Republic of Panama

Administrative Tax Court

Substantive Ruling No. TAT- RF-111 of 15 December 2021

FILE: 112-2019

 

IN VIEW OF:

The attorney ---------------------, acting in his capacity as special attorney-in-fact of the taxpayer ---------, with R.U.C. -------------------------, hereinafter " or taxpayer", have filed before this Court, an Appeal against Resolution no. 201-3306 of 27 February 2015, and the act that resolved the Appeal for Reconsideration, Resolution no. 201-1278 of 16 February 2015. No. 201-1278 of 16 April 2019, both issued by the Directorate General of Revenue of the Ministry of Economy and Finance, and through which it was resolved to issue an additional assessment to the aforementioned taxpayer, in the amount of TWO HUNDRED AND NINETEEN THOUSAND AND FOUR HUNDRED AND FIFTY SEVEN BALBOAS AND 55/100 (B/. 219,457.55), for deficiency in his Income Tax Affidavit for the period 2013, Transfer Pricing Report Form 930 and Transfer Pricing Study both for the year 2012.

 

I.          BACKGROUND

 

By Note n. ° 201-01-0489 DGI of 19 January 2015, the Director General of Revenue carried out to the taxpayer, a Comprehensive Audit for the years 2012, 2013 and 2014 which included the review of the Transfer Tax on Movable Goods and the Provision of Services (ITBMS), for the years 2011 to the present and International Taxation in particular Transfer Pricing (See f. 1 to 3 of the background file of the DGI).

 

II.         ORIGINAL RESOLUTION

By virtue of the audit carried out not only on International Taxation, specifically on Transfer Pricing for the year 2012, but also due to deficiencies in its Sworn Income Tax Return for the 2013 tax period, the Tax Administration resolved to issue the original administrative act by Resolution no. 201-3306 of 27 February 2015, and in its grounds it set out, among others, the arguments detailed below (See fs. 933 to 963 of Volume 3 of the DGI's background file):

1. that in the sworn income tax return for legal entities for the 2013 tax period, the taxpayer stated that it carried out operations with related parties in accordance with the provisions of article 762-D of the Tax Code for costs amounting to B/.9,981,703.50.

2.         That the taxpayer, availed himself of the provisions of paragraph c) of Article 123 of Executive Decree No. 170 of October 27, 1993, which provides that construction companies may determine the income tax allocated to the fiscal year the total gross income and expenses and the respective costs (method of finished work).

3. It is also established that the taxpayer was penalised for the failure to submit the Transfer Pricing Report, Form 930 for the 2013 tax period through another resolution, i.e. resolution no. 201-503 of 14 October 2014.

4.         That the taxpayer, by virtue of said resolution, filed an Appeal for Reconsideration together with which it provided the transfer pricing study for the 2012 tax period and on 30 June 2013 it had filed the Transfer Pricing Report 930 for the 2012 tax period in the amount of B/.8,711,517.45.

5.         Similarly, it is noted in the aforementioned original resolution that the taxpayer defined in its 930 Report for the 2012 period, as "Intercompany Transaction 1", as the Management Services received (it used the comparable uncontrolled price method CUP) during 2012, from its related parties, whose names are: ---------, hereinafter by its acronym and -------, hereinafter --.

In that order, it is indicated that the Management Services Agreement establishes that the consideration shall be established as the amount equivalent to 3% of the monthly income received by the taxpayer for each of its related parties resident abroad, -------- and , in accordance with the advice received for construction projects. The most experienced related party provides the advice.

Also, the taxpayer called the construction services "Intercompany Transaction 2" (it used the net margin method of the MNT transaction) and during the 2012 period, the taxpayer rented equipment and purchased materials from its related party resident at ----------------, --------- and subcontracted tunnel lining services to its related party resident at -----------, --. It is detailed in the original ruling that the described transactions are part of the company's predominant activity, which is construction services.

6.         It is clear from the ruling that in the price study the taxpayer concluded that the comparable uncontrolled CUP price was the most reliable method to analyse the intercompany transaction of management services received, since here the taxpayer was able to compare the percentage of net sales agreed between it and its related parties resident abroad to establish the consideration for the services provided by -------- and during 2012, with the interquartile range of consideration on net sales obtained from a group of comparable uncontrolled contracts in force during 2012.

That the result of the interquartile range for consideration established in the transfer pricing study ranges from 1.00 percent to 5.50 percent of sales and a median of 2.00 percent, so that the consideration agreed by the taxpayer and its related parties was 3.00 percent of sales, which they found to be within the aforementioned range.

7.         It is also detailed in the resolution that in the transfer pricing study, the taxpayer concluded that the Net Transactional Margin TNMM, using its audited financial information was the most reliable method to analyse the intercompany transaction of "Construction Services" (Equipment rental, purchase of materials and tunnel lining services), as here the taxpayer could compare the operating margin obtained in its global business activity during 2012, with the interquartile range of the operating margin obtained from the group of comparable companies for the weighted average of the period 2010-2012.

That the result of the inter-quartile range of the weighted average operating margin obtained and adjusted for the period 2010-2012 by the comparable companies it selected ranges from 3.70 percent to 7.00 percent with a median of 5.10 percent, whereby the taxpayer obtained an operating margin of 4.07 which is according to it, within the inter-quartile range.

8.         Regarding the analysis of the DGI, concerning the Transaction #1 made by the taxpayer concerning the "Management Services Received", we can highlight the following:

That, from the verification of the comparable contracts of the transfer pricing study submitted by the taxpayer, the 40 contracts selected by the taxpayer were analysed and with this the DGI observed that on the transaction of management services received between the taxpayer and its related parties --------- and , significant differences were found since the services provided by these companies to the taxpayer are for the management of construction projects.

In this regard, the DGI cites articles 762-G and 762-D of the Tax Code, as well as chapter VII of the OECD Guidelines, which in their various commentaries define the circumstances that clarify when intra-group services are considered to have been rendered and whether the remuneration was at arm's length. They mention the comments of the Transfer Pricing Guides 7.6, 7.17, 7.18, 7.19 (See fs.948 and 949 of volume 3 of the DGI's file).

According to the DGI, in order to determine the effective provision of the aforementioned services, it was necessary not only the accounting records of payment and invoices submitted (which were the documents provided by the appellant, in February 2015, at the request of the DGI), but to know what the services provided consisted of and the need for those services and therefore through a Note dated 23 January 2015, the Tax Administration requested a series of documents such as:

Photocopies of the invoices supporting such payments.

Policies and Procedures in relation to the requirements of the management services received

Instructions, service orders, e-mails, technical reports, work budgets, functions and activities performed by staff.

What results were generated in such provision and any other details demonstrating that the management fees were rendered and/or taken advantage of in the Republic of Panama.

Quantification of Economic Benefit

Process Improvement

Efficiency of the company's management and year-on-year comparison of results.

Explanation of the accounting and tax treatment of the Management Services expense received and Construction Services.

Accounting movements of the accounts involved in the recording of Management Services received and construction services.

The Tax Administration, by virtue of the fact that the taxpayer did not prove or demonstrate that the services were in fact received, considers that the amount equivalent to 3.00 % of the taxpayer's monthly income for each of the related parties does not comply with the arm's length principle.

Notwithstanding the above, the DGI acknowledges that the taxpayer did comply with some of its requirements, providing information that would lead them to determine whether the taxpayer's remuneration complied with the arm's length principle.

Among these points, the DGI requested photocopies of the 40 contracts analysed according to the transfer pricing study submitted by the taxpayer, which the taxpayer submitted in English, but the Tax Administration reviewed them as follows. The following is Table 7 concerning the total range of comparable uncontrolled consideration used in the analysis of the external CUP, which can be found on page 951 of Volume 3 of the DGI's file.

 

Cliente

Prestador del Servicio

Porcentaje sobre ventas

 

--------------------------

 

--------------------------

 

2.00%

1.50%

1.00%

0.50%

--------------------------

--------------------------

5.00%

 

 

6.00%

1.00%

6.00%

 

--------------------------

 

--------------------------

 

15.00%

--------------------------

--------------------------

2.50%

--------------------------

--------------------------

0.17%

------------

 

3.00%

Rango Intercuartil

 

 

Percemtil 25

 

1.00%

Mediana

 

2.00%


 

Finally, the DGI determined that the existing differences between the comparable uncontrolled operations and the examined operation affect the results presented by the taxpayer, which served as a basis for the Tax Administration to consider that the companies used are not comparable, according to the provisions of literal A, numeral 1 of article 762-F of the Tax Code and comment 2.14 of the OECD Transfer Pricing Guidelines 2.14.

They therefore consider that it was not demonstrated that the intra-group services were actually provided and that the methodology for the calculation of the remuneration for such services received is inconsistent with the arm's length principle.

9.         Regarding the DGI's analysis of Transaction #2 made by the taxpayer and dealing with "Construction Services" (equipment rental, purchase of materials and tunnel lining services), we can highlight the following:

It notes that Table 11 of the taxpayer's transfer pricing study presents the result of the operating margin and adjusted operating margins during the weighted average 2010-2012 for each of the selected comparables.

Table 11: Interquartile Range of Adjusted Operating Margin for Comparable Companies during the Weighted Average 2010-2012

 

Compañías Comparables

Margen de Operación ajustado

--------------------------.

10.90%

--------------------------.

5.70%

--------------------------

4.60%

--------------------------

1.20%

------------

4.07%

Rango Intercuartil

 

Percentil 25

3.70%

Mediana

5.10%

Percentil 75

7.00%

 

75th percentile 7.00% (See f.953 of Volume 3 of the DGI file)

(See f.953 of Volume 3 of the DGI's file).

The Tax Administration when reviewing the income statements of the comparables provided by the taxpayer with the 10-k reports, observed that the company -------------------------- presents important differences as it considers that the functions performed including the assets or risks assumed in the operation of , differ from the functions, assets and risks of the taxpayer, as well as the contractual clauses considering how the responsibilities are distributed, as well as the economic circumstances, the business strategies and the geographic market and for all these reasons it cannot be included as comparable because it affects the full competition range.

This is based on Article 762-E and OECD comments 1.42, 1.52, 1.53, 1.55, 1.57 and 1.59 of Chapter I, which deals with the Arm's Length Principle of the Transfer Pricing Guidelines.

That upon requesting the taxpayer to provide the segmented income statement indicating the criteria used for such segmentation, the taxpayer indicated that the financial information used for the analysis of the transactions during 2012, was the information contained in the audited financial statements of the company, so the DGI reminded him of the provisions of Article 1 of Executive Decree No. 958 of 7 August 2013, which indicates that for the determination of the principle of Full Competition, the operations must be analysed separately.

 That page 961 of Volume 3 of the DGI's record shows the recalculation of the inter-quartile range of the operating margin adjusted by the companies accepted by the DGI as comparable during the weighted average 2010-2012.

Comparable companies Adjusted operating margin

Ø   

 

Compañías Comparables

Margen de Operación ajustado

--------------------------.

10.90%

--------------------------

5.70%

--------------------------

4.60%

------------

4.07%

Nuevo Rango Intercuartil

 

Percentil 25

5.15%

Mediana

5.70%

Percentil 75

8.30%

-(See table at f.961 of Volume 3 of the DGI's file).

