Everything You Need to Know About Transfer Pricing Regulations in the Philippines
Owing to the loopholes in local and international taxation, it was noticed that there are multinational companies that seek to minimize the tax payments between and among their related entities so they can maximize their net income as a group, rather than as individual entities. With this, tax leakages are expected to exist. Transfer Pricing regulations are set in place to avoid such tax leakages from occurring.
Transfer Pricing is a complicated tax regulation for multinational companies and associated enterprises in the Philippines. Unlike other tax regulations, transfer pricing is contemporaneous. Companies are required to calculate the correct prices for related party transactions when they happen, and not at the end of every fiscal year.
The Bureau of Internal Revenue (BIR) prescribes Revenue Regulations (RR) No. 2-2013, Revenue Audit Memorandum Order (RAMO) No. 1-2019, and Revenue Regulations (RR) No. 19-2020 to provide guidance for transfer pricing transactions in the Philippines. RR No. 2-2013 provides guidelines for the application of the Arm’s Length Principle; RAMO No. 1-2019 provides a framework for Transfer Pricing audits; and RR No. 19-2020 requires the attachment of Transfer Pricing documentation when filing BIR Form 1709, or the Related Party Transaction (RPT) Form.
What is Transfer Pricing?
Transfer Pricing (TP) is a taxation practice that refers to the setting of prices on goods and services exchanged among subsidiaries, affiliates, and other legal entities owned or operated under common control by the same larger entity or parent company. Such entities are referred to as associated enterprises or related parties under TP.
If a subsidiary or affiliate company transacts with any of its associated entities or parent company to sell goods or services, they must ensure the prices of their internal transactions are equivalent to the prices they would charge had these transactions been conducted with third parties.
Transfer Pricing Obligations of Taxpayers in the Philippines
In July 2020, BIR released RR No. 19-2020 to clarify issues on the filing of BIR Form 1709, or the Related Party Transaction (RPT) Form. Under RR No. 19-2020, taxpayers are required to attach the RPT Form to their annual income tax returns. The submission of the RPT Form will follow the guidelines prescribed for the submission of the other required attachments to the annual income tax returns.
More importantly, the guidelines require taxpayers to attach a Transfer Pricing Documentation (TPD) to the RPT Form, regardless of the amount and volume of related party transactions. Whether local or foreign, the TPD must indicate the date of creation or preparation to ensure its applicability to the RPTs conducted within the taxable year.
BIR mandates taxpayers to prepare TP documentation prior to or during every related party transaction. Taxpayers are always required to substantiate exactly how they calculate the prices they charge for related party transactions. The calculation must be contemporaneous (i.e., the prices must be computed when they happen, and not at the end of the year).
RR No. 2-2013 provides guidelines for determining the appropriate revenues and taxable income of the parties in the internal transaction by prescribing the Arm’s Length Principle.
The information indicated in the TP documentation must include but are not limited to the following:
- Organizational structure
- Nature of the business or industry and market conditions
- Controlled transactions
- Assumptions, strategies, and policies
- Cost Contribution Arrangements (CCAs)
- Comparability, functional, and risk analysis
- Selection of the TP method
- Application of the TP method
- Background documents
- Index to documents
What is the “Arm’s Length Principle”?
The Arm’s Length Principle is the internationally accepted standard for determining the appropriate prices of controlled transactions of associated enterprises. It requires the transaction with a related party to be made under comparable conditions as a transaction with a third party. Thus, the income from a related party transaction must be equivalent to what would be earned by a similar transaction with an independent party.
RR No. 2-2013 provides for a three-step approach in applying the Arm’s Length Principle, which is as follows:
- Conduct a comparability analysis;
- Identify the tested party and the appropriate transfer pricing method; and
- Determine the Arm’s Length result.
Transfer Pricing Audit
In August 2019, BIR issued RAMO No. 1-2019 to provide guidelines for TP audit. As a manual for BIR officers, it prescribes standardized audit procedures and techniques in auditing taxpayers with related party or intra-firm transactions to ensure quality audit. Taxpayers are advised to use RAMO No. 1-2019 as guidance in preparing for tax audits and avoiding TP adjustments.
The TP audit guidelines apply to all transactions between related parties where at least one party is taxable in the Philippines. The scope of the audit will cover the sale, purchase, transfer, and utilization of tangible and intangible assets, provisions of intra-group services, interest payments, and capitalization.
TP audits will be conducted similarly with regular audits. As such, the following documents must be submitted to BIR for evaluation:
- Letter of Authority (LOA)
- Notice of Informal Conference (NIC)
A LOA must indicate a request for pertinent documents such as the following:
- Information about related party transactions
- Segmented financial statements
- Functions, assets, and risk analysis
- Characteristics of the business
- Comparability analysis
- Transfer pricing method used
- Comparables used in applying the Arm’s Length Principle
- Determination of the fair prices/profits in related party transactions
If the BIR officers conducting the audit find that the price or margin in the controlled transactions is not in accordance with the Arm’s Length Principle, they will propose an adjustment by imputing the Arm’s Length price, margin, or interest rate. For sales of goods and services, adjustments will be proposed if the consideration received is less than the Arm’s Length price or if no fee is charged. For purchases of goods and services, an adjustment will be necessary if the price or fee is considered excessive.
For NIC, BIR officers will discuss their findings and confirm with the taxpayer their agreement with the facts and the issues identified. The audit will then proceed in accordance with regular audit rules included on the remedies available to the taxpayer, i.e., issuance of a Preliminary Assessment Notice (PAN), Final Assessment Notice/Formal Letter of Demand (FAN/FLD).
Penalties for Non-Filing of BIR Form 1709 and Required TPD Attachment
A penalty of not less than ₱1,000 but not more than ₱25,000 shall be imposed for failure to file BIR Form 1709 and the required TPD attachment for reasonable causes and not for willful neglect. For repetition of the offense, the maximum penalty of ₱25,000 shall be imposed.
If, after receiving valid summons to produce the said attachment, the taxpayer still fails or neglects to submit the said form and its attachment, the corporate officers responsible will be punished by a fine of not less than P5,000 but not more than ₱10,000 and suffer imprisonment of not less than 1 year but not more than 2 years.
In addition, if the BIR finds the transactions as not within arm’s length, a 25% (50% in fraud cases) surcharge and 12% interest per annum on the basic deficiency tax due will be imposed. A compromise penalty of up to ₱50,000.00 may also be imposed.
Transfer Pricing Risks in the Philippines
BIR focuses more on multinational companies with local business activities in the Philippines, local and foreign entities with business activities in Philippine economic zones, or those enjoying special tax privileges.
The following strengthens BIR’s attention to the above mentioned entities:
- Management fees invoiced from head offices to the Philippines
- Service fees invoiced from the Philippines to related parties abroad (especially those involving high-value-added activities such as Research and Development, technical design, consultancy, or knowledge processing and outsourcing services)
- Income is shifted to related company with special tax privileges
- Companies showing sharp swings in profits (especially after a tax holiday)
- Companies generating profits below industry standards
Before the issuance of RAMO No. 1-2019 and RR No. 19-2020, many multinational companies lacked certainty on how TP audit and documentation will be conducted. With a defined set of guidelines in place, TP audit notices will now be inevitable. BIR is gradually seeking to address all TP concerns in the Philippines, ensuring the prevention of tax leakages in the future.
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