An adjustment for FY 2013 and 2014 had been issued to a pharmaceutical company in Panama “Pharma Distributor S.A” that resulted in an income adjustment of 19.5 million dollars, which in turn resulted in additional taxes of 2.4 million dollars.
The resale price method had been used by Pharma Distributor S.A. to determine the market value of an asset acquired from a related entity that was sold to an independent entity. This method was rejected by the tax authorities based on the fact that the analysis presented by the taxpayer did not meet the requirements for application of the method. The tax authorities instead applied a TNMM.
The tax authorities also rejected tax deductions for expenses purportedly paid for administrative services due to the absence of supporting documentation. Provisions of article 762-G “Administrative services received” in the Tax Code in Panama contemplates tax deductibility for such expenses exclusively when services have actually been rendered to the benefit of the recipient.
Decision of the Court
The Court held in favor of the tax authorities.
The Court ratified the position of the tax authorities regarding the non-deductibility of the expense paid for administrative services.
In addition, the Court’s resolution indicates inconsistencies and imprecision in the delineation of the transaction within the comparability analysis, selection and application of the Resale Price Method, concluding that the level of comparability presented in the supporting documentation would be inadequate for application of the method. It was also indicated that Pharma S.A assumed operating expenses in excess of those of simple distributors. Hence Pharma Distributor S.A. should be characterized as a fully-fledged distributor and be compensated for the additional functions performed and risks assumed.
Due to these methodological inconsistencies, the Court agreed that the TNMM – as suggested by the tax authorities – was the more appropriate method in the case at hand.
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It is an excellent decision concerning the most appropriate method, selection of comparables, principle of res judicata, selection of a foreign-related entity as a tested party and deductibility of payment for intra-group services.
The transfer pricing legislation of Panama is very interesting and especially dealing with the deductibility of payments for administrative services. In addition to the payment to be at arm’s length, the recipient of services should demonstrate the effectiveness of services received and economic benefits derived from the service. There needs to be documentary evidence to prove the satisfaction of twin conditions.