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Behind the Numbers: People of P&A Grant Thornton
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Optimism is slowly returning to the global economy, but the financial services industry needs to regain the trust of public and private bodies. To truly go...
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Transfer Pricing Adjustments
28 May 2025
Transfer pricing adjustments are revisions or corrections made to the pricing of transactions between related parties to ensure that such prices reflect the arm’s length principle, reflecting what unrelated entities would have agreed upon under similar conditions.
Adjustments can be initiated voluntarily by the taxpayer or imposed by the tax authority during an audit.
Key Points
1. Arms-Length Principle: Taxpayers must price their related-party transactions as if they are between independent entities under similar conditions.
2. Adjustments
- Comparability Adjustments: To proactively align actual intercompany results with arm’s length benchmarks and to eliminate material differences between controlled and comparable transactions that could affect the reliability of the transfer pricing analysis.
Although comparability adjustments themselves are not accounting entries, they play a critical role in establishing an arm’s length range. Once this range is determined, a taxpayer may perform internal true ups or year-end corrections to ensure that its actual intercompany results fall within the adjusted range. These true ups are acceptable when they reflect genuine economic conditions and are applied consistently with the taxpayer’s documented transfer pricing policy. However, adjustments that are excessive, immaterial, or highly subjective should be avoided, as they may undermine the reliability of the analysis.
For example, a multinational company may notice that due to fluctuating market conditions, its intercompany prices differ from benchmark prices. Before tax filing, it makes year-end true up adjustments to align the transfer prices with arm’s length benchmarks.
- Compensating Adjustments: To reflect changes made by one party to a controlled transaction and ensure a corresponding adjustment is made by the counterparty, preserving symmetry in the tax treatment. This is usually done through reciprocal entries in both parties’ accounting records. Some jurisdictions allow compensating adjustments to be applied simultaneously with comparability adjustments or, alternatively, when comparability adjustments alone are insufficient to achieve arm’s- length results. However, in the Philippines, compensating adjustments are not explicitly allowed under current regulations, which discourage retroactive changes.
- Tax Authority Adjustments: To correct transfer prices that deviate from arm’s length, typically discovered during audit, these may lead to primary and secondary adjustments. Secondary adjustments address the resulting impact of a primary adjustment.
An example is when, during an audit, a tax authority increases a subsidiary’s taxable income after finding that transfer prices were set below market rates (primary adjustment). To address the financial impact, the authority applies a secondary adjustment treating the difference as a deemed dividend, which may be subject to withholding tax.
3. Supporting Documentation: To justify the basis and calculation of any adjustment made, demonstrating compliance with the arm’s length principle. It should provide a clear and transparent explanation of why the adjustment is necessary, how it was determined, and its impact on the transfer pricing analysis.
(Chapter III, IV, and V, OECD Transfer Pricing Guidelines 2022, Chapter II and III, Revenue Audit Memorandum Order No. 1-2019, and Sec. 5, 6, and 9, Revenue Regulations No. 2-2013)
Transfer pricing adjustments play a critical role in aligning related party transactions with the arm’s length principle. These adjustments are essential because they address differences in functions, risks, and financial outcomes that, if left uncorrected, could distort the accuracy of transfer pricing analyses.
Such adjustments are crucial not only for achieving accurate tax reporting but also to reduce the risk of tax disputes, penalties, and double taxation. To be effective, all adjustments must be well-documented and clearly disclosed.
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