By: Hergie Ann De Guzman
The issuance of Revenue Regulations (RR) No. 19-2020 last month created clamor among taxpayers on how they will comply with the BIR Form 1709 or the Related Party Transaction (RPT) Form. To answer the questions of the taxpayers, BIR issued this RMC. Listed below are the highlight discussions in the RMC:
Who will need to submit BIR Form 1709?
All PH taxpayers, either individual or non-individual (including non-stock non-profit organizations for the activities conducted for profit) with related party transactions (RPTs) shall complete and submit BIR Form 1709.
Effectivity of the reporting requirement
Basically, BIR Form 1709 is a new attachment in the Annual Income Tax Returns of those with RPTs. The first set of taxpayers to comply with the new reporting are those taxpayers with fiscal year ended March 31, 2020. With this, the deadline for the submission of the RPT Form, together with ITR attachments, supposedly is on July 30, 2020. However, BIR granted the said taxpayers until September 30, 2020 to file and submit the RPT Form and the required attachments.
What if the said taxpayers have already filed the Annual ITR for the fiscal year ended March 31, 2020 prior to the effectivity of the RR?
The taxpayers are still required to submit the RPT Form and its attachments. Photocopy of the filed Annual ITR should be attached when the RPT Form is submitted to BIR.
Annual ITRs prior to the fiscal year ending March 31, 2020 is not covered by the RR.
Manner of Filing of the RPT Form
Manual filing, unless a revenue issuance is released allowing electronic filing.
When and where to file?
Are all taxpayers required to attach Transfer Pricing Documentation (TPD)?
Yes, regardless of amount and volume of transactions.
What is the required TPD?
The TPD to be submitted is the one prepared on or before the RPT or after the RP but before the filing of the annual ITR for the reporting year.
The TPDs need not be updated unless there are significant changes in the Company’s business model and nature of the RPTs. In occasions when the parent Company already has TPD for RPTs with its subsidiary/ies, the subsidiary/ies can use this TPD as long as such was used in determining the transfer prices of the subsidiary/ies.
Proceeding year’s TPDs can still be used for subsequent RPTs provided that both have the same type of transactions and was undertaken by the same related parties. The taxpayer shall prove that the same conditions, for which the last year’s TPD was made, is also applicable to subsequent RPTs.
Can taxpayers rely on the disclosures made in the Audited Financials Statement (AFS) for the RPTs, as required Philippine Accounting Standards (PAS) 24?
No, RR 19-2020 requires more RPT details to be disclosed in the BIR Form 1709.
The enumeration of RPTs in RR No. 19-2020 is not exclusive
All transactions with related parties that result in the transfer of resources, services or obligations, irrespective of arrangement and regardless of whether a price is charged.
Clarifications on Certain Attachments in the RPT Form
Penalties for Non-Filing of RPT Form
First Offense: Penalty of not less that PhP1,000.00 but nor more that PhP25,000.00. (Section 250 of the Tax Code, as amended).
Second Offense: Penalty of PhP25,000.00 (Section 274 of the Tax Code, as amended).
With Valid Summons: Failure to still provide will have a responsible employee/party fined by not less than PhP5,000.00 but not more than PhP10,000.00 and 1-2 year imprisonment (Section 266 of the Tax Code, as amended).
Read RR 19-2020 here.
REPUBLIC OF THE PHILIPPINES
DEPARTMENT OF FINANCE
BUREAU OF INTERNAL REVENUE
REVENUE REGULATIONS NO. 19-2020 dated July 8, 2020
SUBJECT: New BIR Form No. 1709, Replacing Form No. 1702H, Series of 1992
TO: All Internal Revenue Officers and Others Concerned
______________________________________________________________________________
Section 1. Objective
Pursuant to Sections 244 and 6(H) of the National Internal Revenue Code of 1997 (“NIRC”), as amended in relation to Section 50 thereof of which was implemented by Revenue Regulations (RR) No. 2-2013, this Revenue Regulations is issued to prescribe the use of the new BIR form No. 1709 or Information Return on Related Party Transactions (Domestic and/or Foreign) (Annex “A”), replacing for this purpose BIR Form 1702H – Information Return on Transactions with Related Foreign Persons, series of 1992.
