The law 36/2006 concerning measures for the prevention of tax fraud, and Royal Decree 1793/2008, which elaborates on this law, have introduced important reforms. Among these is a new regulation of transfer pricing transactions. Under this regulation it is compulsory for companies and legal entities in general to prepare and be able to present the appropriate documentation -itemized by transaction- in which arm’s length value is established to the Tax Bureaus. Also, the law calls for the burden of proof of application, correct calculation and justification before the Tax Bureau to fall on the company, under penalty of severe sanctions.

At present, the Tax Bureau may demand presentation of the aforementioned documents and justifications, and may, for not having received them, apply severe penalties. Therefore in such case as the transaction has been correctly calculated but the obligation to present the documentation has not been carried out, penalties of 1,500 euros for each item omitted, inexact, or false will be applied; or, 15,000 euros for each group item omitted, inexact or false. If items have not been calculated correctly, and a correct calculation of value is carried out, the penalties will be double, that is to say, 3,000 euros per item omitted; or 30,000 euros per group item omitted, inexact, or false.

Also, the Tax Control Plan for 2009 includes transfer pricing as an area of special interest. This subject is of special interest given the fiscal and economic consequences it implies, and therefore, we recommend that you pay special attention when carrying out these transactions, and to have the documentation and justifications prepared in such case as the Tax Bureau requests them.

In family owned companies it is extremely frequent if not constant, that retribution is made to shareholders themselves for services rendered to the company; moreover, loans from the company are made to shareholders in different ways, and interest rates must be established according to market value; the same may be said about the use of commercial space where the company keeps its offices, which, in many cases is the property of one of the family members. In all these cases, and many others, the company must draw up the complex, and in many cases extremely complex documents.

With this difficulty and understanding of the subject in mind, in following we shall present a brief report on the keys and principal aspects that should be considered so as to guarantee correct compliance with the current obligations regarding related third party transactions.

SUBJECTIVE LIMITS.
DETERMINING FACTORS FOR RELATED THIRD PARTY TRANSACTIONS

What are related third party transactions?

LINES OF KINSHIP

Blood Relationship	By Marriage	First degree	Fathers/Sons and Daughters	First degree	Father-in-laws/ Spouse’s Sons and Daughters
Second Degree	Grandparents/Siblings/ Grandchildren	Second degree	Spouse’s Grandparents /Spouse’s siblings
Third degree	Uncles, Aunts/ Nieces, Nephews	Third degree	Spouse’s Uncles, Aunts/ Nieces, Nephews

COMPARABILITY ANALYSIS.
EVALUATION AND ADJUSTMENT METHODS

How is the market value agreed to by independent persons in a free market context determined?

What evaluation methods are available?

Special case: Associations of Professional Persons. What should we know if there are services rendered to a related party by a professional who is a partner?

What if the market value has not been applied in the related third party transaction?

Bilateral adjustment: in such cases, the Tax Bureau will modify the price, and propose a modification of the corresponding tax base (Company Tax, Income Tax) of all the parties who have taken part in the related transaction, both upward and downward, in such a manner that the bureau’s evaluation will not represent a rise in the taxes of the group of parties affected.

Secondary adjustment: when the agreed value is different than the market value, as well as the bilateral adjustment, it will be necessary to carry out another adjustment for the same amount, which owes to the shift in patrimony that has been produced in the transaction. Tax will have to be paid, according to the classification of the transaction, for the amount that, as a consequence of the difference between the agreed price and the market value, has not reached the transmitting company and has remained in the acquiring company.

In general, partner’s dividends and assets can be declared. Along with the effects this may produce in the Company Tax in itself, said adjustment will determine, the obligation to tax withholding, and payment on 1 percent of Company Transactions.

Effect on partners	According to share percentage	For part not corresponding to share percentage
Difference in partner’s favor	Participation in benefits (1)	Utility perceived for being a partner (2)
Difference in entity’s favor	Rise in acquisition value of partner’s participation	Liberality (3)

(1) With rights to deductions for double internal taxation.
(2) Returns on moveable capital in case of natural persons.
(3) Tax deductible expenses.

Effects on the entity	According to share percentage	For part not corresponding to share percentage
Difference in partner’s favor	Revenue from funds	Revenue from funds
Difference in entity’s favor	Partner’s contribution to the association’s funds	Earnings included in taxable base of Company Tax (1)

OBLIGATION CONCERNING DOCUMENTATION

Time limits on drawing up documentation and entrance in effect

Types of documentation

System of Penalties

Fiscal risk is not only a result of not applying market value (arm’s length principal) to a related third party transaction, but also of not possessing the proper documentation, it’s being incomplete or inexact. This would result in a serious tax law violation that carries penalties according to the following criteria:

SUMMARY: SYSTEM OF PENALTIES

Scenario	Tax Bureau	Penalty
Correct Documentation	• No value adjustments:	• No penalty.
	• Value adjustments:	• No penalty.
Missing documentation or incomplete, inexact or false documentation	• No value adjustments:	• 1,500 € per item or 15,000 € per group item.
	• Value adjustment:	• 15% of the adjustment with a minimum of 3.000 € per item omitted or 30.000 € per group item omitted.

A group item is considered to be the following information:

MASTER-FILE

LOCAL-FILE

Compulsory documentation (of each participant)	Fiscally consolidated groups UTES and AIE	Both parties are not small businesses	If one of the parties is a small business and the other is…	Documentation not compulsory	Documentation is compulsory	a) Income Tax (modules) w/≥ 25% Participation	b) Transfer of business, shares or stocks of non public companies	c) Transfer of real assets and intangibles	d) Professional partners	e) Other cases
Individual documentation	Identification, nature, and quantity	YES (D)	YES (D)	YES (CD)	YES (D)	YES (CD)	YES (CD)
Comparability analysis	YES (CD)	YES (CD)	NO	NO	NO	YES (CD)
Valuation method	YES (CD)	YES (CD)	NO	YES (CD)	NO	YES (CD)
Agreements and criteria for division of costs	YES (CD)	NO	NO	NO	NO	NO
Additional documentation	YES (CD)	YES (CD)	YES (CD)	YES (CD)	NO	YES (CD)

(D) Items
(CD) Group items

Compulsory Documentation (GROUP)

Fiscally consolidated groups UTES and AIE

Small business groups

Other groups

Documentation is not compulsory

Documentation regarding the group is not compulsory (if certain aspects of the individual)

Documentation is compulsory

Group Documentation

Description of the structure (CD)

NO

YES

YES

YES

YES

YES

Identification of entities (D)

NO

YES

YES

YES

YES

YES

Nature and quantities (CD)

NO

YES

YES

YES

YES

YES

Functions and risks (CD)

NO

YES

YES

YES

YES

YES

Patents and brands (D)

NO

YES

YES

YES

YES

YES

Group’s policies in related transactions (CD)

NO

YES

YES

YES

YES

YES

Agreements on division of costs (D)

NO

YES

YES

YES

YES

YES

Advance pricing agreements (D)

NO

YES

YES

YES

YES

YES

Group memorandum (CD)

NO

YES

YES

YES

YES

YES

(D) Items
(CD) Group items

Principal points of interest in the documentation process

In ending, and by no means in exhaustive detail, we would like to call your attention to some of the most frequent scenarios in related third party transactions (to the extent that it is possible, said transactions should be supported by relevant contracts, invoices, deeds, etc.)