Tax Newsletter | El Salvador May 2021

Tax Newsletter Timely news and information on national tax issues Transfer Pricing considerations related to intragroup financial transactions

Financial transactions between independent parties In different MNE Groups, financial transactions play are based on various commercial considerations, and an important role in their commercial transactions, normally both parties seek to maximize their with these services typically playing a supporting role profitability. However, members of an MNE Group1 in the companies’ value chain. have the flexibility and discretion to decide upon the conditions that will apply to the financial transactions In general terms, financial transactions between performed between companies within such group. As related parties, as with any other intragroup service result, in this intragroup situation, the tax transaction, will be subject to compliance with the consequences of the Transfer Pricing policies arm’s length principle. Consequently, the first applicable to these types of transactions should be consideration for these transactions requires an taken into account, considering their structure and accurate delineation of its economic substance (real nature. transaction), including the justification of its purpose in the context of the business of the MNE Group.

1 For purposes of this document, the Multinational Enterprise Group in question are those not normally engaged in financial intermediation, that is, non-banking, non-insurance or other similar companies.

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In an intragroup context, the most common financial transactions include intercompany , cash 2. Consideration of solvencies and risks pooling, treasury and financial derivative services such as foreign transactions, options on shares, For purposes of aligning the real financial transaction forward contracts and other hybrids. In this and, consequently, being able to properly select document, greater reference is made to “intragroup comparable to use in the Transfer Pricing analysis, an loans” since it is one of the most common analysis of creditworthiness is relevant. In the case of transactions between related companies; however, intragroup loans, this analysis implies, among others, similar considerations may apply to other types of the consideration of the security (that is, the financial transactions. guarantees the borrower can offer) and consideration of the future cash flows for paying interest and 1. Characterization repaying the principal amount of the . One way of assessing debt capacity is to look at the credit rating One of the most relevant aspects in the financial of the debtor, which reflects the credit risk for the transactions is the determination of their actual creditor extending debt to the counterparty. economic circumstance or characterization. The alignment of this characterization should consider the The credit rating expresses the probability of default, current focus of the Transfer Pricing regulations and and thus, the risk to the potential lender. Credit risk of the criteria of the tax authorities, applicable to can be measured by assigning a rating (that is, credit similar transactions. rating) to the debtor or to a specific instrument issued by the debtor. In some cases, these ratings may be Based on the above, the taxpayer could characterize derived from independent commercial credit rating the transaction as a loan, but the economic facts and agencies (Risk Rating Agencies). In other cases, some circumstances, additional information and behavior companies have also developed in-house commercial between the related parties could lead to a different tools that can be used for credit rating purposes; conclusion. however, this last methodology should include qualitative and quantitative factors. The relevant evidence in the characterization could, for example, include an analysis of the debt capacity In addition to the above, it could also be relevant to of the borrower, purpose of the investment, consider the risk of an entity that operates in a commercial strategy and security offered (credit risk). particularly risky country (that is, the risk deriving In such cases, it is possible that for Transfer Pricing from a country’s business environment, including the purposes, the transaction is partly treated as a loan legal environment, levels of corruption, and and partly as something other than a loan, for socioeconomic variables), to the extent that this is not example, as a capital contribution. already reflected in the credit rating of that entity (debtor). Following is a general list of the significant economic characteristics of a financial transaction that should 3. Selection of the Transfer Pricing method be considered when evaluating these transactions for Transfer Pricing purposes: With respect to financial transactions between related parties, the most commonly used method is the  Contractual terms; Comparable Uncontrolled Price Method (“CUP”).  Functional analysis;  Risk analysis between the parties; CUP can be used when there are comparable  Determination of the financial characteristics transactions between one party of the intragroup loan of the product or service; transaction and an independent party ("internal  Economic circumstances; comparable") or between two independent parties,  Business strategies;

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neither of which is part of the intragroup loan cases, the application of a Cost Plus Method (CPM) or transaction ("external comparable"). a Transactional Net Margin Method (TNMM) may be required if the functions performed add value and In a loan transaction between related parties, CUP can require the determination of an arm’s length be applied, with the selection of financial instruments remuneration (Mark Up). and/or loan transactions agreed upon between independent parties. 4. Tax Considerations

