“Tale as old as time” — this now-famous beginning lyric from “Beauty and the Beast” can also applied to the authority of the commissioner of the Bureau of Internal Revenue (BIR) to review, allocate and distribute the income and deductions of related-party transactions, both cross-border and domestic. This include intra-firm transactions between related parties to determine the appropriate revenue and taxable income. Few people would know that this authority is now 81 years old; it was introduced on June 15, 1939 under Section 44 (now Section 50) of Commonwealth Act 466 or the “National Internal Revenue Code.”
Let us recount the notable events and facts on this authority’s implementation and evolution.
1939 to 2012
Since 1939, the BIR has issued several guidelines to put this authority in effect. In 2006, it released a draft comprehensive regulation for various stakeholders to comment on, but it was not officially issued. In March 2008, the BIR said in its Revenue Memorandum Circular 26-08 that, as a matter of policy, it subscribed to the transfer pricing guidelines of the Organization for Economic Cooperation and Development (OECD), and that until its own regulations are issued, all transfer pricing concerns shall be resolved in accordance with the principles laid down by those guidelines.
While there were no official transfer pricing regulations in place then, the BIR commissioner actually exercised this authority. In fact, there were a few cases in which the BIR assessed taxpayers whose transactions with related parties allegedly did not conform to transfer-pricing requirements. Here are some examples of BIR assessments:
– Arising from the overstatement of cost of goods because of the transfer pricing of products purchased from the parent company, and unnecessary and unreasonable payment of royalties to the parent;
– Arising from the underdeclaration of export sales because the products sold to foreign-affiliated companies cost lower than those sold locally;
– Imputed additional commission income for failure to justify with convincing proof why the commission rate charged to affiliate was lower than that charged for similar transactions with other foreign clients; and
– Imputed interest income on interest-free advances extended to affiliates.
The BIR finally issued transfer-pricing guidelines under Revenue Regulations 2-2013 on Jan. 23, 2013 to implement the commissioner’s authority to review controlled transactions among associated enterprises.
The bureau issued the regulations because of the dramatic globalization of trade, which led to harmful tax practices that, in turn, resulted in tremendous losses of tax revenues for the government. The most significant international tax issue emerging from globalization that confronted tax administrations worldwide was transfer pricing. Typically, a transfer price occurs between a taxpayer of a country with high income taxes and a related or associated enterprise of a country with low ones.
The BIR said that, in the Philippines, there is a domestic transfer-pricing issue when incomes are shifted in favor of a related company with special tax privileges. Examples of this would the incentives offered by the Board of Investments and the Philippine Economic Zone Authority, or when expenses of a related company with special tax privileges are shifted to a related company subject to regular income taxes, or when income and/or expenses are shifted to a related party in order to minimize tax liabilities.
The regulation requires the maintenance of transfer-pricing documentation that must be contemporaneous, or if it exists or starts to exist when the associated enterprises develop, or implement any arrangement.
It took the BIR another six to create transfer-pricing audit guidelines. In August 2019, the BIR issued Revenue Memorandum Order 1-19 that provides standardized audit procedures and techniques in auditing taxpayers with related party and/or intra-firm transactions to ensure that the audit would be of good quality.
The guidelines are applicable to controlled transactions between related parties where at least one party is assessable or taxable in the Philippines. For transfer-pricing purposes, transactions of the branch with its head office, as well as with other branches or subsidiaries in the group, shall also be subject to transfer pricing rules.
If revenue officers find during the audit that the price or margin in the controlled transaction is not in accordance with the arm’s-length principle, an adjustment will be proposed 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 there is no fee charged.
While everyone is busy battling the coronavirus disease 2019 pandemic, the BIR issued Revenue Regulations 19-2020, which was published in newspapers on July 10. Taxpayers were caught off guard when the bureau required the submission of information return on related party transactions (BIR Form 1709) and its supporting documents, including transfer pricing documentation, as an attachment to the annual income tax return (AITR), effective July on 26.
Based on the abovementioned effectivity date of RR 19-2020, the BIR told taxpayers that those whose fiscal year ended on April 30 shall be covered by the above requirements, as their AITR is due for filing on August 15, which is right after the effectivity of the regulation. These taxpayers have less than a month to prepare BIR Form 1709, transfer pricing documentation and other supporting documents.
Taxpayers whose calendar year ends on December 31, meanwhile, will have ample time to prepare transfer pricing documentation because their AITR is due for filing on April 15, 2021.
Armed with transfer pricing regulations and audit guidelines, as well as copies of BIR Form 1709 and transfer-pricing reports of taxpayers, the BIR can and will start its transfer pricing audits anytime soon.
That being said, the tale of transfer pricing in the Philippines may not compare to our favorite childhood stories with “happily ever after” endings, because it has only just begun.
Nikkolai Canceran is a partner of Tax Advisory and Compliance at P&A Grant Thornton. P&A Grant Thornton is one of the leading audit, tax, advisory and outsourcing firms in the Philippines, with 24 partners and more than 900 staff members. We’d like to hear from you! Tweet us: @GrantThorntonPH; like us on Facebook: P&A Grant Thornton; and email your comments to firstname.lastname@example.org or email@example.com. For more information, visit www.grantthornton.com.ph.
As published in The Manila Times, dated 22 July 2020