparation of transfer pricing documentation becomes a sort of turnkey task that prevents the group's key personal from being fully involved in the drafting of the documentation. However, it is exactly this absence of internal compromise which deprives the documentation (and the work as a whole) of this notch of extra quality and total observance of the transfer pricing analysis applicable to the relevant client, due to the lack of references and strategic guidelines provided by the person entrusting the work.

Preparation of documentation

In this phase the final product is prepared, that is, the transfer pricing documentation is drafted in accordance with the criteria set out in RD 1793/2008. In this regard, the value of the transfer pricing documentation relies on it being inmediately available to the tax authorities at any time, without requiring last minute amendments of any kind.

From a practical perspective, once the previous two phases have been completed, this third phase entails the transcription of the results obtained in the previous phases as set out in RD 1793/2008.

Exceptions to the documentation requirements

In relation to the specific documentation requirements established by RD 1793/2008, it is worth mentioning that transfer pricing documentation will not be required in respect of the following transactions:

  • Those carried out between entities that belong to the same tax group,
  • Those carried out by economic interest groups (Agrupación de Agrupación de Interés EconómicoInterés Económico, AIEs) or temporary joint venture entities (Unión TemporalUnión Temporal de Empresas, de Empresas, UTEs) with their members, and
  • Those that are the subject of takeover bids or a public offering process for sale.

For related transactions other than these, RD 1793/2008 requires the inclusion of this information:

Information to be included in the Masterfile

The following information must be included in the documentation related to the group:

  • General description of the group's organisational, legal and operational structure,
  • including any relevant changes thereof;
  • Identification of the different group entities which are engaged in related transactions, as far as such related transactions affect, directly or indirectly, the transactions carried out by the taxpayer;
  • General description of the nature, amounts and flows of the related transactions carried out between group entities, as far as such related transactions affect, directly or indirectly, the transactions carried out by the taxpayer.
  • General description of the functions performed and risks assumed by the different group entities, as far as they affect, directly or indirectly, the transactions carried out by the taxpayer.
  • List of the ownership of patents, trade marks, brand names and any other intangible assets, as far as they affect, directly or indirectly, the transactions carried out by the taxpayer, as well as the consideration derived from the utilisation of such intangible assets.
  • Description of the group's inter-company transfer pricing policy, including a description of the transfer pricing methods used.
  • List of cost contribution agreements and services agreements between group entities as far as they affect, directly or indirectly, the transactions carried out by the taxpayer.
  • List of advance pricing agreements and mutual agreement procedures entered into or being negotiated into as far as they affect, directly or indirectly, the transactions carried out by the taxpayer.
  • The group's annual report or, in its absence, any equivalent annual report.

The documentation requirements for the group set out in RD 1793/2008 have been criticised for being disproportionate, excessively costly and, sometimes, impossible to fulfil (for instance, if the multinational group is unwilling to reveal information to its Spanish subsidiary). In our view, this criticism can be refuted by making reference to the wording "as far as they affect, directly or indirectly, the transactions carried out by the taxpayer", introduced by RD 1793/2008 in each of the requirements referred to. The Code of Conduct points towards the same conclusion when it expressly states that "Member States should not request information that has no bearing on the transaction under review". Therefore, and from a practical perspective, the group's documentation or Masterfile shall contain the information on the group required by RD 1793/2008, only to the extent that it affects the Spanish company or companies belonging to the group.

Information to be included in the documentation related to the taxpayer

The following information must be included in the documentation related to the taxpayer:

  • Name, , tax domicile and tax identification number of the taxpayer and of the persons involved in the transaction, as well as a detailed description of the nature, characteristics and value of the transaction.
  • Comparability analysis. The comparability analysis is described in article 16 of RD 1777/2004 and must be carried out for the purposes of determining the fair market value of the related transactions. By way of the briefest of explanations, this analysis consists on the comparison between the circumstances of the related transactions and circumstances of the transactions carried out between independent parties that may be viewed as similar on the basis of five factors: analysis of the characteristics of goods or services, functional analysis, contractual terms analysis, market analysis and the analysis of any other relevant circumstances such as the commercial strategies.
  • Explanation of the method used to determine the arm's-length value, including a description of the reasons justifying the choice, as well as a description of the application of such method, and specification of the value or range of values deriving from its application.
  • Cost sharing criteria of services provided jointly in favour of certain related persons, as well as the corresponding agreements, as the case may be, and cost sharing agreements.
  • Any other information at the taxpayer's disposal which may help to assess the related transaction, as well as any existing shareholders' agreements.

