In the day-to-day activity of a company there are operations of different nature, such as a loan, an acquisition, or a sale… These businesses can be catalogued as related-party transactions, with the consequent obligations before the tax administration. To avoid incurring in administrative infractions and their consequent penalties we are going to explain what related-party transactions are and what documentation we must provide to justify the prices of these transactions.
What are related-party transactions?
We can define related-party transactions as those commercial transactions that are carried out between individuals or legal entities that have some kind of relationship, whether family, participation or shareholding.
They are considered special transactions due to the existing link between the parties involved and the possibility that the agreed prices do not reflect market conditions. They require an exhaustive control and a specific treatment to reduce the risk of tax fraud and, therefore, they must be disclosed in form 232 of the Spanish National Tax Agency.
Who must document related-party transactions?
The Law itself specifies who must be considered as related persons or entities. Specifically, the regulations are contained in Article 18 of the Corporate Income Tax (Law 27/2014). Related persons or entities are those that meet the following criteria:
- A company with its partners or participants.
- An entity and the members of its board of directors, except for the remuneration they receive as consideration for their functions.
- A company or entity and the relatives by blood or affinity of the members of the board of directors or partners if this is less than or equal to the third degree in direct or collateral line.
- Commercial relations between two legal entities belonging to the same business group.
- An entity and the administrators or directors of another entity of the group.
- A company with another company in which it directly owns at least 25%.
- Two companies or legal entities in which partners or their relatives up to the third degree of consanguinity own a percentage greater than or equal to 25% of both.
- Relationships between a Spanish company or entity with its subsidiaries permanently established in foreign territory.
How to document the value of the Related-Party transactions?
In order to justify the arm’s length nature of the related-party transactions, the parties to such business transaction must submit a series of documents evidencing the market value of the transactions at the time they were carried out. Specifically, there are three types of documents that must be prepared, depending on a series of factors:
- Local File: this is mandatory for all companies and permanent establishments that carry out related-party transactions and follows an internationally harmonized content. For those related persons or entities whose Net Turnover is less than 45 million euros (or belong to a group that exceeds this limit) and do not deal with specific operations, this documentation will have a simplified content.
- Master File: All those entities whose turnover is equal to or exceeds 45 million euros (or belong to a group that exceeds this limit) must prepare group specific documentation, describing its structure, main activity, financial and tax activity, as established in article 16.1 of the Corporate Income Tax Regulations.
- Country by Country Report: those groups whose parent company is resident in Spain and whose turnover exceeds 750 million euros must file form 231.
What is the valuation of operations?
The verification of the market value principle explicitly involves the comparison of transactions carried out with related parties with those between independent parties in comparable circumstances.
How are related-party transactions valued?
Following Article 18 of the Corporate Income Tax Law 27/2014, Article 4 establishes the methods for valuing related-party transactions:
- Comparable uncontrolled price method: this is the most commonly used method. It consists of comparing the price of the good or service of the intercompany transaction with the price of the same good or service in a transaction between independent parties but in similar circumstances. If necessary, adjustments should be made to obtain equivalence and thus consider the particularities of the related-party transaction.
- Cost-plus method: this requires a more detailed calculation than the previous method. This method consists of adding to the acquisition value or production cost of the good or service the usual margin in similar transactions with independent customers or, failing this, the margin that independent individuals or entities apply to comparable transactions.
- Resale price method: This method is recommended for marketing activities. It consists of subtracting from the selling price of a good or service the margin applied by the reseller itself in comparable transactions with independent entities. Alternatively, the margin that other independent entities apply to comparable transactions. Once this margin has been obtained, it must be applied to the related-party transaction.
- Profit-split method: This method is recommended when the related party transactions are highly interrelated, and it is not possible to value them separately. It involves two different calculations, each one more complex than the other, to determine the total profit of the transaction and which part of the profit corresponds to each one. Therefore, it is only worth using it when high value intangible assets are involved. Article 18 of Law 27/2014 reflects: “It is assigned to each individual or related entity that jointly performs one or more operations besides the common result derived from such operation or operations, based on a criterion that adequately reflects the conditions that would have subscribed independent individuals or entities under similar circumstances”.
- Transactional net margin method: the objective is to obtain the price at which the related entities should value the transactions to determine a net market margin. This net margin would be calculated on costs, sales or the most appropriate amount depending on the characteristics of similar transactions carried out between independent parties. This method is quite similar to the cost-plus method and the resale price method.
However, Article 18.4 of the Corporate Income Tax Law provides for the possibility of applying other valuation methods whenever it is not possible to use the aforementioned methods. The only condition for this is that they respect the arm’s length principle.
Which related-party transactions are mentioned in form 232?
Following the Corporate Income Tax Law 27/2014, article 18.2 specifies which circumstances must be fulfilled in order to report related transactions in form 232:
- All related transactions with the same related person or entity must be reported where the total amount in the fiscal year exceeds the market value of €250,000 with this same person or entity.
- Specific related transactions when combined total amount in the fiscal year with the same type of transaction and valuation method, exceeds €100,000 per transaction. The following are considered as specific transactions:
- Business transfer transactions.
- Transactions regarding real estate.
- Transactions regarding intangible assets.
- Transactions with individuals who are taxed in modules where their shareholding, either individually or jointly with their relatives, is equal to or exceeds 25% of the capital or shareholders’ equity.
- Transactions of the same type and subject to the same valuation method, where the total amount of such transactions in the tax period exceeds 50% of the entity’s turnover, even if they relate to different persons or entities.
- Transactions involving the assignment of rights of use or exploitation of certain intangible assets such as patents, plans, formulas, etc., when the reduction in the tax base provided for in Article 23 of the Corporate Income Tax Law is applied.
- Transactions in connection with so-called tax havens, regardless of their amount.
TPS has a team of professionals specialized in related-party transactions and in the tax problems they may entail. If your company or firm needs help or clarification on compliance with reporting obligations through form 232 and other transfer pricing documentation, do not hesitate to contact International TPS.