Therefore, the Tax Administration, based on the results obtained, considered adjusting the operating margin of 1.63 percentage points, to the declared operating margin of 4.07% to bring it to the median of 5.70%, as established in article 762-B and 762-F of the Fiscal Code.

           

10.       Income tax assessment

For the reasons stated above, the DGI indicates that it became necessary to adjust to the arm's length median the costs of operations with related parties of , since as they warn, the latter used for the transaction analysis the global financial information of the company's Audited Financial Statements as of 31 December 2012.

 

----------------------------------

Ingresos

B/.53,884,274.50

Gastos de Operación

B/.51,690,701.04

Utilidad de Operación bajo el margen de 4.07%

B/.2,193,573.46

Margen de Operación

4.07%

 

---------------------------------- Ajustado a la Mediana

Ingresos

B/.53,884,274.50

Gastos de Operación aplicando la mediana de 5.70%

B/.50,812,870.85

Utilidad de Operación aplicando la mediana de 5.70%

B/.3,071,403.65

Margen de Operación

5.70%

Diferencia del Margen de operación de -------- --------- ----------------

1.63%

Diferencia neta Objetar en la casilla 26 de costo Operación con Partes Relacionadas-Exterior (Artículo 762-D, CF)

 

877,830.19

 

 

Cálculo del Impuesto sobre la Renta a Pagar

2013

Renta Neta Gravable Declarada

B/.4,433,501.04

Mas: Aumento S/Investigación

B/.877,830.19

Renta Neta Gravable S/Investigación

B/.5,311,331.23

Impuesto causado S/Investigación

B/.1,327,832.81

Menos: Impuesto S/Declaración

B/.1,108,375.26

Diferencia

B/.219,457.55

Recargo (Art.1072-a del C.F.)

0

IMPUESTO A PAGAR TOTAL

B/.219,457.55

 (See tables f.962 of volume 3 of the antecedent file of the DGI).

 

III. APPEAL FOR CONSIDERATION (See fs. 981 to 991 of volume 3 of the antecedent file of the DGI)

In due time, the taxpayer's representatives filed a formal Appeal for Reconsideration, in which, inter alia, they stated the following:

1. They point out that they filed the income tax returns corresponding to the tax periods 2011, 2012 and 2013, accumulating the totality of the income received and costs and/or expenses incurred during the development of the construction project, in the income tax return corresponding to the tax period 2013.

2. They also state that they filed Report 930 for the 2012 tax period, which details the total operations carried out with related parties abroad in that period, as well as the income generated and costs and/or expenses incurred.

3.         That, by virtue of the above, they were also obliged to have a Transfer Pricing Study for the 2012 tax period, in accordance with the provisions of Article 762-J of the Tax Code.

4.         They indicate that the search for potentially comparable companies to establish the market values that would allow compliance with free competition led them to search in the domestic market and due to the limited public information, it was necessary to search in other more developed markets.

5.         They argue that the criteria used by the Tax Administration with the company ----------------------------------- (which was not selected as a comparable company), concur with the rest of the other companies chosen and were not rejected by the Tax Administration.

6.         They also state that transactions with related parties abroad have no effect on the financial information used in the comparison.

7.         They point out that what the DGI did was to analyse the results presented for the 2012 tax period and made an adjustment to the income of ------------, for the period ending on 31 December 2013, without considering that they use the method of work completed and that the DGI should have, according to them, evaluated the profitability obtained by the work completed in the 2013 period, which gave the following result:

 

 

Total de Ingresos gravables

B/.84,749,273.28

Total de Costos deducibles

B/.75,526,068.01

Utilidad bruta

B/.9,223,205.27

Gastos deducibles antes de impuestos

B/.3,247,536.19

Utilidad Operativa

B/.5,975,669.08

Margen de Operaciones

7.05%

 (See detail on f.989 of Volume 3 of the DGI's precedent).

 

8.         They state that the inter-quartile range calculated by the DGI goes from 5.15% to 8.30% and a median of 5.70% and the operating margin obtained by , in its finished work is 7.05%, therefore the result obtained by the taxpayer is considered adjusted to the prices or amounts of operations between independent parties.

9. Together with its appeal, the taxpayer submitted documentary evidence such as the Income Tax Returns for the tax periods from 2011 to 2013, as well as the Transfer Pricing Report for the period 2012, submitted to the DGI and that an expert test be carried out to resolve two of the appellant's questions.

10.       Finally, they requested the Tax Administration to revoke in all its parts the original ruling issued on the basis of the explanations provided in the aforementioned appeal.

 

IV. THE TAKING OF EVIDENCE AT FIRST INSTANCE

Through the resolution of Evidence n. ° 0079 of 26 December 2017, the Tax Administration decided to admit the expert evidence requested by the taxpayer (See fs.1025 to 1028 of volume 3 of the DGI precedent),

In that order, it is noted that the experts of both the DGI and the taxpayer submitted their respective reports.

Thus, the expert report of -------------------------- and ----------------------------, experts appointed by the appellant, can be found on pages 1060 to 1075 and from pages 1076 to 1082, the expert report submitted by -------------------------------, expert appointed by the Tax Administration, both located in volume 3 of the DGI's preliminary file, which we will analyse in greater detail in the section on the Tribunal's considerations.

V.         RESOLUTION OF THE RECONSIDERATION APPEAL

The Tax Administration reiterates several of the arguments already set out in its first administrative act issued, so we will specify others that are very specific and that are derived from the confirmatory Resolution n. 201-1278 of April 16, 2019 visible on pages 1088 to 1107 of Volume 3 of the DGI's preliminary file.

1. The Tax Administration indicates that the taxpayer in its Appeal for Reconsideration, that for the calculation of the operating margin of 7.05%, it used the information contained in its Sworn Income Tax Return for the 2013 tax period.

2. However, in the Appellant's 2013 transfer pricing study, specifically on page 32, it stated an operating margin of 4.07 percent, which is based on the audited financial statements for the 2012 tax period.

3. On the two points described above, the Tax Administration points out that based on article 762-F of the Tax Code, that for the calculation of the profitability indicator the audited financial statements of the taxpayer must be used, which are in accordance with the NIFS, not the Income Tax Return that serves for tax purposes, so the taxpayer must then use the operating margin of 4. 07% contained in its 2012 Financial Statements and declared in its 2012 transfer pricing study and not the 7.05% margin of the 2013 Affidavit of Income.

4.         The DGI, also indicated in the resolution in question, that it rejected the use of information from the comparable companies for the period between 2011 and 2013, since it used the taxpayer's financial information for the 2012 tax period and compared it with financial information from the comparables for the period between 2010 and 2012, which is consistent with the use of the taxpayer's financial information for 2012.

5.         Regarding the rejection of the comparable company, the DGI reiterates that it found significant differences between the risks assumed by the taxpayer and the company, which operates in a politically and economically unstable market such as ----------- and because of these risks, an appropriate adjustment could not be made and was aggravated by a labour strike in that country. They consider that the situation affected the operating result of the company in the periods 2010 to 2012 as stated by the tax authorities' expert.

 

VI.        APPEAL

The Appeal filed by the plaintiff is received in due time, in which it reiterates several of the arguments already presented in its Appeal for Reconsideration and raises others, which will be mentioned below (See fs.1-19 of the TAH file).

1. They state that the Tax Administration focused on analysing only the expert opinion of the tax authority's expert, but not the expert opinion of the taxpayer's expert, in order to be able to fully evaluate both opinions, so they consider that the DGI disregarded the principle of motivation of the administrative act established in article 201 of Law 38 of 2000, as well as the provisions of article 980 of the Judicial Code.

2. They point out that the average operating margin for the period 2010-2012 obtained by -------------------- in its main business activity, which was not objected to by the DGI as an activity not comparable to that of , is 1.43%, which is very similar to the 1.20% obtained through the global business activity of , which was used, according to them, in the transfer pricing study of ------- - --------- for the fiscal year 2012.

 In that order, they argue that the business segment of -------------------- construction claims consultancy is not material, nor does it differ in terms of profitability from the overall business of --------------------, as to significantly affect the financial situation of the company and that even if only the information regarding the main activity of the company were used, the results would show that the taxpayer -------- ---------, complied with the arm's length principle during the 2012 tax year by being within the calculated interquartile range.

3.         They also indicate regarding the significant decrease in financial results due to the work stoppage at ------ of the company , in 2011, that, despite this, they do not consider that this is a valid functional reason to disregard the company as comparable since the provision of construction services are risks assumed by both the company and the taxpayer when providing them in emerging economies. They present as an example, what happened to the taxpayer itself in 2012 in a work stoppage in Panama due to an accident and in 2018 in the entire construction sector which was paralysed for 27 days due to a workers' strike.

In this regard, they state that it is not correct to conclude that work stoppages in the construction sector, due to situations beyond the scope of a company, are grounds to functionally reject it as comparable, in the way that the DGI did.

4.         They go on to argue that even under the assumption that , should not be considered as a comparable company, the taxpayer would still comply with the arm's length principle, as established by the 2010 Transfer Pricing guidelines specifically in its paragraph 3.68 and which were in force at the financial year of the years in question (See f.15 of the TAH file).

5.         They point out that the Taxpayer's Affidavit for the tax year 2013, collected the operations of all the work carried out during three years (2011-2013) and as mentioned in the Transfer Pricing Guidelines, the appropriate thing to do is to use a period of the companies selected as comparable contemporaneous to the period of -------- ---------, which would be from 2011 to 2013 because it is the time of duration of the work carried out by them.

6.         They state that the profitability indicator for -------- --------- should be calculated using the multi-year information for the 2011-2013 work, as this indicator reflects the true performance that this work represented for -------- ---------.

7.         They also argue their point that they complied with the arm's length principle during fiscal year 2012, as per the 2010 Transfer Pricing Guidelines, paragraphs 3.75 to 3.79 (See f. 16 of the TAF file).

The taxpayer indicates through a table on page 17 of the TAT file, that comparing its operating margin obtained during the entire period of duration of the work from 2011 to 2013 of 4.72%, with the operating margin obtained by the selected comparable companies, and despite excluding --------------------------, from the set of comparables, it complied with the arm's length principle by being within the calculated interquartile range.

 

VII.       PROCEEDINGS AT SECOND INSTANCE

By means of note no. 203-N-01-291 dated 23 August 2019, and received by the TAH on 30 August 2019, the Directorate General of Revenue sent us the antecedent file of the case, so that by resolution TAT-ADM-298 dated 20 September 2019, the Appeal was admitted (See fs.42 and 43 of the TAH file), filed before the Court on 6 August 2019.

Subsequently, the Tax Administration filed a formal notice of opposition (See fs. 46 to 50 of the TAH file), from which the following is to be highlighted:

1. They indicate that the DGI, not only issued the administrative act n.° 201-3306 of 27 February 2015, additionally liquidating in concept of Income Tax to the taxpayer for differences in the Transfer Pricing Study submitted and the Sworn Income Tax Return for the period 2013, but also for objections to the management services received and construction services, since it was not demonstrated that in fact the same have been effectively provided as stated in Article 752-G of the Tax Code.