Section 2. Background
Through the years, transactions around the world have become more complex and have been subject to abuse by taxpayers with intent to evade taxes by concluding transactions between them at unreasonable prices, thus eroding the tax base. Undeniably, this usually happens between related parties. While majority of related party transactions (RPTs) are not detrimental, there is a pressing worldwide concern that they can be easily abuse in the absence of a relevant framework and effective enforcement. Significant risks arise when RPTs are not conducted at arm’s length and are used as a conduit to channel funds out of the company into another related party, such as the risk material misstatement in the financial statements as a result of inappropriate accounting, and non-identification or non-disclosure.
Therefore, in order to ensure that proper disclosures of related party transactions are made and that these transactions have been conducted at arm’s length so as to protect the tax base, there should be an effective implementation of Philippine Accounting Standards (PAS) 24, Related Party Disclosures, for tax purposes. Under this PAS, an entity’s financial statements shall contain the disclosures necessary to draw attention to the possibility that its financial position and profit or loss may have been affected by the existence of related parties and by transactions and outstanding balances, including commitments, with such parties.
This Revenue Regulations requires, therefore, the submission of BIR Form No. 1709 and its supporting documents following the guidelines prescribed by the related revenue issuances for the submission of the required attachments to the Annual Income Tax Returns.
Tax examiners are hereby enjoined to conduct a thorough examination of the related party transactions and see to it that revenues are not understated and expenses are not overstated in the financial statements as a result of these transactions.
Section 3. Definition of Terms
The following definition of terms as used in this Regulations were adopted from the relevant PAS:
Section 4. Related Parties and Related Party Transactions
In determining whether a person or entity is a related party, the following rules shall be considered:
The list of family members in Section 3(2) hereof is not exhaustive and does not preclude other family members from being considered as close members of the family of a person.
Consequently, other family members, including parents or grandparents, could qualify as close members of the family depending on the assessment of specific facts and circumstances.
In all cases, the substance of relationships between entities shall be taken into account and not merely the legal form.
On the other hand, related party transactions shall include, but not limited to the following:
Section 5. Related Party Disclosures
To attain the objective of the PAS to provide an understanding of the potential effect of the relationship on the financial statements, the following requirements shall be observed by the taxpayer, who may either be a reporting entity or a related party:
Section 6. Procedures and Guidelines
In filing out BIR Form No. 1709, the taxpayer is hereby directed to observe the following:
Section 7. Penalties
Any violation of the provisions of this issuance shall be subject to penalties provided in Section 250 and other pertinent provisions of the NIRC, as amended.
Section 8. Repealing Clause
All existing revenue issuances or portions thereof inconsistent herewith are hereby revoked and/or amended accordingly.
Section 9. Effectivity
This Regulations shall take effect after fifteen (15) days following its publication in a newspaper of general publication.
CARLOS G. DOMINGUEZ
Secretary of Finance
Recommending approval:
CAESAR R. DULAY
Commissioner of Internal Revenue
(Manual encoding credits: Magdaleno Abdon, July 2020)
Quezon City
REVENUE REGULATIONS NO. 2-2013 dated January 23, 2013
SUBJECT : Transfer Pricing Guidelines
TO : All Internal Revenue Officers and Others Concerned
__________________________________________________________
BACKGROUND.- The dramatic increase in globalization of trade has also led to harmful tax practices that have resulted in tremendous losses of tax revenues for governments. The most significant international tax issue emerging from globalization confronting tax administrations worldwide is transfer pricing.
