Russia 2018 and the World Cup of Transfer Pricing

A competitive tournament – Russia 2018

October 10, 2017. 8:30 p.m.

It was a hot night in Asunción. Humid, stifling, but full of hope.

The Paraguayan national team was playing against its Venezuelan counterpart at home, and it wasn’t just a soccer match—it was a game that would determine whether they would qualify for the 2018 World Cup in Russia. After several setbacks—particularly in the qualifiers for the 2014 World Cup in Brazil—the Paraguayan national team found itself in a promising position. If they beat Venezuela—and with a few other favorable results—the team had a chance to qualify for the world’s premier soccer tournament after eight long, seemingly endless years. Expectations were high, and the match captured the attention of an entire country.

The Venezuelan national team was at a “disadvantage,” as it had already been eliminated from the competition, was fielding a reserve squad, and was playing away from home; but it was more willing to take risks. This situation encouraged the home team to play with confidence in front of their fans and dream of a victory that would catapult them to Russia 2018.

The game began.

The 90 minutes of play seemed to drag on, feeling like an eternity. The match saw many back-and-forth exchanges from both teams. One team, on the one hand, seemed anxious, unsettled, and under pressure, relentlessly seeking the goal that would give them the victory. The other, patient, organized, and calm, steadily built up their play and tested strategies to capitalize on any mistake by their opponent.

In the end, the night in Asunción would be anything but the one the local fans had dreamed of and longed for. A bewildered and unrecognizable national team faced a well-organized visiting squad that played a dynamic and agile game. The 84th minute would deliver the “final blow.” A skillful Yangel Herrera would be the executioner, with a goal that would mark the end of an era. The “Defensores del Chaco” stadium fell silent. Victory for Venezuela.

After the game, Paraguayan analysts, journalists, and experts sought an explanation for the disaster they had just witnessed. Yet another story of failure. The opposing team had played better—much better. The home team had succumbed to the pressure. The strategy hadn’t worked. The players hadn’t stepped up.

Perhaps, however, the explanation was much simpler: the Paraguayan national team simply wasn't up to the competition.

A Tax Tournament – Transfer Pricing Rules

Just as the South American Qualifiers—considered by many sports experts to be one of the most competitive tournaments in the world— in the field of international law—and, above all, in the field of international tax law—an “international tax competition” has been underway for several years now as a result of trade dynamics and the trend toward globalization among nations. This gave rise to what we now know as the regime of transfer pricing. A system that requires companies to remain competitive on the international stage.

So, what are transfer prices?

Transfer pricing is a way to mitigate the conflicts that may arise in the area of international taxation, but so far we have not defined or conceptualized the issue.

It is important to note that the issue of transfer pricing inevitably arises among multinational companies that operate in more than one jurisdiction. For example: a parent company in Country A and a subsidiary in Country B.

In light of this situation, the transfer pricing regime seeks to “prevent abusive pricing practices between related companies, generally with the ultimate goal of paying less tax, whether by selling goods (tangible or intangible) or services at prices higher or lower than market values.”[1] The transfer price, per se, is “…the unit price assigned to goods and services between the parent company and its subsidiaries, or between different divisions within the same firm…”[2]

This explanation may be a bit abstract, so let's look at an example to see how the process works and what, strictly speaking, the transfer pricing rules are intended to correct.

Let’s assume there is a French company, X, that manufactures vehicles. It has a subsidiary, Y, based in Paraguay, whose purpose is to resell the vehicles manufactured by X within the local Paraguayan market. Now, the subsidiary’s taxable income is determined by three variables: 1) the sale price to customers in Paraguay, 2) the inputs used (excluding the vehicles), and 3) the cost of the vehicles imported from the parent company in France. While the market determines the first two variables, the third depends exclusively on the internal management of the parent company and the subsidiary. Given that, assuming the parent company’s tax rate is higher than that of the subsidiary, the parent company will have an incentive to set the “transfer price” as low as possible in order to capture the profits generated by the subsidiary’s sales in the local market.[3]

This price manipulation has some well-documented adverse consequences. On the one hand, it creates this “tension” between jurisdictions, offering a tax advantage to multinational companies at the expense of tax revenue in the country harmed by this strategy (in the example, France). And second, this scheme gives multinational companies a competitive advantage over domestic companies, which are unable to take advantage of these benefits in their tax planning.[4]

In short, countries that do not have a transfer pricing regime are essentially at a competitive disadvantage compared to those that do, due to the distortions in taxation and tax collection that we have discussed.

Local Tournament – Paraguayan Law

As was to be expected, Paraguay—after a long wait—has finally become competitive in tax matters, bringing its transfer pricing regime into line with international standards.

In fact, following a few isolated provisions on the subject in previous years, Law 6,380/2019 “On the Modernization and Simplification of the Tax System” established a comprehensive body of tax legislation that incorporated a series of articles regarding the transfer pricing regime, and finally regulated the matter within our tax system. The regulations were supplemented by the recent Regulatory Decree 4,644/20.

If you want, let's take a closer look ex ante, Regarding the operational implementation of the system, we can note that Paraguayan regulations have been aligned with international standards in this area, following the guidelines of international organizations specializing in the field. Whether or not these standards will be effective within our market and institutional framework remains a question to be evaluated in the future. However, we can say that the national government has taken an important step by adapting to changes and international trade rules in order to maintain its tax competitiveness.

Conclusions

In conclusion, we can note—as a milestone of great significance—that all jurisdictions in the region now have transfer pricing regulations. This, naturally, contributes to a regulatory landscape that creates a scenario of tax competition (if you will fair) between domestic and multinational companies, eliminates tensions between different jurisdictions in this regard, and also contributes to a more favorable business climate for attracting foreign investment, given the predictability of conditions across different countries.

Finally, we can say today that, regardless of the competitiveness of our national soccer team—which failed to qualify for the South American Qualifiers for Russia 2018—Paraguay has qualified, along with the rest of the countries in the region, for the “transfer pricing World Cup.”.

[1] Luis A. Carísimo, “A Brief Introduction to Transfer Pricing,” SODEUC, September 10, 2020, https://www.sodeuc.org.py/notas/articulos/una-breve-introduccion-a-los-precios-de-transferencia/652

[2] André Gabor, Pricing: Concepts and Methods for Effective Marketing (Cambridge: University Press, 1988), 113–114.

[3] Example adapted from: Ian Roxan et al., Resolving Transfer Pricing Disputes: A Global Analysis. (New York: Cambridge University Press, 2012), 10–11.

[4] Baistrocchi, Transfer Pricing Disputes: Theory and Practice., 86.