They also state that the administrative act was issued because the company -------------------------- did not comply with the comparability requirements as stipulated in article 762-F of the Tax Code and the OECD Transfer Pricing Guidelines.

2. They also state that it is not true that they have not made any kind of assessment and/or analysis of the expert opinion issued by the taxpayer's expert, but at the time of assessing the expert evidence, they alluded to a fact mentioned by the tax authority's expert that was not mentioned by the taxpayer's expert and that was the operating results of the comparable company --------------------------, which were affected by its operation in ------ and that was the determining factor for the rejection of the company in question.

3.         In the same vein, they point out that it is not true that the company in question enjoyed similarities with the other comparable companies selected by the taxpayer in terms of the risks assumed, functions performed and markets and that they were amply supported in resolution no. 201-3306 of 27 February 2015.

4.         Regarding the construction claims consultancy segment of the rejected company as comparable, they do not agree with the taxpayer's statement that this business segment is not significant because it represents only 25% of the total revenues of the company --------------------------, as they do consider it to be significant and different from the functions performed by -------- ---------.

They also indicate that they do not agree with the apportionment of corporate expenses shown by the taxpayer on page 11 of its Appeal. The lack of segmentation of the financial information prevented them from concluding that the operating margin of the aforementioned segment is similar to the overall business activity of the comparable disallowed company, as the appellant would have us believe.

5.         Regarding the significant decrease in the financial results due to the work stoppage at ------ of the rejected comparable company, they state that it cannot be compared to any situation faced by the taxpayer during its construction activity in Panama during the years 2011 to 2013, as the risk was much higher in Panama than in Panama.

In relation to the examples cited by the taxpayer regarding construction stoppages for various reasons in Panama, they are irrelevant because they occurred six years prior to the 2012 period under discussion.

6.         Finally, they point out that they oppose the multi-year utilisation based on the provisions of article 715 of the Tax Code.

It is important to mention, at this point, that since there is no evidence to be presented, this Tribunal, through resolution TAT-PR-056 of 7 October 2020 (See f.53 to 55 of the TAH file), granted the parties the corresponding stage for their written arguments and it is recorded in the TAH file that none of them made use of the corresponding stage.

 

VIII.      CONSIDERATIONS OF THE COURT

Once the corresponding procedural stages have been exhausted, we proceed to issue our considerations, taking into account the arguments and evidence provided by the parties and which make up the present case file, as follows:

1. General information on the taxpayer

----------------------------------, is a corporation incorporated under the laws of the Republic of Panama, since May 31, 2011, located in the Province of --.

On June 14, 2011, days after the incorporation of the referred company, it was awarded the open tender called by ----------------------, for the: Design, Building, Repair and Construction

of the ------------

Now, it can be seen on page 936 of Volume 3 of the DGI's previous file that ---------------------------------- is made up of the following companies:

 - ( )

--------------- (Forms part of the group )

In view of the above, we shall now describe the activities of both companies:

--------------------------------------- (---------)

Spanish company that started operations in 1952 and currently operates worldwide. It is active in construction, energy, mining and tunnel sealing and was involved in the construction of railway networks and road developments in Spain at the time of preparing the 2012 price study.

--------------- (Part of the group )

---------------, is part of the -------- group, i.e. through the internal technology division and five subsidiaries in which it is included:

-

-

This company is Italian, founded in 1950, and is a specialist in all phases from the construction of TBMs to underground excavation and is a world leader in its sector, as can be seen from the file, as it is a contractor and equipment manufacturer, i.e. manufacturer of TBMs as mentioned above and underground excavation equipment, as well as support systems for underground excavation.

Therefore, -------- --------- ----------------, (------------), has the capacity to develop construction projects with the appropriate materials and personnel and receives construction advice from its related parties. Thus, we have:

- Main Activity or Function of the company: Construction of Underground Works (under the contract it held with ).

- Specialises in three business areas:

Construction (Roads, highways, railways, subways). Mining (Underground infrastructures, caverns) Energy (power stations)

- Main suppliers: ----------------- and -----------------

- Main customers: Public Administrations, Contractors and Private Clients.

- Intercompany or Related Party Transactions Resident Abroad

Management services received (--------- and )

--------- and -------- provided to ------------. Services in the process of consultancy in the construction process, i.e. for the management of the construction projects

Equipment rentals, purchase of materials and Tunnel lining services (construction services) (--------- and )

------------ carried out transactions with its related party, i.e. for the rental of machinery and purchase of materials.

------------ carried out transactions with its related party ------------ -----, subcontracting of tunnel lining services.

2.         Matter in dispute

The Directorate General of Revenue, decided to issue additional liquidation for Income Tax through the original administrative act n.º 201-3306 of 27 February 2015, due to differences found in the study of Transfer Pricing corresponding to the year 2012, in the  Income tax return for the 2013 tax period and in the Transfer Pricing Report 930 for the 2012 tax period, the latter filed on 30 June 2013, of the taxpayer ---------------, with RUC.

It can be deduced from the present case that the disputed point is mainly focused on the objection of the Tax Administration, regarding the "Construction Services", which include equipment rental, purchase of materials and tunnel lining services, provided to , since at the time of reviewing the income statements of one of the companies used as a comparable company named --------------------------, the Tax Administration determined that it could not be included as comparable because it affected the arm's length range.

In addition to the above, and despite the fact that the DGI, in the contested administrative act, devoted a large part of its analysis to the "Management Services" operation, objecting to the agreed remuneration because it did not comply with the arm's length principle described in articles 762-F and 762-G of the Tax Code, this analysis did not result in an adjustment to the taxpayer's income or financial information.

This being so, this Tribunal, with regard to the objection of the service described in the previous paragraph, will not issue any further pronouncement or analysis by virtue of the Principle of No Reform in Perjury or "non reformatio in peius", as it is also known, which constitutes a limitation to the action and competence of the hierarchical superior in an administrative proceeding that has come to his knowledge by virtue of a duly filed appeal, so that the scope of his pronouncement is restricted to what was expressly stated in the appeal action and the taxpayer does not see the conditions existing before the moment in which he appealed exclusively to an administrative act improved.

In the analysis corresponding to the "Construction Services" segment, we note that the DGI indicated that the company --------------------------, differed from ------------, both in functions, assets and risks, as well as in the contractual clauses, i.e., in how responsibilities are distributed. They also state that they rejected the comparable company described above due to economic circumstances, business and market strategies.

Thus, we consider that the point on which our analysis should focus is the rejection of the comparable company --------------------------, since the taxpayer, i.e. ------------, presented four (4) comparable companies, of which three (3) were accepted by the Tax Administration and one of them was rejected or discarded, which resulted in the Tax Administration adjusting the operating margin of ------------, by 1. 63 percentage points, to the margin that they (------------) declared was 4.07%, to bring it to the median of 5.70%, which in effect, said percentage change, represented an increase of B/.219,457.55, in the Income Tax that they had already paid according to their Sworn Income Tax Return for the 2013 tax period.

 

3.         Background and Applicable Regulations

Chapter IX of the Tax Code introduces rules related to International Taxation, including the transfer pricing regime, which seeks to adjust transactions carried out by related companies to the arm's length principle; it being understood that the arm's length principle seeks to ensure that transactions carried out by related companies are carried out as if they had been carried out between independent companies.

Next, we will briefly explain the scope of the concept of transfer pricing, which is very important to address, as it will allow us to complement our analysis prior to deciding this issue.

Transfer pricing is a mechanism used to ensure that related companies agree on the value of their sales and purchases of goods and services at the same value that they would agree with independent companies. Therefore, the agreed prices have a fiscal effect, since they have an impact on the income, costs and expenses of the operations between related companies, as well as on the tax payable on the taxable income of such companies, which includes the tax on profits.

In this respect, the foreword to the OECD guidelines states the following: ".....

...

6. In order to apply the separate entity test to intra-group transactions, tax should be levied on each group member individually, on the basis that, in its transactions with the other members, it acts on an arm's length basis. ...

11. In applying these principles to multinationals, one of the most difficult issues that has arisen is the determination of transfer prices that are appropriate for tax purposes. Transfer prices are the prices at which an enterprise transfers tangible goods and intangible assets, or provides services, to associated enterprises. For the purposes of these Guidelines, an "associated enterprise" is an enterprise that meets the conditions set out in Article 9(1)(a) and (b) of the OECD Model Tax Convention. ...

12. ...

Transfer Pricing is significant for both taxpayers and tax administrations because it determines to a large extent the distribution of income and expenses and thus taxable profits of associated enterprises located in different tax jurisdictions.  " .

Therefore, an increase or decrease in the prices agreed between related companies has a tax impact, since, if transfer prices produce lower costs and higher profits, corporate tax planning could lead multinationals to use this transfer pricing scheme in jurisdictions where profits are taxed at low rates. Conversely, if transfer pricing is such that costs are higher and profits are lower, such companies may use this model in jurisdictions where tax rates are high.

In view of the above, the Tax Administrations adopt mechanisms to ascertain the prices agreed or the transfer prices obtained as a result of transactions with related companies, which is carried out through income tax returns, as well as transfer pricing reports and studies.

By means of such mechanisms, the Tax Administrations are able to obtain information and verify, not only if the operations took place within the arm's length principle, but, as this has tax implications, they can also verify the incidence that such transfer prices had on the income, costs, expenses and taxable profits of the companies with related operations.

In this sense, it is necessary to refer to the legal regulations in force in the case at hand, some of which are found in articles 762-A, 762-B, 762-D and 762-E of the Fiscal Code, whose texts are as follows:

"Article 762-A. The principle of free competition. Transactions carried out by taxpayers with related parties shall be valued in accordance with the arm's length principle, i.e., the ordinary and extraordinary income and the costs and deduction necessary to carry out such transactions shall be determined by considering the price or amount that independent parties would have agreed to under similar circumstances under arm's length conditions. The value so determined shall be reflected for tax purposes in the tax returns filed by the taxpayer, following the methodology established in the articles contained in this Chapter."

"Article 762-B. Powers of the Directorate General of Revenue. The Directorate General of Revenue may verify that transactions carried out between related parties have been valued in accordance with the provisions of the preceding Article and shall make the corresponding adjustments when the price or amount stipulated does not correspond to those that would have been agreed between independent parties in comparable transactions, resulting in less taxation in the country or a deferral of taxation, as the case may be."

"Article 762-D. Objective scope of application. The transfer pricing regime is established, aimed at regulating for tax purposes the transactions carried out between related parties, in the terms defined by this Chapter, in such a way that the considerations between them are similar to those carried out between independent parties.

...

For the interpretation of the provisions contained in this Chapter, the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, approved by the Council of the Organisation for Economic Co-operation and Development in 2010, or those that replace them, shall be applicable as a technical reference, insofar as they are consistent with the provisions of this Chapter...."

"Article 762-E. Comparability analysis. For purposes of determining the price or amount that would have been agreed to by independent parties under similar circumstances at arm's length as referred to in Article 762-A, the terms of transactions between related persons shall be compared to comparable transactions between independent parties. Two or more transactions are comparable where there are no differences between them that significantly affect the price or amount and where such differences can be eliminated by reasonable adjustments.

