In accordance with the provisions of RTF No. 01428_1_2023, we set forth the Tax Court’s position regarding the analysis of financial statements expressed in the functional currency for the application of the Net Transactional Margin method.
Background
The Tax Administration applied a transfer pricing adjustment using financial information expressed in the national currency; in response, the appellant argues that the Tax Administration should have used the information expressed in its functional currency (the U.S. dollar).
Position of the Appellant
The appellant argues that the application of the Net Transaction Margin method must seek to reflect the economic reality of the transaction under review, which is achieved by using financial information expressed in the functional currency. Furthermore, the appellant maintains that its purchase and sale contracts and invoices demonstrate that its functional currency is the U.S. dollar.
Furthermore, the appellant argues that, when considering the financial information expressed in the functional currency and the results of comparable companies that perform functions similar to those of a traditional or low-risk distributor, the application of the transactional net margin method would show that the transaction falls above the range. Therefore, a transfer pricing adjustment would not be warranted.
Position of the Tax Administration
The Tax Administration argues that the obligation to determine and pay tax liabilities is in national currency, except for certain exceptions to which the appellant does not apply. It also states that it was able to verify that the appellant’s books and accounting records are expressed in national currency, and that it has not been established that the financial statements in the functional currency effectively reflect the economic reality of the transactions in question, nor was it demonstrated that the financial statements expressed in the national currency were not appropriate for reflecting that reality.
Therefore, to determine whether the transactions in question were at market value, the Tax Administration applied the net transaction margin method using the operating profit-to-costs-and-expenses ratio, based on segmented financial information expressed in the national currency. Finding that the appellant’s profitability was below the interquartile range—which indicated that the sales made by the appellant to its related party were not conducted at market values—the Tax Administration adjusted the appellant’s profitability to the median of the range, resulting in a transfer pricing adjustment of S/ 14,843,332.00.
Tax Court Ruling
The Tax Court’s response was that the appellant provided the information requested by the Tax Administration during its audit, which demonstrates that the currency used in its primary business activity of trading mineral concentrates—and in which the prices of the goods traded are set—is the U.S. dollar. This demonstrates that the financial information expressed in U.S. dollars reflects the primary economic environment in which the appellant operates. Therefore, the Tax Administration’s refusal to use the financial information in the functional currency for the transfer pricing analysis of such transactions using the transactional net margin method is unfounded. Consequently, the transfer pricing adjustment objection must be set aside.
Conclusions
The appellant demonstrated that the U.S. dollar is the currency that best reflects the economic reality of the transactions involving the sale of its products to its related party. Therefore, the segmented financial information used to determine the interquartile range using the transactional net margin method should have been expressed in U.S. dollars, treating it as the functional currency, rather than in the national currency, as the Tax Administration indicated in its calculation of the transfer pricing adjustment.