Transfer pricing is generally defined as the pricing of cross-border, intra-firm transactions between related parties or associated enterprises. 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 high income taxes and a related or associated enterprise of a country with low income taxes. In the Philippines, “intra-firm/inter-related” transactions account for a substantial portion of the transfer of goods and services, however, the revenue collection from related-party groups continue to go on a downtrend.
The revenues lost from intra-related transactions can be attributed to the fact that related companies are more interested in their net income as a whole (rather than as individual corporations), as such there is a desire to minimize tax payments by taking advantage of the loopholes in our tax system.
While transfer pricing issue typically occurs in cross-border transactions, it can also occur in domestic transactions. One context where transfer pricing issue occurs domestically is where one associated enterprise, entitled to income tax exemptions, is being used to allocate income away from a company subject to regular income taxes. In the Philippines, there is a domestic transfer pricing issue when income are shifted in favor of a related company with special tax privileges such as Board of Investments (BOI) Incentives and Philippine Economic Zone Authority (PEZA) fiscal incentives or when expenses of a related company subject to regular income taxes or in other circumstances, when income and/or expenses are shifted to a related party in order to minimize tax liabilities.
SECTION 1. OBJECTIVE AND SCOPE.- Pursuant to the provision of Section 244 in relation to Section 50 of the National Internal Revenue Code of 1997, as amended (“Tax Code”) these regulations are hereby promulgated to:
a. Implement the authority of the Commissioner of Internal Revenue (“Commissioner”) to review controlled transactions among associated enterprises and to allocate or distribute their income and deductions in order to determine the appropriate revenues and taxable income of the associated enterprises involved in controlled transactions;
b. prescribe guidelines in determining the appropriate revenues and taxable income of the parties in the controlled transaction by providing for the methods of establishing an arm’s length price; and
c. require the maintenance or safekeeping of the documents necessary for the taxpayer to prove that efforts were exerted to determine the arm’s length price or standard in measuring transactions among associated enterprises.
These Regulations apply to:
SECTION 2. PURPOSE OF THE REGULATIONS.– These Regulations seek to provide guidelines in applying the arm’ length principle for cross-border and domestic transactions between associated enterprises.
These guidelines are largely based on the arm’s length methodologies as set out under the Organisation for Economic Cooperation and Development (OECD) Transfer Pricing Guidelines.
SECTION 3. AUTHORITY OF THE COMMISSIONER TO ALLOCATE INCOME AND DEDUCTIONS.- Pursuant to Section 50 of the Tax Code, the Commissioner is authorized to distribute, apportion or allocate gross income or deductions between or among two or more organizations, trades or businesses (whether or not incorporated and whether or not organized in the Philippines) owned or controlled directly or indirectly by the same interests, if he determines that such distribution, appointment or allocation is necessary in order to clearly reflect the income of any such organization, trade or business.
Thus, the Commissioner is authorized to make transfer pricing adjustments, in line with the purpose of Section 50 to ensure that taxpayers clearly reflect income attributable to controlled transactions and to prevent the avoidance of taxes with respect to such transactions.
SECTION 4. DEFINITION OF TERMS.– As used in these Regulations, the following terms shall have the following meaning:
Comparable transaction. A transaction that is comparable to the controlled transaction under examination taking into consideration factors such as the nature of the property or services provided between the parties, functional analysis of the transactions and parties, contractual terms, and economic conditions.
Comparable uncontrolled transaction. A comparable uncontrolled transaction is a transaction between two independent parties that is comparable to the controlled transactions under examination. It can be either a comparable transaction between one party to the controlled transaction and an independent party (“internal comparable”) or between two independent parties, neither of which is a party to the controlled transaction (“external comparable”)
Associated enterprises. Two or more enterprises are associated if one participates directly or indirectly in the management, control, or capital of the other, or if the same persons participate directly or indirectly in the management, control, or capital of the enterprises. These are also referred to as related parties.
Control refers to any kind of control, direct or indirect, whether or not legally enforceable, and however exercisable or exercised. Moreover, control shall be deemed present if income or deductions have been arbitrarily shifted between two or more enterprises.