In determining whether two or more transactions are comparable, the following elements shall be taken into account to the extent that they are economically relevant:

1.         The specific characteristics of the transactions including.

a.         In the case of financing transactions, elements such as the principal amount, term, risk rating, collateral, creditworthiness of the obligor, and interest rate.

b.         In the case of the provision of services, elements such as the nature of the service and whether or not the service involves technical expertise or knowledge.

c.         In the case of granting rights of use or disposal of tangible goods, elements such as the physical characteristics, quality, reliability, availability of the good, and volume of supply.

d.         In the case of granting the exploitation or transfer of an intangible asset, elements such as the type of asset, patent, trademark, trade name, transfer of technology or know-how, the duration and degree of protection and the benefits expected to accrue from its use.

e.         In the case of a disposal of shares, the issuer's net assets, the present value of projected earnings or cash flows, or the issuer's stock price as of the last event on the day of disposal.

2.         The significant economic functions or activities undertaken by the parties in connection with the transactions under consideration, including the risks assumed and weighting, if any, of the assets used.

 3.        The actual contractual terms, if any, under which the transactions arise, taking into account the responsibilities, risks and rewards assumed by each contracting party.

4.         The characteristics of the markets or other economic factors that may affect the transactions.

5.         Commercial and business strategies, such as market penetration, permanence or expansion policies, as well as any other circumstance that may be relevant in each case.

The comparability analysis thus determined and the information on comparable transactions constitute the factors which, in accordance with the provisions of Article 762- F, shall determine the most appropriate method in each specific case. "

For its part, Executive Decree n. ° 958 of August 7, 2013, which regulates Chapter IX of Title I of Book Four of Book Four of the Tax Code, on Rules for Adaptation to Treaties or Conventions to Avoid Double Taxation, indicates both in its Article 4 and 5, the following:

"Article 4. Search for comparable transactions. The comparability analysis, which shall include the search for information on comparable transactions, shall aim to determine and find the most reliable comparable transactions, as part of the process of selecting the most appropriate method and its application".

"Article 5. Internal and external comparables. Any transaction carried out by the taxpayer with an independent third party, as well as any transaction carried out by any related party of the taxpayer with an independent third party, shall be considered an internal comparable, provided that the definition of comparable transactions set forth in Article 762-E is met.

Any transaction other than the one described in the previous paragraph shall be considered as an external comparable, provided that the definition of comparable transactions set forth in Article 762-E is met.

... internal comparables shall be given preference over external comparables. If external comparables are used, the reasons why the use of internal comparables was not possible shall be documented.

...".

As can be seen, the search for comparables is an essential element of the transfer pricing analysis, therefore, its correct application is of vital importance to determine compliance with the arm's length principle.

In this sense, the OECD Guidelines, 2010 version, also specify in section 3.46 the importance of the process to identify potential comparables. Here is what it states:

"3.46. The process followed to identify potential comparables is one of the most critical aspects of the comparability analysis and should be transparent, systematic and verifiable. In particular, the choice of selection criteria has a significant impact on the outcome of the analysis and should therefore reflect the most significant economic characteristics of the transactions being compared. It may not be possible to completely eliminate subjective judgements in the selection of comparables, but much can be done to increase objectivity and ensure transparency in the application of these subjective judgements. The optimal degree of transparency of the process will depend on the extent to which the criteria used to select potential comparables can be disclosed, as well as the ability to explain the reasons for eliminating certain potential comparables. Enhancing the objectivity and ensuring the transparency of the process may also depend on the extent to which the person reviewing the process (the taxpayer or the tax administration) has access to information about the process and the same data sources.

Having transcribed the relevant rules for the case at hand, we turn to the following analysis.

 

4.         AS A CONSTRUCTION COMPANY

The taxpayer , uses the finished work method provided as one of the methods for construction companies and in that sense, filed its income tax returns corresponding to the tax periods 2011, 2012 and 2013, accumulating all the income, costs and/or expenses incurred during the development of the construction project, in the Income Tax Return for the tax period 2013.

We must remember that, in the case of construction companies, whose income generating operations affect more than one fiscal year, the taxpayer has the option to apply any of the three methods established in article 123 of Executive Decree 170 of 1993. The following is described in paragraph c) of Article 123 of said regulation:

"Article 123. Determination of the tax in the case of constructions.

Of the construction companies:

1.         In the case of construction companies or companies that carry out work on real estate and whose income-generating operations affect more than one tax year, the taxpayer may, at his option, apply any of the following methods:

(a) Allocate to each tax year the taxable income resulting from applying to the amounts actually received in that year, the percentage of net profit calculated for the entire work. This percentage may be modified by the part corresponding to the following tax years, in the event of an obvious modification of the calculation made.

b) Allocate to the value of the work executed in each fiscal year, the percentage of profit calculated on the total value of the work and deduct from this result the costs and expenses actually incurred in the respective fiscal year.

c) Allocate to the fiscal year in which the work is completed the total gross income and the respective costs and expenses.

In the cases of subparagraphs a) and b), the difference ultimately obtained by comparing the net profit at the end of the work with that established by means of any of the procedures indicated in said subparagraphs shall affect the fiscal year in which the work is completed. In the case of subparagraph c), the taxable income to be taken into account will be that corresponding to the totality of the work".

In the sense pointed out we bring up a pronouncement of the Court, regarding companies engaged in this type of construction activity, specifically in resolution TAT-RF-058 of 4 July 2018.

"...

It can be seen that in the finished work method, the taxable income taken into account is that which corresponds to the totality of the work. In this sense, following article 762-D of the Tax Code, the scope of application for income tax purposes, refers to the tax period in which the income is declared and not when the operation is carried out (annual), since it would seem that it would not make any sense to apply it in years where the income tax return boxes - operations with foreign related party, were left blank and that can be seen in the income tax returns tax period 2011 and tax period 2012.

Although these special income tax regimes typify the same taxable event, the elements for determining the amount of such tax, the time and manner in which it must be paid differ in comparison with the general regime.

In this regard, it is appropriate to quote the author Edison Gnazzo, who in his book Impuestos y Gastos Públicos de la República de Panamá, refers to the special income tax regimes:

"Under the special regimes and as will be seen in Chapter 4.12., the above conditions are essentially maintained in terms of the need for the income to be of Panamanian source, varying particularly with regard to the annuality of the tax, the determination of the net taxable income and the applicable rates" ....

... In the first place we are dealing with a taxpayer of the group that has, because the law allows it, a different system for determining the income tax that it must pay to the tax authorities. In this sense it is clear, because resolution no. 201-503 of 14 October 2014 recognises it, that -------------------------., is a company that carries out the activity of construction and follows the method of finished work.

... In this particular case, the taxpayer filed his income tax return in 2013 including or accumulating by means of the aforementioned method, the periods 2011 and 2012. The filing of the income tax return under this method does not pose a major legal problem in this case, except that, by means of Law 33 of 2010, the Republic of Panama adopted the Transfer Pricing Regime by adding Chapter IX to the Tax Code, which came into force the day after its enactment, i.e. it came into force on 1 July 2010 and although retroactive effect was included for some of its rules, this was not so for the aforementioned articles, which came into force from the enactment of the law.

That last annotation takes on particular relevance in the analysis of the present case because as we can see, resolution no 201-53 of 14 October 2014 which is appealed (fs 7 to 9 of the antecedent), in order to establish the scope of application of the transfer pricing regime, merely transcribes articles 762-D and 762-I as amended by law 52 of 2012 making abstraction of the system that the taxpayer was following, which was the system of finished work, and without further analysis to verify whether the obligations imposed by the regulation were in fact applicable to the taxpayer over time, taking into account that the return generating the controversy referred to the periods 2011, 2012 and 2013, and the rules applicable to the case were approved in 2010 and 2012. In addition to this, article 762-I as added by law 33 of 2010 (which, as mentioned above, came into force on 1 July 2010) established that ".... Taxpayers must file, annually, an informative declaration of the operations carried out with related parties that are tax residents of the countries with which the Republic of Panama maintains treaties or agreements to avoid international double taxation, which must be filed within six months following the closing date of the tax period of the taxpayer, under the terms established by the Directorate General of Revenue through the regulations that are prepared for that purpose". Form 930, which is the means approved by the tax administration to submit the report in question, was adopted by re solution no 201-6845 of 15 June 2012, which means that it was approved 15 days before the expiry of the term established in the law.

... the Tax Administration acknowledged that the taxpayer filed his income tax returns for the periods 2011, 2012 and 2013 in a timely manner. Furthermore, it acknowledged that the taxpayer was entitled to accrue the totality of the income received and/or expenses incurred linked to the construction project which according to the appellant was completed in 2013, as indeed it did ...

...

In the case under analysis, it is clear that --., following the completed work method, filed his income tax return in 2013 where he accrued the income and expenses corresponding to the periods 2011 and 2012. It is even accepted by the Directorate General of Revenue in resolution 201-0846 of 19 January 2015 that the taxpayer did not declare transactions with related parties in 2012, and that even though he was not obliged to do so, he submitted his transfer pricing report for that period. It is equally clear that the 930 report was not submitted together with the income tax return filed in 2013 (which accumulated the aforementioned periods).

Given this background, it is understandable that the Tax Administration acted on the basis of the result contemplated in the rule imposing an obligation, however, it should have considered other elements that it was aware of in this case such as the activity carried out by the taxpayer ......."

As it is clear from the above decision, being one of the parties involved, the same taxpayer who challenged the present case, the activity carried out by the appellant is that of construction which opted for the method of finished work.

This method, we reiterate, consists of the taxpayer accumulating the costs it incurs for the construction of the work during the time it takes. If the work covers several fiscal periods, the taxpayer records its costs in an asset in process account and when the ownership of the property is transferred to the buyers, the taxpayer recognises the income, costs and expenses and declares them in the results section of the income tax return.

From what is on record in the income tax forms for 2011, 2012 and 2013, it can be deduced that the taxpayer effectively uses the completed work method, since in 2011 and 2012 the taxpayer did not report income, costs or expenses with foreign related parties, but did report them in the construction in progress section. On the other hand, in the income form of 2013, it reflects operations in the section of costs with related parties abroad, for B/.9,981,703.50, while in the construction in process line (Assets) the field is without value, which confirms the fact that the taxpayer used the aforementioned method (See fs.994 to 1005 of Volume 3 of the DGI's precedent).

The obligation to file the transfer pricing report arises when the income, costs and expenses between related parties are taken to profit and loss, and not before. The taxpayer, although it is true that it filed the 930 Report for 2012, was not obliged to do so, because it reported neither income, nor costs, nor expenses with related parties abroad and as for the transfer pricing study, it was not obliged to have it either, but in practice they choose to do so to keep track in order to have knowledge of the behaviour of the transactions, and to be able to make the corresponding adjustments very early in the tax year, keeping their prices within the arm's length range.

Having clarified the above, in its Appeal, it indicates that, in accordance with the Transfer Pricing Guidelines, it is appropriate to use a period of the companies selected as comparable contemporaneous with the period of ---- --------, which would be from 2011 to 2013, that is to say, to use multi-year information to obtain the profitability indicator as it would reflect the true performance that such work represented and not on the basis of an analysis of the results obtained from the 930 Report and the 2012 Transfer Pricing Study submitted by the taxpayer itself and which entailed an adjustment to the Income Tax for the period ending on 31 December 2013.

