The Dominican Republic recently enacted new rules that expand the country’s transfer pricing program so that it now applies to a much larger group of foreign companies doing business in the Dominican Republic than it did previously. Before these new rules took effect, the Dominican Republic’s transfer pricing system only applied to a limited group of Dominican companies – i.e., (1) those that were considered “related entities,” which included entities that were under majority control of foreign owners, that were permanent establishments of foreign entities, exclusive agents or distributors, or that had preferential contractual terms, among others or (2) those Dominican companies engaged in transactions with related parties outside of the Dominican, with related parties that were obtaining benefits under the Dominican Free Trade Zone program, or with individuals or companies that were located in “tax havens” or other low-tax countries.
Now, as a result, of the new rules, all U.S.-based entities (and all entities headquartered in other countries around the world) that have operations in the Dominican and that are engaged in transactions involving “related parties” must be familiar with, and must comply with, the new transfer pricing rules.
Accordingly, U.S. companies with operations in the Dominican Republic must pay particular attention to the new definition of “related parties,” including the standards for determining when multiple entities constitute a “decision unit.” Additionally, the new rules provide significant guidance on “Advance Pricing Agreements,” which, if properly adopted and approved, can help avoid transfer pricing problems.
Background
On June 2, 2011, the Dominican Republic’s General Directorate of Internal Revenue (the “DGII”) issued General Rule No. 04-2011 on Transfer Pricing, setting forth the rules applicable to transactions between related parties or affiliates. Based on the Transfer Pricing Guidelines for Multinational Companies and Tax Administrations of the Organization for Economic Cooperation and Development (“OECD”), the principal purpose of General Rule No. 04-2011 was to prevent tax avoidance between related entities.
General Rule 04-2011 applies to operations or transactions performed by foreign entities doing business in the Dominican Republic with connected or related parties abroad; persons, companies, or entities resident or domiciled in jurisdictions with lower taxation or those considered to be tax havens; and connected or related parties benefiting from the country’s Free Trade Zone program.
In addition, General Rule 04-2011 applies to foreign shareholders who are not resident in the country but who own, directly or indirectly, more than 50 percent of the capital shares of a company governed by the rule or who are unable to demonstrate the source of their funds as Dominican-sourced income.
Related Parties
One of the most important provisions of the new rule relates to the definition of “related parties.” Under the rule, local or foreign persons or entities are considered to be connected or related parties in a variety of specific situations. For example, parties are connected or related where one party participates directly or indirectly in the management, control, or capital of another company, provided that a person or entity must hold an executive position in both entities where participation is based on connected management and further provided that where participation is based on voting rights or capital, there must be a direct or indirect participation of at least 50 percent.
Additionally, related parties will be found when an entity in the Dominican Republic has a permanent establishment in another country or when an entity with a permanent establishment in the Dominican Republic has a parent company in another country.
Moreover, the rule provides that parties are connected or related where the foreign company has a person or entity with exclusive rights as agent, distributor, or concessionaire for the purchase and sale of products, goods, services, or rights from a different entity, as long as their contractual relationship provides advantages when compared to the contractual relationships it has with third parties.
General Rule 04-2011 also provides that persons or entities are connected or related parties where:
- The parties’ contract contains an unusually preferential contractual provision as compared to the provisions in similar agreements with third parties;
- A person or entity assumes responsibility for the losses or expenses of another;
- Entities constitute a “decision unit,” which occurs whenever one entity is a shareholder in another and, with respect to the first, has the majority of voting rights; has the power to appoint or dismiss the majority of the members of the board; has control as a result of proxies with other shareholders of the majority of voting rights; has the majority of board members; the majority of the board members of the controlled entity are part of the board of the controlling entity or of another controlled by the latter; or the shareholders or board members are directly or collaterally related as provided by the rule.
There are important practical ramifications for parties that are related or connected. Most significantly, taxpayers that engage in activities or transactions between related parties or affiliates are required to prepare a comparability analysis to determine the price or amount that would have been agreed on between independent parties in comparable transactions, and thus to justify the use of a price different from the market price.
Tax Reform Law
The Dominican’s recent Tax Reform Law, Law No. 253-12, authorizes the use of any of five different methods for determining price in these circumstances. These methods are the:
- Comparable Uncontrolled Price Method;
- Resale Price Method;
- Cost Plus Method;
- Utility Partition Method; and
- Transaction Net Margin Method.
The Tax Reform Law establishes the priority between these methods, stating that a taxpayer must first use, if possible, the Comparable Uncontrolled Price method. If that is not feasible, a taxpayer must use the Resale Price Method or the Cost Plus Method.
A taxpayer that has income from operations with a related or connected party must submit a report to the DGII no later than 60 days after the annual deadline for submitting its income tax return. Moreover, such a taxpayer must submit a comparability analysis report that contains the assessment process it undertook to set the transfer prices with its related entities or affiliates. If, after verification by the Dominican authorities, the price or amount determined by a taxpayer differs from the market-determined price or amount, either by overvaluation or undervaluation, the country’s tax administration may challenge it and adjust it according to the market value.
The Tax Reform Law authorizes related entities to request and agree with the DGII on an Advance Pricing Agreement that sets the value of the commercial and financial operations between related parties in advance for a period of three fiscal years (which is the statute of limitations related to tax liability in the Dominican Republic), including the year in which the Advance Pricing Agreement is executed. (In connection with this new provision, a limitation in the law for Advance Pricing Agreements in connection with the tourism industry has been repealed.)
In certain industries, the Dominican Republic’s tax administration will be able to determine and establish a price or minimum profit margin that, if included on the taxpayer’s comparability analysis, will be considered as a price agreed on by unrelated parties and therefore valid. The factors that the Dominican tax administrators will consider when calculating a profit margin range from the total amount of income, the value of the assets used by the parties, the parties’ operating costs and expenses, and other relevant factors.
It should be noted that, under Dominican law, a company that provides services for a related party in the Dominican is presumed to be providing those services at a fair market value in an amount that independent parties – not related or connected parties – would have agreed upon. Furthermore, the Dominican rules presume that these services have been rendered.
Tax Havens
Many countries around the world have been considering how to respond to the challenges presented by tax havens or countries with essentially no, or very low, taxation, and the Dominican Republic is no different. The new transfer pricing rules provide that entities headquartered in countries listed by the Global Forum on Transparency and Exchange of Tax Information are in tax haven countries. The DGII also has the authority to prepare a list of countries that are not considered to be tax havens, which include countries with which the Dominican Republic has reached an agreement to avoid double taxation or to share tax information as well as countries that the DGII has determined are not tax havens. Currently, the Dominican Republic has only one Double Taxation Treaty, with Canada. There is a double taxation treaty signed with Spain but it has not been ratified by the Dominican Congress to enter into force.
Conclusion
It is important for companies operating in the Dominican Republic to carefully consider the new transfer pricing rules and to recognize that the DGII has the authority to challenge pricing allocations by related parties when they do not correlate to the prices that independent parties would have charged and paid. Indeed, pricing allocations that may be deemed appropriate for income tax purposes are not necessarily going to withstand transfer pricing scrutiny.
Therefore, it is vitally important that businesses with Dominican operations become fully familiar with the new transfer pricing system and, where appropriate, that they consider whether to seek an Advance Pricing Agreement from the DGII.
Published March 27, 2013.