Controlled transaction means any transaction between two or more associated enterprises.
Independent enterprises or parties. Two enterprises are independent enterprises are independent enterprises with respect to each if they are not associated enterprises.
Advance Pricing Arrangement (“APA”) is an arrangement that determines, in advance of controlled transactions, an appropriate set of criteria (e.g. method, comparables and appropriate adjustments thereto, critical assumptions as to future events) for the determination of the transfer pricing for those transactions over a fixed period of time.
Mutual Agreement Procedure (MAP) is a means through which tax administrations consult to resolve disputes regarding the application of double tax conventions. This procedure, described in Article 25 of the OECD Model Tax Convention, can be used to eliminate double taxation that could arise from a transfer pricing adjustment.
SECTION 5. ARM’S LENGTH PRINCIPLE.- The Bureau of Internal Revenue (the “Bureau”) hereby adopts and the use of arm’s length principle as the most appropriate standard to determine transfer prices of related parties.
a. Background and Concept:
The arm’s length principle is the internationally recognized standard for transfer pricing between associated enterprises. Paragraph 1 of Article 9 of Philippine tax treaties is virtually identical to paragraph 1of Article 9 of the OECD Model Tax Convention on Income and Capital, which is considered, in the international arena, as the authoritative statement of the arm’s length principle.
Paragraph 2 of Article 7 (Business Profits) of the OECD Model Tax Convention on Income and on Capital specifies that, when attributing the profits to a permanent establishment should be considered as ‘a distinct and separate enterprise engaged in the same or similar activities and under the same or similar conditions’. This corresponds with the application of the arm’s length principle specified in paragraph 1 of Article 9 (Associated Enterprises) of the OECD Model Tax Convention on Income and on Capital.
The arm’s length principle requires the transaction with a related party to be made under comparable conditions and circumstances as a transaction with a independent party. It is founded on the premise that where market forces drive the terms and conditions agreed in an independent party transaction, the pricing of the transaction would reflect the true economic value of the contributions made by each entity in that transaction. Essentially, this means that if two associated enterprises derive profits at levels above or below the comparable market level solely by reason of the special relationship between them, the profits will be deemed as non-arm’s length. In such a case, tax authorities that adopt the arm’s length principle can make the necessary adjustments to the taxable profits of the related parties in their jurisdictions so as to reflect the true value that would otherwise be derived on an arm’s length basis.
b. Guidance on the Application of the Arm’s Length Principle:
The application of arm’s length principle would, first and foremost, involve the identification of comparable situation(s) or transaction(s) undertaken by independent parties against which the associated enterprise transaction or margin is to be benchmarked. This step is commonly known as “comparability analysis”. It entails an analysis of the similarities and differences in the conditions and characteristics that are found in the associated enterprise transaction with those in an independent party transaction. Once the impact of these similarities or differences on the transfer price have been determined, the arm’s length price/margin (or a range) can then be established using an appropriate transfer pricing method.
In the application of the arm’s length principle the following 3-step approach, discussed in detail in Sections 6,7, and 8 of these Regulations, may be observed.
These steps should be applied in the line with the key objective of transfer pricing analysis to present a logical and persuasive basis to demonstrate that transfer prices set between associated enterprises conform to the arm’s length principle.
SECTION 6. COMPARABILITY ANALYSIS.
a. The Concept of Comparability
The arm’s length principle is based on a comparison of the prices or margins adopted or obtained by related parties with those adopted or obtained by independent parties engaged in similar transactions. For such price or margin comparisons to be meaningful, all economically relevant characteristics of the situations being compared should be sufficiently similar so that:
b. Factors Affecting Comparability
A comparability analysis should examine the comparability of the transactions in 3 aspects:
(1) Characteristics of Goods, Services or Intangible Properties
(i) The specific characteristics of goods, services or intangible properties play a significant part in determining their values in the open market. For instance, a product with better quality and more features would, ceteris paribus, fetch a higher selling price. Such product or service differentiation affects the price or value of the product or service. Hence, the nature and features of the goods, intangible properties or services transacted between related parties and those between independent parties must be examined carefully. The similarities and differences (which would influence the value of the goods, services or intangible properties) should identified.