The Tax Administration's argument, in response to the taxpayer's statement ------------, is that they oppose the use of multi-year information based on the provisions of Chapter III, Title I, Article 715 of the Tax Code, which states that "The income tax return for each taxable year must form a whole independent of the returns for the other years, both in terms of gross income and in terms of deductible expenses or expenditures, except as provided in Article 698 of this Code" (italics added by this Court).

Likewise, the Directorate General of Revenue, in its confirmatory act, pointed out to the appellant that it used for the calculation of the operating margin, the information contained in its Sworn Income Tax Return for the 2013 tax period and that it also obtained another operating margin based on the audited financial statements corresponding to the 2012 tax period, extracted this time, from its Transfer Price Study for the 2013 period, for which reason it was reminded in said resolution, that for the calculation of the profitability indicator, the audited financial statements of the taxpayer must be used, based on the provisions of article 762-F, of the Tax Code and not from the Sworn Income Tax Return, which is used for Tax purposes.

On the above, this Court has already ruled, in Resolution TAT-RF-066 of 9 July 2021 as follows:

"...

On the other hand, it should be recalled that the purpose of the adjustment to the financial information is that the indicator determined by the transfer pricing analysis is aligned with the arm's length range, and if not, to bring it to the median of that range. ...

...

Without prejudice to the foregoing, we must clarify that the adjustments to the financial information must use, precisely, the financial information, which leads us to disagree with the decision of the taxpayer's expert to use the information from the income tax return for the calculation of the operating margin, knowing that there are quantitative and qualitative differences with respect to the financial information (page 565 of the Court's file), and even with the information contained in the transfer pricing studies, which makes his answers to questions 1 and 2 less reliable, since the information used to determine the interquartile range is based on financial information (not tax information) of the comparables.

...".

Now, with regard to the taxpayer's request to use a period of the companies selected as comparables contemporary to the period 2011 to 2013, in other words, to use multi-year information to obtain the profitability indicator to reflect the true performance of ------------, the DGI indicated that it rejected the use of information from the comparable companies for the periods 2011 to 2013, because, according to the argument, it used financial information from the period 2012 and compared it with the financial information of the comparables for the period 2010 to 2012.

In this regard, this Court considers that although the OECD Transfer Pricing Guidelines indicate in the section entitled "Multi-year data" of the Comparability Analysis Section, in paragraphs 3.75 to 3. 79, the possibility of using data relating to several years for the profitability analysis or multi-year data, the Tax Administration, used information from 2010 to 2012 of comparable companies since the appellant itself indicated in the 2012 Transfer Pricing Study, the total transactions carried out with its related parties abroad, taking into account that it was in this period, in which the transactions were carried out, according to the global financial information of the audited Financial Statements as of 31 December 2012 by , therefore the operating margin that should be adjusted to the median of free competition, the costs of the operations with related parties of ------------ to the year 2012, but we agree with the Tax Administration that the additional liquidation for the Income Tax is the one declared for the fiscal period 2013, since it was in that period due to the opted method where the total gross income, costs and expenses were allocated, which includes as already mentioned the adjustment of the operating margin (See fs. 221 to 244 of Volume 1 of the DGI's file).

Therefore, it is not possible for the taxpayer, at this stage, to point out that the Tax Administration should have used the information from the periods of the companies selected as comparable, in accordance with the Transfer Pricing guidelines, taking into consideration the income tax return for the 2013 tax period, which includes the 3 years of operations of the work, i.e. from 2011 to 2013 (instead of 2010-2012), and which yields a profitability indicator or operating margin according to ------------, (even though the company -------------------- has been rejected, and maintaining those that the DGI did accept), of 4. 58%, a median of 4.67% and 7.85%, which, in its opinion, would place it within the range of compliance with the arm's length principle.

Similarly, we consider it important to point out that in the same way that the taxpayer cannot claim to use its aggregated financial information, ignoring the analysis made in its transfer pricing report submitted in the 2012 period, neither is it correct for the tax authorities to make an adjustment to the taxpayer's segmented financial information (2012), and use, for the purposes of the additional assessment, the taxpayer's accumulated income tax return, corresponding to the entire project.

It is essential that any adjustment to the taxpayer's financial/tax information is made in a congruent manner, i.e. taking into account the accumulated activity and not in a partial manner.

 

5.         EXPERT EVIDENCE

Before starting our analysis on the expert evidence admitted and practiced by the first instance at the request of the appellant, we must recall the provisions of article 966 of the Judicial Code, which establishes that the express purpose of the expert evidence is "to know, appreciate or evaluate some data or fact of influence in the process, of a scientific, technical, artistic or practical nature, which does not belong to the common experience or the specific training required of the judge. "Given the technical and complex nature of the subject matter, it is reiterative, mainly for these reasons, that the practice of expert evidence is carried out to provide greater clarity within the process.

Similarly, Article 968 of the same regulation establishes that the judge must specify the points on which the expert opinion will be based, which is evident, in this case, in the questions set out in the Resolution of Evidence 0079 of 26 December 2017, issued by the DGI, which denotes that the work of the experts is subordinated to that expressly entrusted in this case, by the instance that orders the test, which must be presented, according to the provisions of article 974 of the Judicial Code, also in a clear and precise manner.

In the present case, the appellant formulated two specific questions to be addressed by the appointed experts. Below, we will point out the most important aspects of their reports, which can be found on pages 1060 to 1075 (taxpayer's experts) and 1076 to 1082 (DGI's experts) of Volume 3 of the DGI's file.

Question No. 1

Determine whether the companies selected as comparables in the transfer pricing study are suitable companies to establish the market values of the activity of . S.A.

Answer of the Experts of ------------:

1.         The search was carried out in accordance with the process of selection of comparable companies established in the Transfer Pricing Guidelines, which establish that in the absence of internal comparables, it is possible to use various sources of information that can be used to identify possible independent external comparables.

2.         The approach used for fiscal year 2012 was deductive (focusing on the process and relevance of the selection criteria chosen) rather than additive, to identify comparable external companies operating in the same sector as ------------ and eliminating companies performing activities considered not comparable, so that 47 potentially comparable external companies were identified whose business activities were classified under the SIC codes of provision of design services, building, construction and repair services, which are comparable to the services performed by , during fiscal year 2012, as well as using the databases --------------- and --------------- and the 10-K forms of each comparable company for the application of these filters.

3.         Using the quantitative filters, 14 companies were eliminated as they either did not provide sufficient financial information or had recurring operating losses and were determined to be ineligible for comparability and then the qualitative filters were applied by reviewing the business descriptions of the remaining potentially comparable companies to identify companies engaged in the provision of project management and technical support services to the construction industry, activities carried out by ------------ during the 2012 fiscal year and also eliminated 43 companies that carried out activities other than those indicated above, to be left with a total of 4 companies comparable to the operation carried out by ------------, during the 2012 fiscal year.

4.         After all of the above, the companies selected as external comparables to the activity carried out by --------- during fiscal year 2012 were four (4), the same are:  , ,----- and --------------------------., these companies selected as comparables have enough similarity in terms of their functions performed globally, being leaders within the construction sector and applying generally similar business strategies.

5.         Regarding the company considered not comparable by the DGI, --------------------------, they state the following:

- It is a global company with approximately 3,200 staff and 100 offices in more than 35 countries.

- It offers construction management services (fee-based) to its clients, which are typically billed on a per diem basis and a negotiated multiple of the direct cost of each consultant assigned to a project.

- It contracts with its clients in three different ways, through cost-plus-fee, time-and-materials, and fixed-price contracts in which it uses the percentage completed method to recognise revenue and these types of contracts are the usual ones used in the construction sector, and are the same as those used by the other selected comparable companies.

- It mainly presents the operating risks that a construction company would present, of which one of the most important and comparable with ------------ is the dependence on subcontractors and specialists for the development of its activities through which it assumes the risk of not being able to comply with the projects in the correct time.

6.         They point out that although the DGI does not propose new comparable companies, it merely ignored the company with the lowest profitability margin, i.e. --------------------------. Similarly, the DGI points out that the services of -------------------------- have significant advantages over traditional general contractors as they do not assume the risk of completion of the Project.

Response from the DGI's appointed expert

1. She stated that there is no objection to the quantitative and qualitative criteria presented by ------------, but that the discussion regarding comparables seems to focus on the proper application of these criteria.

2.         He also indicated that he reviewed publicly available information in the annual reports or 10-Ks of these companies on the U.S. Securities and Exchange Commission (SEC) website and on the System for Electronic Document Analysis and Retrieval (SEDAR) website.

3.         He indicated that the company, -----------------------------------, derives its revenues from construction consulting services and comes from two business segments: project management consulting and construction claims consulting, the latter representing approximately 25% of its consulting revenues and corresponds to advisory services to its clients in preventing and resolving claims and lawsuits based on non-compliance with dates, cost overruns, among others.

4.         In addition, from the company's public financial information, it was noted that the company's operating results decreased, mainly due to:

- The loss of revenues and earnings from discontinued operations in

- The completion of a project at the end of 2010 and,

- The decrease in work, in the project management business of US$21,377,000 in ------ ...and a decrease of US$5,055,000 in --.

5.         In the same order, during the periods 2008, 2009 and 2010, the company presents operating profitability margins of 5.83%, 6.28%, and 4.12%, respectively. From 2011 onwards, the company shows a significant decrease in its operating results, from 4.12% in 2010 to -0.77% in 2011 and 1.09% in 2012.

6.         Also, the company's 2012 10-K report notes that accounts receivable related to work performed prior to March 2011 under contracts at ------ were approximately US$60 million, which impaired -----------------------------------'s operating cash flows in both 2011 and 2012, causing the company to rely on borrowing to support its operations.

7.         Finally, the expert concluded that the construction claims consulting segment differs from the activities performed by and the rest of the companies selected in the interquartile range and for that reason the company, in terms of the qualitative criteria of significantly different activities and deviations in the normal course of business, differs significantly from ------------.

Question 2

Does the Expert determine whether the profitability margin obtained in the project developed by ---------------------------------- complies with market values?

Answer of the experts of ------------:

1. They considered that the financial information of the comparable companies and the calculation of the interquartile range is correct, together with the calculation of the indicator obtained by ------------, for the fiscal year 2012, according to its financial information, being within the market values obtained from the interquartile range of the weighted average 2010-2012 of the adjusted operating margin obtained by the selected comparable Companies.

2.         The interquartile range of the weighted average adjusted operating margin for the period 2010-2012 obtained by selected comparable companies ranges from 3.70% to 7.00% with a median of 5.10%.

3.         The operating margin obtained by ------------ for its construction services rendering activity for fiscal 2012 was 4.07%, which is within the interquartile range obtained by the selected comparable companies.

4.         This margin is quite reasonable considering the fact that ------------ did not have to make efforts to obtain the contract for the project ---------------, but was created to comply with the agreement signed with the company ----------------------, so it did not assume any risk in that sense as the project was secured.

