Transfer Pricing Considerations for Intra-Group Services
By Emmylou P. Limwan
First Published in Business World (2/25/2013)
For the past three weeks, we have been discussing the Transfer Pricing Regulations (“TP Regs”) recently released by the BIR as Revenue Regulations No. 2-2013. While the TP Regs will generally apply to controlled transactions among associated enterprises, and can be used to distribute, apportion or allocate their income and deductions to reflect the true taxable income of such enterprises following the arm’s length principle, they may not necessarily apply in all cases of services between related parties.
Under the Organization for Economic Cooperation and Development (OECD) TP Guidelines, the term “intra-group services” refers to the provision of services between or among members of a multinational enterprise (MNE), and is defined as activities, such as administrative, technical, financial or commercial, for which an independent enterprise would have been willing to pay or perform for itself. Common examples include contract manufacturing services being rendered between members of the MNE or backroom support services being centralized and rendered through a shared service center. While discussions on intra-group services usually involve MNEs, OECD principles also apply to related domestic corporations.
Under the OECD Guidelines, there are two issues that should be considered with respect to services:
1) Whether the services provided are intra-group services
Under the OECD Guidelines, an intra-group service has been rendered if the activity provides a group member with economic or commercial value to enhance its commercial position. This can be determined by considering whether an independent enterprise, in comparable circumstances: a) would have been willing to pay for the activity if performed for it by an independent enterprise; or b) would have performed the activity in-house for itself. If either of these conditions exist, then the activity would ordinarily be considered an intra-group service, which could then raise a TP issue and there would then be a need to comply with the arm’s length principle.
Generally, backroom support services such as human resources, information technology, finance and accounting, planning and financial services, are considered intra-group services because of their value. Admittedly also, these would be services that companies would gladly pay for. Hence, in these instances, the services must be rendered at arm’s length. On the other hand, no intra-group service is deemed rendered in the case of duplicative services, except when such duplication is merely temporary or when undertaken to reduce the risk of a wrong business decision, such as a second opinion on a legal issue. Another instance is where incidental benefits accrue to other group members due to their being part of a larger concern, and not to any specific activity performed. An example of this is when a higher credit rating is obtained by an associated enterprise because it is part of the group. In these situations, since no service was deemed rendered by a related party, there should be no TP issue to begin with, and the determination of the arm’s length charge for said services should not even come into play.
2) Determining an arm’s length charge for the intra-group service
Once it is established that intra-group services have been rendered, the next issue is to determine what may be considered an arm’s length charge for such services.
Under the OECD Guidelines, the perspective of both the service provider and the service recipient should be considered in determining an arm’s length consideration. Other relevant factors to consider include the value of the service to the recipient, how much a comparable independent enterprise would be prepared to pay for the service in comparable circumstances, and the cost to the service provider.
One area of discussion related to the arm’s length charge pertains to whether it is necessary that the charge for intra-group services must result in a profit. While an independent enterprise will normally charge for services in order to earn some profit, there are also cases where an independent enterprise may not realize a profit from the performance of the service activities alone. An example is when the market value of intra-group services is not greater than the costs incurred by the service provider, as in the case of a service that is not an ordinary or recurrent activity of the service provider, but is offered incidentally as a convenience to the MNE group. One example would be a one-time performance of incidental backroom support by an affiliate in a developed country mainly for the convenience of the other group members.
The OECD Guidelines provide that the methods to be used to determine the arm’s length price for intra-group services could either be the Comparable Uncontrolled Price (CUP) Method, Cost-Plus Method (CPM) or Transactional Profit Methods, whichever is most appropriate.
The CUP method is appropriate where there is a comparable service provided between independent enterprises in the recipient’s market, or by the group member providing the same services to an independent enterprise in comparable circumstances. In the absence of CUP, the CPM will be appropriate where the nature of the activities involved, assets used, and risks assumed are comparable to those undertaken by independent enterprises.
The transactional profit methods – which are so-called because an arm’s length price is determined by reference to the net profit earned from comparable uncontrolled transactions – may be used when they are the most appropriate to the circumstances of the case. If the enumerated methods are all not appropriate, more than one method may be used to satisfactorily determine the arm’s length price.
Intra-group services can give rise to transfer pricing issues in the same way as sales of goods or properties between or among associated enterprises. Recipients of such services who fail to take these issues into consideration run the risk of not being able to claim a deduction for such services or having a downward adjustment to the claimed deduction and a higher taxable income to conform to the arm’s length standard.
Emmylou P. Limwan is a Tax Senior Director of SGV & Co.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.