In regard to the application of this Transfer Pricing According to local laws, among the main tax aspects method, the basic determination of the cost of the to be considered by taxpayers in financial debt (price) of these transactions can be based on the transactions, with respect to income tax matters, are consideration of the following items: the following:

a) For certain loan transactions, (for example, Law Scope of Application loans between entities domiciled in the Art. 16 of the LISR 2 Interest income and its country), internal transactions performed by possible consideration of the taxpayer, quotes with local or taxable income in El Salvador financial information of the Central Reserve Art. 158 CT3 Withholdings on non- can be evaluated. domiciled parties Art. 158-A of the CT Withholdings on parties b) For transactions in which the debtor is located located in some preferential in a different country than the creditor, an tax regimes (tax havens) alternative for the analysis of the arm’s length Art. 74-A of the Withholdings for the granting principle in the cost of the debt may include LISR of loans, mutual agreement the consideration of the following items: or advances or any other way of financing I. Risk-Free Rate (for example, LIBOR Art. 29 numeral 10 Deductibility of interest, rate); of the LISR general rules II. Yield or margin (basis points according Art. 29-A numeral Non-deductibility of interest, to the financial or debt instrument); 14) letter b) of the commissions and any other III. Spread or credit risk of the debtor; LISR of financial IV. Country risk (in the event it is not transactions, evaluating their included in the credit risk); declaration as taxable income The selection of comparable (financial instruments), in Art. 29-A numeral Non-deductibility of interest, general terms will depend on the characteristics of 14) letter c) of the analyzing the average the transaction (see section 1 “Characterization”), LISR lending rate active plus four that is, its functional analysis. The application of percentage points adjustments in the determination of the price (cost of Art. 29-A numeral Non-deductibility of the debt), will also depend on the risks assumed 14) letter d) of the made, analyzing between the parties and the economic risks of the LISR the level of indebtedness of transaction. the credit transactions of the borrowing taxpayer In other types of financial transactions, for example, cash pooling, it is possible that the functions performed do not add value; therefore, a remuneration at cost may be considered. In other

2 Income Tax Law 3 Tax Code

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5. Final Comments

For the types of financial transactions mentioned above, within our local Transfer Pricing regulations, the tax authorities have not established the application of an explicit methodology for performing an analysis. Therefore, each type of transaction of this nature should be evaluated individually so that the taxpayer can ensure compliance with the arm’s length principle and Art. 62-A of the Tax Code. Federico Paz Tax Partner Undoubtedly, business strategies and the corporate [email protected] decisions of the various MNE Groups and their capital structures are of great relevance for the analysis of these transactions for Transfer Pricing purposes.

The determination of the price in each case will depend to a great extent on the functional analysis and risks assumed between the parties, as well as on the public information that is available for similar transactions.

We suggest that our clients and friends perform the analysis mentioned above, which will allow them to characterize the transaction and document it in order Mario Coyoy to support their position in the event of a future Transfer Pricing Partner review by the tax authorities. [email protected]

Wilmer García Transfer Pricing Manager [email protected] www.deloitte.com/sv

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Tax Calendar May 2021

The updated 2021 tax calendar is now available on the Tax Administration’s website, which includes public holidays and deadlines for all tax obligations.

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May 17 Beverages, Potable Ethyl Alcohol and Printing Presses Beer, Carbonated Beverages, Isotonic Monthly Report on Documents Printed for VAT Beverages, Fortified Beverages or Energy Taxpayers Registered under the VAT (F-945) Declaration and payment of the Tax on the Drinks, Juices, Nectars, Soft Drinks and May 31 Transfer of Movable and the Concentrated or Powder Mixtures for the Rendering of Services (F-07). Preparation of Drinks (F-955). Other Obligations  Report on Specific and Ad Valorem Taxes Financial Income and Transactions  Appoint Tax Auditor per the Tax Code and on Producers and Importers of Firearms, International Services Law for the 2021 fiscal Monthly declaration of Payment on Account, Ammunitions, Explosives and Similar year. and Tax Withheld on Income, Financial Items, Producers of Tobacco and  Tax opinion and report per the Tax Code for Transactions, and the Special Contribution for Producers, Importers and those that clear the 2020 fiscal year, general type; Tax Citizen Security and Coexistence (F-14) fuels through customs (F-988) opinion and report for dissolution and  Monthly Report of Sales to Producers, Specific and Ad Valorem Taxes liquidation and transformation process (F- Distributors or Retailers of Tobacco and Declaration and payment of Specific Taxes, Ad 455) Tobacco Products (F-956) Valorem Taxes and Special Contribution (F-  Semi-annual opinion on compliance with the 06). obligations contained in the International Other obligations May 24 Services Law corresponding to the second half of the 2020 fiscal year (F-455)  Report on Donations (F-960) VAT  Report on Specific and Ad Valorem Taxes Monthly Report on Withholdings, Collections, May 10 on Producers and Importers of Alcoholic or Payments on Account of VAT (F-930). Mother’s Day

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Contacts

Federico Paz Cosette Fuentes Tax Partner Legal Services Manager Wilmer Garcia [email protected] [email protected] Transfer Pricing Manager [email protected] Ghendrex Garcia Henry Aguirre Tax and BPS Partner BPS Manager Jhonny Flores [email protected] [email protected] Tax Consulting Manager [email protected] Mario Coyoy Alvaro Miranda Transfer Pricing Partner Transfer Pricing Manager [email protected] [email protected]

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