5.         Notwithstanding the above, the experts indicated that the selected comparable companies, in their operations with independent third parties, were willing to obtain operating margins similar to those of ------------ despite the fact that they did make efforts in terms of commercial and business strategies, assuming a market risk.

DGI's expert's reply

1. He pointed out that since the company is not considered comparable to the taxpayer, the interquartile range would be from 5.15% to 8.30% with a median of 5.70%; therefore, the taxpayer's operating margin of 4.07% is outside the interquartile range.

At this point, it is necessary to make a considered assessment of the evidence, in accordance with sound criticism and subject to the guidelines enshrined in article 980 of the Judicial Code, which states:

"Article 980: The strength of the expert opinion will be estimated by the Judge taking into consideration the scientific principles on which it is based, the relationship with the factual material, the concordance of its application with the rules of sound criticism, the competence of the experts, the uniformity or disagreement of their opinions and other evidence and other elements of conviction offered by the process".

 Regarding the guidelines that the Court must follow for the evidential appreciation of the expert opinions, according to the rules of sound criticism, the national doctrine has listed a series of factors that must be taken into account, as follows: Jorge Fábrega P., MEDIOS DE PRUEBA, Editorial Plaza & Janés, Bogotá, 2001, Volume II, second edition, corrected and augmented, pp. 533 and 534.

"CONCRETE ELEMENTS OF VALUATION.

Experience shows that there are certain relevant elements and criteria of evidential appreciation that the judge must take into account in the assessment of the expert evidence. These are, among others:

1. Competence and professional specialisation of the expert in relation to the matter he/she is ruling on (as a rule, and without prejudice to other elements, greater probative value has an expert and independent expert, than several mediocre ones).

2.         Accuracy, coherence and degree of certainty of the report.

3. Method of investigation and presentation.

4.         Sources and data on which the opinion is based.

5.         Technical principles on which the opinion is based.

6.         Answer to the opposing party's cross-examination.

7.         Conduct of the Expert in the proceedings.

8.         Prestige, especially in professional circles and in court.

9.         Sound criticism.

10.       Consistency with the rest of the evidence".

The integral appreciation of the aforementioned technical opinions rendered during the course of the process, show that the expert opinions merit evidential value, with respect to the point under discussion, after the evaluations ordered by article 980 of the Judicial Code.

As can be seen in the transcript, it is the judge who is responsible for analysing the expert evidence under attack and determining whether it complies with the provisions of its admission, at the time of evaluating the body of evidence, giving it the value that corresponds in relation and proportion to the rest of the evidence provided.

In this sense, the taxpayer states in his Appeal that the DGI only analysed the expert opinion of the tax authority's expert, and did not evaluate both reports in their entirety, thus disregarding the principle of motivation of the administrative act described in article 201 of Law 38 of 31 July 2000.

For its part, the Tax Administration, in response to the allegation made by , pointed out that the above assertion is not true, since the confirmatory act sets out the arguments of both experts and at the time of assessing the expert evidence, alluded to a fact not mentioned by the taxpayer's experts regarding the operating results of the comparable rejected or challenged that was mentioned by the tax authority's expert in his report.

This Court, upon reviewing the administrative act that resolved the Appeal for Reconsideration referred to by the taxpayer ------------, observes that the Tax Administration only referred to the expert evidence provided by the taxpayer's experts, in order to indicate the following:

1. That, based on what is indicated in the expert reports, the company ,the same has a segment of consulting in construction claims that represents 25%, approximately of the income obtained by the company for consulting services, so that this function differs from those carried out by --.

2.         That the report does not refer to the global risk situation involving --------------------, due to the situation originating at ------, due to acts of terrorism, political and social unrest, among others, which could lead to the evacuation of personnel, cancellation of contracts, affecting the timing and collectability of accounts receivable, which represents the largest asset in the balance sheet, and which affected the operating results of the company, as the expert witness of the Treasury did in her report.

In the opinion of this Court, although the Tax Administration in its confirmatory act did not refer to all the aspects pointed out by the taxpayer's experts in their report, it did raise differentiating situations and arguments between one report and the other, and in this sense we cannot conclude that the administrative act lacked a comprehensive motivation of the set of factual and legal factors in this case, regarding the expert evidence, since the expert evidence is only a part of the other aspects to be considered and which make up the file and which resulted in the original decision being maintained.

The appellant's representatives should bear in mind that the way in which the findings are presented in each report after they comply with what has been requested, are valued independently of the form or style in which they have been presented, referring specifically to the content and the way of presenting the findings that are at the discretion of the experts to assert their positions as experts against public information obtained from various reports that does not vary at least with regard to the company and the period investigated and is available to anyone who wants to use it and extract from it the information they consider to be of interest.

In the following section, therefore, we will discuss what aspects emerge from these reports and from all the other elements that make up the file in order to reach a conclusion in this case.

6. Comparability analysis

From a technical point of view, a distinction must be made between transfer pricing adjustments, made by the Tax Administration to the taxpayers' income, based on Article 762-B of the Tax Code, and comparability adjustments, which seek to eliminate (or reduce) the effects of the existing differences between the analysed party and the comparable companies, as part of the comparability analysis developed in Article 762-E of the Tax Code.

Similarly, paragraph 1.33 of the OECD Transfer Pricing Guidelines, for the period 2010, concerning the importance of the comparability analysis and the meaning of the term comparable, states the following:

"The application of the Arm's Length Principle is generally based on a comparison of the terms of a related transaction with the terms of transactions between independent enterprises. For such comparisons to be useful, the relevant economic characteristics of the situations being compared must be sufficiently comparable. Comparability means that none of the differences (if any) between the situations being compared can significantly affect the terms analysed in the methodology (e.g. price or margin), or that sufficiently precise adjustments can be made to eliminate the effects of such differences. To determine the degree of comparability and what adjustments are necessary to achieve comparability, it is necessary to understand how independent companies assess potential transactions...".

In this sense, it should also be noted that the transfer pricing methodology adopted by our legislation, inspired by the OECD Guidelines, does not pretend that two companies or products are the same, and even if this were the intention, there is countless literature on the difficulties that this poses.

In this regard, the OECD Guidelines, in paragraphs 1.36 and 1.37, state the following:

1.36 As noted above, significant differences between transactions or between enterprises being compared should be taken into account in making the comparison. In order to determine the actual degree of comparability, it is necessary to assess the characteristics of the transactions, or of the firms, that would have influenced the terms of open market trading, and thus to make appropriate adjustments to establish arm's length conditions (or a range thereof).

The characteristics or "comparability factors" that may be important in determining comparability are the characteristics of the property or services transferred, the functions performed by the parties (taking into account the assets used and the risks assumed), the contractual terms, the economic circumstances of the parties and the business strategies pursued by the parties.

1.37 The importance of these factors in determining comparability will depend on the nature of the controlled transaction and the pricing method adopted...".

Going into the matter, we have that the Tax Administration when reviewing the income statements of the comparables provided by the taxpayer with the 10-k reports, they observed that the Company -------------------------- presents important differences, as they consider that the functions performed including the assets or risks assumed in the operation of --------------------------, differ from the functions, assets and risks of the taxpayer ------------, as well as in the contractual clauses, considering how responsibilities are distributed, economic circumstances, and the business strategies and geographic market, for which reason it did not maintain it as a comparable company, because it affects the range of full competition.

These conclusions were based on Article 762-E described in the preceding paragraphs and on the OECD's comments in points 1.42, 1.52, 1.53, 1.55, 1.57 and 1.59 of Chapter I, which deals with the Arm's Length Principle of the Transfer Pricing Guidelines. The following is what they state:

"Functional Analysis

1.42 In business transactions between two independent enterprises, remuneration normally reflects the functions performed by each enterprise (taking into account the assets used and the risks assumed). Therefore, in order to determine whether related and unrelated transactions or associated and independent entities are comparable, it is necessary to perform a functional analysis. This functional analysis seeks to identify and compare the economically significant activities, functions performed, assets used and risks assumed by the parties to the transaction. For this purpose, it may be useful to understand the structure and organisation of the group and how these influence the context in which the taxpayer operates.

It will also be relevant to understand the legal rights and obligations of the taxpayer in the exercise of its functions.

...

Contractual Clauses

a.                     In arm's length transactions, contractual terms generally define, expressly or implicitly, how responsibilities, risks and outcomes are allocated between the parties. In this respect, the examination of the contractual terms should be part of the functional analysis, referred to above. The terms of a transaction can be found not only in the written contract, but also in correspondence and communications between the parties. Where the contractual terms between the parties are not in writing, they must be inferred from their conduct and from the economic principles that normally govern relations between independent enterprises.

b.                     In commercial relationships between independent enterprises, differences of interest between the parties ensure that they will normally ensure that they themselves ensure compliance with the terms of the contract, which will only be ignored or modified if it is in their mutual interest to do so. This divergence of interest may not exist in the case of associated enterprises, so it is important to examine whether the parties' conduct is in accordance with the terms of the contract, or whether the contract indicates that they have not been followed, or are simulated. In such cases, a more thorough analysis is necessary to determine the true terms of the transaction.

...

Economic circumstances

1.55 Arm's length prices may vary between different markets even for transactions involving the same goods or services; therefore, comparability requires that the markets in which independent and associated enterprises operate do not differ significantly in terms of price, or that appropriate adjustments can be made. As a first step, it is essential to identify the market(s) by considering the alternative goods and services available. Economic circumstances that may be relevant in determining the comparability of markets are: their geographic location; their size; the degree of competition and the relative competitive position of buyers and sellers; the availability (the risk) of alternative goods and services; the levels of supply and demand in the market as a whole, as well as in certain areas, if relevant; the purchasing power of consumers, the nature and extent of market regulation; transport costs; the level of market ...; the time and date of the transaction etc. The facts and circumstances of the particular case will determine whether differences in economic circumstances have a significant effect on price, and whether reasonably accurate adjustments can be made to eliminate the effects of such differences.

...

1.57 The geographic market is another economic circumstance that may affect comparability. The identification of the relevant market is a question of fact. For a number of sectors, large regional markets that include more than one country may be reasonably homogeneous, while for others, the differences between national markets ... are very significant.

...

Business Strategies

1.59 Business strategies also need to be considered when determining comparability for transfer pricing purposes.

These take into account a large number of company-specific aspects, such as innovation and new product development, degree of diversification, risk aversion, assessment of political changes, impact of existing and proposed labour laws, duration of agreements, as well as any other factors that influence the day-to-day management of the company. These business strategies may need to be taken into account in determining comparability between related and unrelated transactions and between associated and independent enterprises.

..."

For this reason, we proceed to evaluate the comparables selection process, carried out by both parties, based on the information in the record, and the substantive arguments proposed by the parties, in order to determine whether, indeed, the comparables selection process was carried out properly, or whether, on the contrary, the measure taken by the Tax Administration is justified, based on the comparability analysis developed in the rules set out above with respect to the only comparable company selected by the taxpayer that was rejected by the DGI.

Notwithstanding the above, we consider it appropriate to quote what the author Rubén Bustamante R., in his book "Manual de Impuesto Sobre la Renta", on page 664 et seq. states in this respect, regarding what we should understand as comparability analysis and how it is carried out.