In an attempt to follow the provision of the Code of Conduct which intends "not to require smaller and less complex enterprises (including small and medium-sized enterprises) to produce the amount or complexity of documentation that might be expected from larger and more complex enterprises", RD 1793/2008 establishes that only the requirements set out in the first and last bullet points are applicable to small and medium size enterprises. However, RD 1793/2008 also imposes on such small and medium size enterprises the obligation to identify the method or methods used and the range of values derived therefrom. Thus, it constitutes a futile attempt to reduce the documentation requirements applicable to the small and medium size enterprises, since they nevertheless have to carry out the comparability analysis set out in Article 16 of RD 1777/2004 and referred to in the second bullet point of this section.

All the documentation requirements concerning either the group or the taxpayer must relate to the tax period in which the taxpayer has carried out the relevant related transaction or transactions with other group companies. In this regard, if the documentation prepared for a relevant tax period continues to be valid for subsequent periods, it will be unnecessary to prepare new documentation, without prejudice to the updates and new contributions that may have to be introduced.

The documentation required by RD 1793/2008 must be at the disposal of the tax authorities from the final date of mandatory filling of the corporate income tax returns.


The Corporate Income Tax Law foresees two serious infringements concerning related transactions:

  • failure to provide the mandatory transfer pricing documentation, or providing incomplete, inaccurate or false documentation; and
  • failure to use the value resulting from the documentation on the relevant tax (corporate income tax, personal income tax or non-resident income tax).

The first infringement seems logical, while the second one is more questionable since it requires the existence of a divergence between the value resulting from the documentation and the value applied by the taxpayer in its relevant tax form. This new type of infringement again reiterates the importance of coordinating phase II, Economic assessment, and III, Preparation of documentation, and of the involvement of the key persons on the relevant companies for the preparation of the transfer pricing documentation.

Penalties resulting from these infringements are calculated depending on whether or not the tax authorities make transfer pricing adjustments when checking the related transactions pursuant to article 16.2 of the Corporate Income Tax Law.

In this regard, if the tax authorities do not make transfer pricing adjustments to the related transactions, the sanctions imposed will consist of a fixed penalty of €€1,500 per data ($1,933) or €€15,000 ($19,334) per set of data omitted, inaccurate or false included in the transfer pricing documentation regarding either the group or the taxpayer.

In contrast, if the tax authorities make transfer pricing adjustments to the related transactions and the relevant group or taxpayer has committed either of the infringements, the penalty will amount to 15% of the amount resulting from the valuation adjustments, with a minimum of two times the penalty derived from the application of the first criteria resulting from the absence of tax assessment by the tax authorities. This penalty is incompatible with the penalties that may be triggered from infringements such as failure to pay tax, non-fulfilment of the obligation to file the tax forms, unduly obtaining tax refunds and claiming or declaring either positive or negative amounts or apparent tax credits (articles 191, 192, 193 or 195 of the General Tax Law -Law 58/2003, respectively).

Finally, if the tax authorities make transfer pricing adjustments to the related transactions but the relevant group or taxpayer has not committed either of the two infringements, the taxpayer's actions would not be considered punishable as per articles 191, 192, 193 or 195 of the Law 58/2003. In brief, if the taxpayer fulfils all the transfer pricing documentation requirements imposed by RD 1793/2008 and declares the value resulting from such documentation in the relevant returns (corporate income tax, personal income tax or non-resident income tax), penalties will not be imposed even if the tax authorities make a transfer pricing adjustment to the fair market value resulting from the transfer pricing documentation.