By Dr. Harold McClure, New York City
Ecuador’s tax authority, the Servicio de Rentas Internas, recently published new transfer pricing guidance.
Carlos Subero of BasaFirma, Colombia, summarized key provisions in MNE Tax on August 10, including:
The government also published guidance that establishes transfer pricing rules to comply with the arm’s length principle in transactions involving the exportation of bananas … This new resolution includes procedures for the calculation of the monthly comparable price for banana boxes type 22XU, depending only on the country of destination, and calculated as of March 15 of the tax year following the year under analysis. Banana box type 22XU refers to premium cavendish variety bananas packed in boxes or cases known as 22XU. The export destinations of these products are the Russian Federation; European Union countries; and other countries … This value may be adjusted only by freight and insurance costs associated with that invoice in the case of comparable CIF prices, provided that the taxpayer proves with documentation that these values were established at arm’s length.
Ecuador’s main exports include petroleum products; fish, including shrimp; and bananas.
Bananas and plantains represented almost 15 percent of Ecuador’s exports, about ECS 22.3 billion (USD 3.4 billion) in 2019.
Many of these exports were to customers in the European Union. Ecuador’s bananas compete with bananas from growers in the Caribbean and Pacific region.
These Caribbean and Pacific region growers began losing market share to Latin American growers when the EU lowered banana tariffs in 2009 to approximately 4 cents per pound.
The banana wars represented a dispute between the US and the EU over trade practices involving the EU practice of giving favorable treatment to bananas imported from former colonies in the Caribbean. US multinational affiliates in Latin America produce most of the bananas consumed in the EU.
For multinationals that face customs duties or tariffs, the intercompany price between the grower affiliate and the wholesale distribution affiliate can be challenged by two income tax authorities and by the customs officials for the importing nation.
The income tax authority of the grower affiliate and the customs officials for the importing nation would favor higher intercompany prices. A higher intercompany price increases the income tax base for the growing affiliate and increases the customs tax base. In contrast, the income tax authority of the importing nation would prefer lower intercompany prices in order to increase the income tax base for the distribution affiliate.
I previously reviewed several aspects of this issue, noting a US customs ruling involving the importation of bananas (“A Renewed Interest in the Modified Resale Price Method for Customs Valuation,” Journal of International Taxation, April 2020).
The key facts of this US customs ruling were that the operating expenses for the US distribution affiliate represented 3 percent of sales, and a profits-based analysis established that the appropriate return to these operating expenses should be 33 percent.
As such, the appropriate gross margin would be 4 percent.
For issues such as the importation of bananas, the income tax authority of the importing nation and its customs authority would agree on this basic approach.
Carlos Subero’s summary of the new Ecuador transfer pricing guidance noted:
The new Ecuador transfer guidance states that when applying transfer pricing methods based on margins, the local entity should not necessarily be considered as the tested party for developing the transfer pricing analysis.
If a profits based approach was used to examine the transfer pricing issue, Ecuador’s Servicio de Rentas Internas would likely agree that the financials for the foreign distribution affiliate should be evaluated.
The Servicio de Rentas Internas insists on a specific comparable uncontrolled price (CUP) based on the market price for premium cavendish variety bananas packed in boxes or cases known as 22XU boxes.
The guidance recognizes the role of transportation or logistics costs as long as the multinational can demonstrate that declared freight and insurance costs are arm’s length.
This approach implicitly assumes that the observed market prices represent what a wholesale distributor pays to the growers and shippers.
If the market price, however, represents what a retail grocer pays to the wholesale distributor, then an additional deduction for the appropriate gross margin should be allowed.
As we argued, however, this deduction would represent only a 4 percent gross margin under arm’s length pricing.
In my recent discussion, I provided a graph of wholesale prices for bananas where the inflation-adjusted price has averaged $0.50 per pound from 2010 to 2019 but with some variability over the decade.
During the first half of 2020, the wholesale price of bananas has increased by almost 20 percent, reaching nearly $0.60 per pound.
The market price that should be received by the growing affiliate would start with this wholesale price. Under arm’s length pricing, 2.4 percent should then be deducted from this amount to account for the distributor’s gross margin, and a further deduction should be taken for logistics costs.
To the degree that Ecuador exports bananas to European customers, the customs valuation and income tax issues will involve the views of Ecuador’s Servicio de Rentas Internas versus the approaches taken by the European income tax authorities and customs officials.
Given the different issues involved in the appropriate transfer pricing for bananas as well as potential disagreements as to the appropriate methodology, how these issues are eventually resolved will be interesting.
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