"Up to this point we have examined important elements involved in concluding whether or not the arm's length principle is complied with in a transaction between related parties:

The comparable or simply "comparable" transactions (internal and external)

the factors that affect the comparability of transactions; and

the adjustments that increase the degree of comparability between transactions (controlled vs. independent).

It is however necessary to pause to integrate these elements into the analysis process, which like all analysis is a process that has stages or phases that follow a methodology according to the object under study; ....

... an analysis is a detailed examination of an element, in order to distinguish its characteristics or qualities or its state, and to draw conclusions, which is carried out by separating or considering separately the parts of the whole that constitute it, following an established methodology.

..., specialists in the field, agree that the comparability analysis itself constitutes the transfer pricing analysis, i.e. it comprises the whole process of analysis, the results of which are set out in a document called "Transfer Pricing Study".

Other authors ... point out that the comparability analysis is a part of the process, which corresponds to the examination of the comparability factors that influence the subsequent selection and application of the valuation method. They define it as a step in the process of analysing transfer prices. This is the case in our legislation as it follows ... from Article 762-E of the Tax Code and Article 7 (numeral 5) of Executive Decree No. 958 of 2013.

In daily business, it is observed that the concept of comparability analysis is often confused and assimilated to the search for comparables.

...

In order to perform a proper analysis to conclude whether transfer prices between related parties comply with the arm's length principle, the nine steps indicated by the OECD Guidelines must be carried out, however for practical reasons these steps are often grouped into broad phases these tasks. The classification proposed below is not strict and may vary depending on the source consulted:

 

1) Preliminary Analysis (of comparability factors):

-Functional analysis (functions, assets and risks assumed by the tested company) (Steps 1 to 3 according to OECD-type process).

 

2.) Economic and statistical analysis:

-Selection of valuation method

-Search and identification of comparables

-Application of the valuation method

-Comparability adjustments

Application of the statistical method (interquartile range) (steps 4 to 9 according to the OECD-type process).

....".

In this regard, in this case, the taxpayer used external comparables, located abroad, as it did not have information on the companies operating in the Panamanian market, using international databases, a decision that has not been objected to by the Tax Administration.

Notwithstanding the foregoing, we consider it essential to bring up the most relevant aspects of the expert evidence on Transfer Pricing carried out by the first instance, in order to have a clearer view of its findings, but focusing on those important elements or factors of comparability that must be present in such analysis.

Opinion of the Taxpayer's Experts:

- Regarding the companies selected by the taxpayer and Accepted by the Tax Administration.

The appellant's experts state that they chose the following companies because they met the qualitative and quantitative criteria and because they are the most comparable companies according to their functions performed, assets used and risks assumed, as well as the limitations of the availability of comparables as described in paragraph 3.38 of the OECD Guidelines and because they are comparable, external companies with slightly different strategies or business models to the party under test. Let us see:

 

Global Company

Has 46,800 employees

Global leader in specialised planning services, engineering design and construction programme management services.

 

Global Company

Has 7,300 employees

Provides consulting services in the areas of planning, engineering, architecture, interior design, landscape architecture, project management in the infrastructure and facilities project markets and maintains a fee-for-service revenue model.

 

Global Company

13,000 employees

Provides consulting services in the areas of planning, engineering, construction, project management in the infrastructure and natural resources markets.

Company rejected as comparable by the DGI, which was selected by the taxpayer:

 

Global Company

Has 3,2000 employees

Providing services in the real estate development and infrastructure markets.

 

Thus, the experts of the plaintiff presented how they came to the conclusion that the selected companies complied with the elements of comparability distinguished in the Law and other regulatory instruments, as we present below:

1. Characteristics of the operations

a.         Financing Operations

Principal Amount

Term

Risk Rating

 Collateral

Debtor's Solvency

Interest Rate

The appellant's experts state that this figure distinguished as "a" does not apply to the analysis of the comparables of the selected companies, since what is analysed is the provision of the service, which in this case would be in the construction sector.

b.         Provision of Services

Nature of the Service

Whether or not the service involves technical expertise or knowledge.

As can be seen, the business strategies of the selected and rejected companies are similar:

-----------------------------------: Global leader in specialist planning, engineering design and construction programme management services.

--------------------------: Provision of consulting services in the areas of planning, engineering, architecture, interior design, landscape architecture, project management in the infrastructure and facilities project markets and maintains a fee-for-service revenue model.

--------------------------: Provision of consulting services in the areas of planning, engineering, construction, project management in the infrastructure and natural resources markets.

--------------------------: Provision of services in the real estate and infrastructure development markets.

The appellant's experts indicate that the comparable activity of the selected companies with the provision of services are:

Buildings

Repairs

Infrastructure Construction

They are active in the construction sector

 

c.         In the case of the granting of rights of use or disposal of tangible assets, elements such as:

Physical characteristics

Quality

Reliability

Availability of the good and volume of supply

The appellant's experts state that this figure distinguished as "c" does not apply to the analysis of the comparables of the selected companies, since what is analysed is the provision of the service, which in this case would be in the construction sector.

d.         The exploitation or transfer of an intangible asset

e.         Disposal of shares, liquid assets or profits.

 The appellant's experts point out that these figures "d and e" do not apply to the analysis of the comparables of the selected companies, since what is analysed is the provision of the service, which in this case would be in the construction sector.

2. Significant economic functions or activities undertaken by the parties in relation to the transactions under analysis, including the risks assumed and weighting, where appropriate, the assets used.

f.          Functions: Consultancy design, design, engineering, planning, construction and project management, among others.

g.         Risks:

 Vulnerability of accounts receivable which represents 42.30% of its total assets for 2012.

It is exposed to operational risks such as the loss of qualified personnel for the performance of its activities and security risks that could result in harm to workers and generate significant costs for the company.

.

Vulnerability of accounts receivable representing 24.24% of its total assets for 2012.

It is exposed to risks of loss of personnel due to acts of terrorism, political, governmental, social unrest, among others, and risk of contract cancellations.

.

Vulnerability of accounts receivable which represents 41.91% of its total assets for 2012.

It is exposed to risks of loss of personnel due to acts of terrorism, political, governmental, social and other unrest and risk of contract cancellations.

Vulnerability of accounts receivable which represents 50.08% of its total assets for 2012.

It is exposed to risks of loss of personnel due to acts of terrorism, political, governmental, social and other unrest and risk of contract cancellations.

In the case of the taxpayer ------------, the experts point out that it is identified with the other companies in that:

Vulnerability of accounts receivable, which represents 75.86% of its total assets for 2012.

It is exposed to risks of loss of qualified personnel and personnel security risks.

h.         Assets

Indicate that the assets used in the provision of construction services used the financial indicator, return on assets ROA for its acronym in English, which measures the relationship between the profit achieved in a given period and the total assets of a company.

The following is a breakdown of the ROA of each selected company presented in their report:

 

-------------------------- 1.45%

--------------------------.   1.05%

--------------------------.   1.62%

-------------------- 1.14%

-------- --------- (TAXPAYER / ------------) 6.63% 6.63

Referring to the previous result, the taxpayer's experts point out that there is a great similarity between the ROA of the comparable companies selected within their provision of services in the construction sector while obtaining a higher ROA specifically due to the fact that, being a Consortium of two shareholders, it does not own the machinery for the development of its services, but rather rents them to its shareholders for business reasons.

 

 3. Actual contractual terms from which operations are derived taking into account the responsibilities, risks and benefits assumed by each contracting party.

In the construction sector, the projects in which the comparable companies and the taxpayer participate are carried out through service contracts.

Revenue model based on contracts in which service fees are set considering the costs incurred plus the fee agreed with the client or by means of fixed price contracts.

.

Fee-for-service business model.

.

They maintain three types of contracts: Fixed price; time and materials incurred; costs incurred plus fees.

They maintain three types of contracts: Fixed price; time and materials incurred; costs incurred plus fees.

For its part, -------- ---------, was awarded the contract for construction services to carry out repair works for the Project --.

It is exposed to risks of loss of personnel due to acts of terrorism, political, governmental and social unrest, among others, and risk of contract cancellations.

 

4.         Market characteristics or other economic factors that may affect operations

The selected comparable companies do not operate in the Panamanian market, and these companies were used as comparables after exhausting the possibility of using companies in Panama, as no public financial information could be found and they were comparable to --.

 

5.         Commercial and business strategies such as market penetration, permanence or expansion policies, as well as any other circumstance that may be relevant.

Leverage competitive strengths and leadership position in the core market.

Enter new emerging and geographic markets.

.

Business strategy in the provision of consultancy services in infrastructure markets and facility projects.

 Aims to become one of the first companies focused on deepening and expanding its services through organic growth and acquisitions.

.

It bases its business strategy on the provision of consulting services in the infrastructure and natural resources markets, maintaining its growth and competitive position through strategic acquisitions to maintain continued growth in the different areas of the business, as well as expanding its service offering.

Generation of project management work, as well as expansion through organic growth and the acquisition of different project management companies and construction consultancies around the world.

In the case of -----------, they indicate that no effort was made in commercial and business strategies since, as mentioned, the company was created to attend to a specific project. The articles of association state that it was created for the duration of the contract signed by the company ----------------------, for the repair of the tunnel of the -------- project, but it can be dissolved at any time.

The business strategy was previously made by its shareholders.

Opinion of the DGI's expert witness

Agreed that the selected companies are engaged in the activities detailed in the 2012 transfer pricing study and that they (with the exception of ) generally meet the criteria of

comparability criteria of --.

The differences found with the comparable company --------------------------, and the taxpayer, were as follows:

Differs in the construction claims consulting segment as it comprises 25% of its consulting revenues and differs from the activities not only of , but of the other companies.

Decrease in operating results of 4.12% in 2010; -0.77% in 2011 and 1.09% in 2012.

The reasons for the above, according to the expert, are due to the following reasons:

Loss of revenues and earnings from discontinued operations in --.

Completion in 2010 of a project in --.

Decrease in work in the construction claims business in --.

Decrease in operating income from construction claims business in --.

Decrease in operating income of the project management business at ------ of $21,377 due to work stoppage and $5,055,000 in --.

 Receivables with work performed prior to March 2011, under contracts in were $60 million and had a detrimental effect on operating cash flows, causing the comparable company to rely on borrowings to support its operations.

 

3.         As to the comparison made by the DGI's expert with respect to the comparable accepted by the DGI, --------------------------, as opposed to --------------------------, the rejected comparable, he pointed out:

Although the company -------------------------- was also affected by the political instability in its operations in ------, it stopped providing services to the client "-------------------------------------------", it did not report having uncollectible accounts for operations that caused it to have to ask for credit to cover its liquidity needs, as did --

.

That even though the amount of the reduction of services from --------------------------, for its operations in ------ amounts to 30 million dollars, it is not significant to the operating results, unlike the detrimental effect it had on the operating cash flows of --.

Having set out the expert reports, this Tribunal notes that, while both party-appointed experts agreed that three of the companies selected as comparables were appropriate for establishing the market values of the business, there is no uniformity in their opinions on the other or the fourth selected company.

Thus, in the following points we will address our consideration of the accepted and rejected comparables, as well as the differences that the DGI found with the company -------------------------- with the taxpayer ------------, in terms of the functions performed, including assets used or risks assumed.