(ii) Characteristics to be examined include, but are not limited to, the following:
(iii) Similarities in the actual characteristics of the product, intangible or service, are most critical when one needs to compare prices of related party transactions against independent ones, such as when the Comparable Uncontrolled Pricing (CUP) method is adopted as the transfer pricing method. On the other hand, comparisons of profit margins (used in methods other than CUP) may be less sensitive to the features and characteristics of the product or service in question, as the margins generally correlate more significantly with the functions performed, risks borne and assets used by the entity.
(2) Analysis of Functions, Risks and Assets
(i) Economic theory purports that the level of return derived by an entity should be directly correlated to the functions performed, the assets used and risks assumed. For instance, an entity selling a product with warranty should earn a higher return compared to another entity selling the same product without the provision of warranty. The difference in margin is due to the additional function performed and risk borne by the first entity. Likewise, a product with a reputable branding is expected to fetch a higher return compared to that of a similar product without the branding, due to the additional asset (in this case, trademark) employed in enhancing the value of the product.
(ii) Hence, a crucial step in comparability analysis must entail a comparison of the economically significant functions performed, risks assumed and assets employed by the related party with those by the independent party (which has been selected as the party against which the associated enterprises margin or transactions are to be benchmarked). This is typically known as conducting a “functional analysis”.
(iii) The functions that should be compared include (but are not limited to) design, research and development, manufacturing, distribution, sales, marketing, logistics, advertising, financing, etc.
(iv) It is also relevant and useful, when identifying and comparing the functions performed, to consider the assets that are employed or to be employed. This analysis should consider the type of assets used, such as plant and equipment, valuable intangibles, etc. and the nature of the assets used (i.e., the age, market value, location, availability of intellectual property protections), etc.
(v) An appraisal of risks is also important in determining arm’s length prices/ margins. The possible risks assumed that should be considered in the functional analysis include market risks, risks of change in cost, price or stock, risks relating to the success or failure of R&D, financial risks such as changes in the foreign exchange and interest rates, credit risks, etc.
(vi) In practice, one cannot be expected to compare all functions, risks and assets employed. Hence, it must be emphasized that only functions, risk and assets that are economically significant in determining the value of transactions or margins of entities should be identified and compared.
(3) Commercial and Economic Circumstances
(i) Prices may vary across different markets even for transactions involving the same property or services. In order to make meaningful comparisons of prices or margins between entities/transactions, the markets and economic conditions in which the entities operate or where the transactions are undertaken should be comparable.The economic circumstances that may be relevant in determining market comparability include the availability of substitute goods or services, geographic geographic, location, the market size, the extent of competition in the markets, consumer purchasing power, the level of the market at which the enterprises operate (i.e., wholesaler or retail), etc.
(ii) Government policies and regulations (such as price controls,national insurance, etc.) may have an impact on prices and margins. Hence, the effects of these regulations should also be examined as part of the examination for comparability of the market and economic conditions.
(iii) Business strategies should also be examined in determining comparability for transfer pricing purposes. Business strategies would take into account many aspects of an enterprise, such as innovation and new product development, degree of diversification, risk aversion, assessment of political changes and other factors bearing upon the daily conduct of business.
(iv) An entity may embark on business strategies of temporarily charging a lower price for its product compared to similar products in the market or incurring higher expenses in the short run (hence resulting in lower profit levels). Such strategies are commonly used for market penetration and market share expansion or defense. The key issue with respect to business strategies that temporarily reduce profits in anticipation of higher long- term profit is whether the adoption and outcome of such strategies produce an arm’s length result. Hence, a claim that such strategies have been adopted ought to be demonstrated with evidence that an independent party would have been prepared to sacrifice profitability for a similar period under similar economic circumstances and competitive conditions, so that a higher long-term profit can be realized.
