Transfer Pricing from a Philippine perspective
By: Maria Cristina V. Chan
First Published in Business World (9/17/2012)
Multinational enterprises (MNEs) and tax administrations around the world are deeply focused on the issue of transfer pricing as part of their tax agendas.
In the Ernst & Young 2010 Global Transfer Pricing Survey 74% of the respondents from parent companies of multinational enterprises (MNEs), and 76% of the respondents from subsidiary companies believe that transfer pricing will be “absolutely critical” or “very important” to their organizations over the next two years.
While the survey was conducted in 2010, the findings remain relevant and true. The survey shows that globally, transfer pricing rules and regulations are in a state of flux, the audits becoming more intense and intrusive, with the number of cases being litigated in courts continuing to rise.
Transfer Pricing in General
Transfer pricing is defined as the price charged for tangible or intangible goods or services or loans between related legal entities.
From a tax perspective, transfer pricing is important because the price affects profit and, consequently, the taxable income from a transaction between the related parties. In an intercompany sale of goods and services, for instance, the price will determine the revenue to be reported by the seller and the cost to be reported by the buyer of the goods or services. Where the seller and the buyer are affiliated with each other and operate in different tax jurisdictions, the price of the goods or services determines how much income will be taxed in their respective countries. Given differences in tax rates, there may be a tendency to price transactions in a way that the party in the low tax rate country gets more of the profit, while the party in the higher tax rate country gets less, in order to reduce the overall tax burden of the group.
Because of the possibility that profits may be shifted to a low tax rate country, fiscal authorities have to ensure that their revenue base is protected by implementing rules to regulate the use of pricing between affiliated entities. These rules are critical to ensuring that fiscal authorities receive their fair share of the global profit pie.
Section 50 of the Tax Code
In the Philippines, the legal provision applicable to transfer pricing is found in Section 50 of the Tax Code. Section 50 empowers the Commissioner of Internal Revenue (CIR) to allocate, apportion or distribute income and deductions between or among related companies if the CIR “determines that such distribution, apportionment or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income” of such companies. It is therefore necessary to determine the true net income, which is the net income that would have resulted had the affiliated entities dealt with each other on an arm’s length basis. The arm’s length standard means that pricing for transactions between related parties should be handled as if they are independent entities.
To date, the Department of Finance has yet to issue comprehensive regulations on transfer pricing. However, in 2008, the Bureau of Internal Revenue (BIR) issued Revenue Memorandum Circular No. 26-2008, which adopted the OECD Transfer Pricing Guidelines as an interim transfer pricing standard until formal regulations are issued. The OECD stands for the Organization for Economic Cooperation and Development, an international organization that helps governments formulate policies to address the economic, social and environmental issues of globalization, which include transfer pricing. The OECD Transfer Pricing Guidelines has become the international rule book on transfer pricing and the basis for many countries’ relevant legislation.
Notwithstanding the fact that the BIR formally adopted the OECD Transfer Pricing Guidelines in the interim only in 2008, the BIR has nevertheless focused on intercompany transactions for a long time now. In 1998, the BIR issued regulations prescribing guidelines and procedures in the conduct of joint and coordinated examination of interrelated companies. This was followed by another regulation in 1999, which prescribed the rules in determining taxable income on intercompany loans and advances.
The audit of interrelated companies and conglomerates from certain industries was once again the subject of Revenue Regulations issued in 2009. Various schemes employed by conglomerates were to be considered in the audit, such as the use of tax-exempt entities or those with special tax privileges, inter-related company loans and advances, cost-sharing and the supply of goods and services. The recent regulation adopting the use of the performance benchmarking method is also another example of how transfer pricing principles and methodologies are applied by the CIR in the exercise of the power to allocate income and expenses between related companies.
These regulations suggest that the power given to the CIR under Section 50 of the Tax Code may be harnessed whenever the need arises. Given the increasing efforts of tax jurisdictions around the world to protect their revenue base, companies are advised to actively and regularly revisit their internal pricing policies on related transactions to ensure compliance with the arm’s length standard. Not only will this enhance reportorial consistency in the larger organization, it may also reduce the risk of the CIR applying Section 50 in the event of an audit.
Maria Cristina V. Chan is a Tax 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.