- Similarities of the rejected comparable company with those accepted by the Tax Administration

In this case, the objections of the Tax Administration were based on the fact that one of the selected companies should not have passed the filter as it had significant differences in its functional analysis (functions, assets and risks), as we have emphasised throughout this resolution.

After all the above, we consider that, although it is true that this company has certain differences in terms of some very specific lines of business, it is also true that these do not represent a significant percentage of the revenues of the company's main activity, which is clearly construction.

Likewise, it is observed that, when verifying the description of the operations of the other selected companies, which were not objected to by the tax authorities, similar differences can be found.

Thus, among their risks, they have vulnerability in accounts receivable, which represent 42.30%, 24.24% and 41.91% of their total assets, and -------------------------- accounts receivable represent 50.08% of their total assets.

Likewise, two of them, -------------------------- and --------------------------., are exposed to risks of loss of personnel due to acts of terrorism, political, governmental, social unrest, among others, and risk of contract cancellations, as in the case of

Regarding the actual contractual terms of the operations, taking into account the responsibilities, risks and benefits assumed by each contracting party, the three comparable companies selected and accepted by the DGI have revenue models based on contracts in which the fees for services are fixed considering the costs incurred plus the fee agreed with the client or through fixed price contracts, as in the case of the rejected company ---------.

Similarly, regarding the characteristics of markets or other economic factors that could affect operations, the DGI's own expert accepts that the company was also affected by political instability in its operations in ------, as was the case with --------------------------, although ------------- did not report having uncollectible accounts for operations in , we do not agree with the allegation in view of the fact that, as mentioned above, -------------------------- has a vulnerability in accounts receivable that represents 42.30% of its total assets. 30% of its total assets, the same as -------------------------- even though it did not have them with that country specifically for the 2012 period.

Regarding the business and commercial strategies applied by the three selected companies, we note that they are very similar, particularly with , which, among others, bases its business strategy on the provision of consultancy services in the infrastructure markets, as well as --------------------------.

At this point, this Court considers that there are similarities between the selected companies and the comparable company rejected as comparable, an exercise that we consider carrying out by virtue of the allegations made by the taxpayer ------------, when it emphasised this aspect in its appeals.

Briefly, we would like to refer to what the taxpayer also pointed out regarding the fact that the Tax Administration rejected the comparable company (--------------------), with the lowest indicator of the other three accepted companies.

In this sense, this Court has stated in Resolution n.° TAT-RF-002 of 10 January 2020, regarding the possible manipulation of comparables known by the Anglo-Saxon expression "cherry picking", in the following terms:

"just as the criteria for discarding must be applied uniformly by the taxpayer, they must also be applied uniformly by the Tax Administration, regardless of whether the results of the analysis are in favour of or against the Treasury (The three companies challenged by the Tax Administration were those that presented the lowest operating margins: 1. 00%; -0.03% and -23.64% respectively), concluding that "it is incongruous to object to comparables that are in similar circumstances with others that have been accepted, i.e. that have a reasonable level of comparability with the examined party". .

Similarly, this Court has also pointed out in resolution TAT-RF-083 of 8 November 2017, with regard to the number of comparables, that it is more of a qualitative aspect than a quantitative one. Below, we transcribe what was raised:

"In this regard, the taxpayer made, in the framework of its defence, certain points regarding the statistical reliability of using two comparables to calculate the arm's length range, referring to the quantity of the sample as insufficient.

In this regard, it should be recalled that the method recommended by article 762-F of the Fiscal Code is precisely the statistical interquartile method, which does not establish a specific number for its implementation, it being understood that when speaking of ranges, there must evidently be more than one, which in our opinion does not work in favour or against any of the parties, We conclude that the selection of comparables is of a qualitative rather than quantitative nature, especially given the difficulties implicit in the search for comparables, which the taxpayer itself has raised. " (emphasis added).

For its part, the expert appointed by the DGI, in its report, pointed out that it had not objected to the quantitative and qualitative criteria presented by , but that the discussion regarding the comparables it considered focused on the appropriate application of these criteria.

In that order, it is important to understand in a simple manner what these quantitative and qualitative criteria consist of in order to put into context what was alleged by the Tax Administration's expert.

Identifying external comparables is known to be possible due to the international financial markets and financial information of companies can be found in databases that include automated tools that facilitate the cleaning and management of this information, as well as brief descriptions of the companies.

In order to group the information and functionalities available in the databases and the transaction to be analysed, a search strategy must be defined that optimises the quantitative and qualitative criteria to be considered to identify, evaluate, accept or discard a potentially comparable company.

Common quantitative criteria include: average losses or recurring losses; research and development or advertising expenditures above certain sales levels; sufficient financial information.

Common qualitative criteria include: controlled company; in bankruptcy, restructuring or liquidation; in start-up phase; performing different functions.

In this sense, the taxpayer in the process of searching for comparable companies used quantitative criteria by selecting those companies whose financial information was inadequate, i.e., lacking sales or operating profit information for three fiscal years, and with such exclusion criteria, would eliminate the economic impact of business cycles or extraordinary results.

Similarly, it used quantitative criteria framed within recurring losses for the tax years 2010-2012, as well as eliminating companies whose ratio of R&D expenses (research and development expenses) to net sales exceeded 3% even if the taxpayer did not carry out R&D activities.

Regarding the qualitative criteria implemented by the taxpayer, it is clear that it eliminated companies that performed functions, served markets and assumed risks significantly different from those performed by the taxpayer and related to the provision of project management and technical support services.

- Rejection of the Tax Administration of the company --------------------------, due to differences with the taxpayer ------------

The Tax Administration when reviewing the income statements of the comparables provided by the taxpayer with the 10-k reports, observed that the company -------------------------- presents important differences, as it considers that the functions performed including the assets or risks assumed in the operation of --------------------------, differ from the functions, assets and risks of the taxpayer, as well as the contractual clauses, considering how the responsibilities are distributed, as well as the economic circumstances, the business strategies and the geographic market and for all these reasons, it cannot be included as comparable because it affects the range of full competition.

Notwithstanding the above, they emphasised the construction claims consultancy segment, stating that it differs from the activities carried out by ------------, in terms of qualitative criteria of significantly different activities and deviations in the normal course of business.

Likewise, the DGI indicates that -------------------------- is in search of new business opportunities and ------------ is dedicated to the provision of services in the real estate and infrastructure markets.

For its part, the taxpayer indicates that it mainly presents the operational risks that a construction company would present, of which one of the most important and comparable with -------- ---------, is the dependence on subcontractors and specialists for the development of its activities, through which it assumes the risk of not being able to comply with the projects in the correct time.

By virtue of the above, it considers that this risk assumed by , differs from that mentioned by the DGI, where it points out that the services of , have significant advantages over traditional general contractors, as they do not assume the risk of completion of the Project.

The taxpayer also indicates that no efforts were made in commercial and business strategies, as the company was created to serve a specific project. The articles of association state that it was created for the duration of the contract signed by the company for the repair of the Project tunnel, but it can be dissolved at any time.

Concluding our considerations, and by way of summary, we highlight the following aspects:

a.         The Tax Administration must always try to comply with basic principles that emanate from our Law 38 of July 31, 2000, on general administrative procedure, one of them, the principle of objectivity, that is to say, that its decisions, among other aspects, are based on the factual background and procedural evidence and not in a subjective or capricious manner.

b.         We point this out because when analysing the reasons why the Tax Administration accepts the other three (3) comparables, we find more similarities than differences, as we have already pointed out previously and which we summarise as follows:

- The main type of service they offer is in the construction sector and their service strategies are very similar;

- In terms of risk factors, and the vulnerability of the accounts receivable of the total assets of the accepted comparables versus the rejected comparables, the percentages range from 24.24% to 42.30% and the objected comparables range from 50.08%, and the reasons for obtaining these percentages are relatively similar.

- With regard to assets, we also note that the financial indicator used for return on assets (ROA), which measures the relationship between the profit obtained in a period and the total assets of a company, ranged from 1.05% to 1.62% for the comparables accepted by the DGI, and 1.14% for the rejected comparable.

- In general, the contractual terms of both the accepted and rejected comparables are very similar.

- On the other hand, the risk factors and the vulnerability of the accounts receivable of the total assets of the rejected comparable was, as previously indicated, 50.08%, and it obtained 75.86%, that is, a difference attributable to not having the liquidity to settle its operations as the other companies that were not created for a specific project do.

- Likewise, in terms of the profit obtained and total assets, the comparable company rejected showed a 1.14%, as we have already pointed out, however, it obtained 6.63%, most likely due to the fact that as it is a Consortium made up of two shareholders, it does not have the machinery to offer its services, so obviously having to rent, it has an impact on its results, different from the other comparables.

By virtue of the allegations made by both parties, we consider from the procedural evidence in the file that the process followed to identify potential comparables by both parties has been systematic and verifiable; however, we agree with the taxpayer that the companies selected by them are comparable with ------------, and comply with the Principle of Full Competition, therefore, they should be taken into account within the interquartile range, since we consider that the elements of the comparability analysis, indicated by the DGI, are not compromised.

In view of the above, as we do not agree with the objection made to this comparable company by the Tax Administration, and as the taxpayer is within the range of full competence, this Court must revoke Resolution no. 201-3306 of 27 February 2015, and its confirmatory act Resolution no. 201-1278 of 16 April 2019, both issued by the Directorate General of Revenue.

OPERATIVE PART

In view of the foregoing, the TAX ADMINISTRATIVE COURT, in Plenary Session, and in exercise of the powers conferred upon it by Law, resolves:

FIRST: TO REVOK Resolution no. 201-3306 of 27 February 2015, and its confirmatory act Resolution no. 201-1278 of 16 April 2019, both issued by the Directorate General of Revenue of the Ministry of Economy and Finance, and through which it was resolved to issue an additional assessment to the aforementioned taxpayer, for the sum of TWO HUNDRED AND NINETEEN THOUSAND AND FOUR HUNDRED AND FIFTY SEVEN BALBOAS AND 55/100 (B/. 219,457.55), for deficiency in its Income Tax Affidavit for the period 2013, Transfer Pricing Report Form 930 for the year 2012 and Transfer Pricing Study for the year 2012.

SECOND: NOTICE that this resolution is effective from the date of its notification and that with it the governmental channels are exhausted, so that the taxpayer may bring an action before the contentious-administrative jurisdiction of the Third Chamber of the Supreme Court of Justice, according to the forms provided by law.

THIRD: ORDER the closure and filing of the file, once this resolution has been executed, and return the antecedent file, together with an authenticated copy of the same to the General Directorate of Revenue of the Ministry of Economy and Finance.

BASIS OF LAW: Articles 694, 695, 718, 719, 720, 762-A to 762-K, 1238, 1238-A of the Fiscal Code; Article 156 of Law 8 of 2010; Executive Decree 958 of 2013. Notify and comply.

(S ED.) ANEL JESÚS MIRANDA BATISTA

Magistrate

(S) MARIA ELENA MORENO DE PUY (S) ANA TERESA PAZ REINA

Magistrate Magistrate

(s) MARCOS POLANCO MARTÍNEZ

Secretary General