SECTION 7. IDENTIFICATION OF THE TESTED PARTY AND THE APPROPRIATE TRANSFER PRICING METHOD.
a. Determination of the Tested Party
The tested party is the entity to which a transfer pricing method can be most reliably applied to and from which the most reliable comparables can be found. For an entity to become a tested party, the Bureau requires sufficient and verifiable information on such entity.
b. Selection and application of Transfer Pricing Methodologies (TPM)
(1) The specific methods to be used in determining the arm’s length price are discussed in Section 10 of these Regulations.
(2) The selection of a transfer pricing method is aimed at finding the most appropriate method for a particular case. Accordingly, the method that provides the most reliable measure of an arm’s length result shall be used. For this purpose, the selection process should take into account the following:
(3) The Bureau does not have a specific preference for any one method. Instead, the TPM that produce the most reliable results, taking into account the quality of available data and the degree of accuracy of adjustments, should be utilized.
(4) In exceptional circumstances where there may not be comparable transactions or sufficient data to apply the above-described methods the Bureau may use the following approaches to verify whether the controlled transactions comply with the controlled transactions comply with the arm’s length principle:
(5) In all cases, taxpayers should be able to explain why a specific TPM is selected or used in recording controlled transactions through proper documentation.
c. Selection of Profit Level Indicator (PLI)
(1) In applying the TPM, due consideration must given to the choice of PLI which measures the relationship between profits and sales, costs incurred or assets employed. The use of an appropriate PLI ensures better accuracy in the determination of the arm’s length price of a controlled transaction. PLI is presented in the form of a generally recognized or utilized financial ratio. The selection of an appropriate PLI depends on several factors, including:
(2) Commonly used PLI include:
SECTION 8. DETERMINATION OF THE ARM’S LENGTH RESULTS.- Once the appropriate transfer pricing method has been identified, such is applied on the data of independent party transactions to arrive at the arm’s length result.
In some cases, it will be possible to apply the arm’s length principle to arrive at a single figure or specific ratio (e.g. price or margin) that is the most reliable to establish whether the conditions of a transaction are arm’s length. However, it is generally difficult to arrive at a specific ratio or range of deviation that may be considered as arm’s length. More likely, the transfer pricing analysis would lead to a range of ratios. Hence, the use of ranges to determine an arm’s length range shall be applied, provided that the comparable are reliable.
a. If the relevant condition of the controlled transaction (i.e. price or margin) is within the arm’s length range, no adjustment should be made. If the relevant condition of the controlled transaction (e.g. price or margin) falls outside the arm’s length range asserted by the Bureau, the taxpayer should present proof or substantiation that the conditions of the controlled transaction satisfy the arm’s length range (i.e. that the arm’s length range is different from the one asserted by the tax administration). If the taxpayer is unable to establish this fact, the Bureau must determine the point within the arm’s length range to which it will adjust the condition of the controlled transaction.
b. In determining this point, where the range comprises results of relatively equal and high reliability, it could be argued that any point in the range satisfies the arm’s length principle. Comparability comparability defects remain, it may be appropriate to use measures of central tendency to determine this point (for instance the median, the main or weighted averages, etc., depending on the specific characteristics of the data set), in order to minimise the risk of error due to unknown or unquantifiable remaining comparability defects.
SECTION 9. COMPARABILITY ADJUSTMENT.- Differences between the transaction of the comparables and that of the tested party must be identified and adjusted for, in order for the comparables to be useful as basis for determining the arm’s length price. Comparability adjustments include accounting adjustments and function/risk adjustments.
a. Comparability adjustments are intended to eliminate the effects of differences that may exist between situations being compared and that which could materially affect the condition being examined in the methodology (e.g. price or margin). These should not be performed to correct differences that have no material effect on the comparison, as these adjustments are neither routine nor mandatory in a comparability analysis. When proposing a comparability adjustment, a resultant improvement or increase in the accuracy in the comparability should be demonstrated.
b. The following adjustments should be avoided as they do not improve comparability:
SECTION 10. ARM’S LENGTH PRICING METHODOLOGIES.– In determining the arm’s length result, the most appropriate of the following methods may be used.
a. Comparable Uncontrolled Price (CUP) Method– The CUP Method evaluates whether the amount charged in a controlled transaction is at arm’s length by reference to the amount charged in a comparable uncontrolled transaction in comparable circumstances. Any difference between the two prices may indicate that the conditions of the commercial and financial relations of the associated enterprises are not arm’s length, and that the price in the uncontrolled transaction may need to be substituted for the price in the controlled transaction.
The use of the CUP Method to determine transfer price entails identification of all the differences between the product or service of the associated enterprise and that of the independent party. If these differences have a material effect on the price, adjustment of the price of products sold/services rendered by the independent party to reflect these differences shall be made to arrive at the arm’s length price. A comparability analysis under the CUP Method shall take into account the following:
b. Resale Price Method (RPM)- RPM is applied where a product that has been purchased from a related party is resold to an independent party. Essentially, it seeks to value the functions performed by the reseller of a product. The resale price method evaluates whether the amount charged in a controlled transaction is at arm’s length by reference to the gross profit margin realized in comparable uncontrolled transactions. This method is generally appropriate where the final transaction is made with an independent party. The usefulness of the method largely depends on how much added value or alteration the reseller has done on the product before it is resold, or the time lapse between purchase and onward sale. Thus, RPM is most appropriate in a situation where the reseller adds relatively little value to the properties. The greater the value added to the properties by the reseller, for example, through complicated processing or assembly with other products or, the longer the time lapse- to the extent that market conditions might have changed- before it is resold or, when the reseller contributes substantially to the creation or maintenance of an intangible property that is attached to the product, such as trademarks or tradenames, the more difficult it is to use RPM to arrive at the arm’s length price.
The starting point in RPM is the price (the resale price) at which a product that has been purchased in a controlled sale is then resold to an independent third party (uncontrolled resale). This price (the resale price) is then reduced by an appropriate gross margin (the resale price margin) representing the amount out of which the reseller would seek to cover its selling and other operating expenses and, in the light of functions performed (taking into account assets used and risks assumed), make an appropriate profit. An arm’s length price for the original transfer of property between the associated enterprises (controlled transaction) is obtained after subtracting the gross margin (resale price margin) from the resale price, and adjusting for other costs associated with the purchase of the product, such as customs duties.
The following are factors which may influence the resale price margin and other considerations when performing a comparability analysis for purposes of the resale price method:
As gross profit margins represent the gross compensation (after cost of sales) for specific functions performed, assets used and risks assumed, product differences are less critical than under the CUP Method. Therefore, where the related and independent party transactions are comparable in all aspects except for the product itself, RPM might produce a more reliable measure of arm’s length conditions that the CUP Method. Nonetheless, it can be expected that the more comparable the products, the more likely it is that the RPM will produce better results.
c. Cost Plus Method (CPM)– CPM focuses on the gross mark-up obtained by a sup;ier who transfers property or provides services to a related purchaser. Essentially, the method attempts to value the functions performed by the supplier of the property or services. CPM is most useful where semi-finished goods are sold between associated enterprises or where the controlled transaction involves the provision of services.
CPM indirectly measures whether the price for the property or service in the controlled transaction is an arm’s length price by assessing whether the mark-up on the costs incurred by the supplier of the property or service in the controlled transaction meets the arm’s length standard. This method is often useful in cases involving the manufacture, assembly, or other production of goods that are sold to related parties or where controlled transaction involves the provision of intra-group services.
The starting point in CPM is the cost incurred by the supplier of property or services in a controlled transaction for property transferred or services provided to a related purchaser. An appropriate mark-up is added to this cost to find the price that the supplier should be charging the buyer.
The cost base used in determining costs and the accounting policies should be consistent and comparable between the controlled and uncontrolled transaction, and over time in relation to the particular enterprise. The costs referred to in CPM are the aggregation of direct and indirect costs of production.
Comparability, when applying CPM, should take into account the similarity of functions performed, assets used and risks assumed, contractual terms, market conditions and business strategies as well as any adjustments made to account for the effects of any differences in the aforementioned factors when between the controlled and uncontrolled transactions.
A comparability analysis under CPM shall take into account the following:
As in the RPM, fewer adjustments may be necessary to account for product differences under CPM than the CPU Method, and it may be appropriate to focus on other factors of comparability (such as the functions performed and economic circumstances). Where the associated enterprise and independent party transactions are not comparable in all aspects the differences have a material effect on the margin, taxpayers are expected to make appropriate adjustments to eliminate the effects of these differences.
d. Profit Split Method (PSM). PSM seeks to eliminate the effect on profits of special conditions, made or imposed in a controlled transaction (or in controlled transactions that appropriate to aggregate) by determining the division of profits (or losses) that independent enterprises would have expected to realize from engaging in the transaction or transactions.
This method provides an alternative in cases where no comparable transactions between independent parties can be identified. This is true normally in a situation where transactions are very interrelated that they cannot be evaluated separately, or in situations involving a unique intangible. The method is based on the concept that profits earned in a controlled transaction should be equitably allocated among associated enterprises involved in the transaction(s) on an economically valid basis that approximates the allocation of profits that would have been anticipated and reflected in an agreement made at arm’s length.
Generally, the profit to be split is the operating profit, but it may be appropriate to carry out a split of the gross profit and then deduct the expenses incurred by or attributable to each relevant party.
The allocation of profit or loss under the profit split method shall be made in accordance with the following approaches:
(1) Residual Profit Split Approach.- The combined profits from the controlled transactions under examination are split in two stages.
(2) Contribution Profit Split Approach.– The combined profits, which are the total profits from the controlled transactions under examination, are divided between the associated enterprises in a single stage based upon the parties’ relative contribution to the profit or the relative value of the functions performed by each of the associated enterprises participating in the controlled transactions, supplemented as much as possible by external market data that indicate how independent enterprises would have divided profits in similar circumstances.
e. Transactional Net Margin Method (TNMM)- TNMM operates in a manner similar to the cost plus and resale price methods in the sense that it uses the margin approach. This method examines the net profit margin relative to an appropriate base such as costs, sales or assets attained by the member of a group of controlled taxpayers from a controlled transaction.
TNMM compares the net profit margins attained by an entity from a related party transaction to those attained by the same entity in uncontrolled transactions or, by comparable independent entities involved in similar transactions, relative to some appropriate base such as costs, sales, or assets.
In short, TNMM evaluates whether the amount charges in a controlled transaction is arm’s length by reference to the operating profit earned in comparable uncontrolled transactions.
Being a transactional profit method that is typically applied to only one of the parties involved in the transaction, the TNMM is closely aligned to the resale price and cost plus methods
This similarity means that this method requires a level of comparability similar to that required for the application of the two traditional transaction methods (the resale price method, and the cost plus method).
The primary difference between TNMM and RPM or CPM is that the former focuses on the net margin instead of the gross margin of a transaction. However, one of the weaknesses of using net margin as the basis for comparison is that it can be influenced by many factors that either do not have an effect, or have a less substantial or direct effect, on price or gross margins. Examples of such factors include the efficiency of plant and machinery used, management and personnel capabilities, competitive position, etc. Unless reliable and accurate adjustments can be made to account for these differences, TNMM may not produce reliable measures of the arm’s length net margins.
TNMM is usually appropriate to use when the gross profit of the business is not easy to determine such that either CPM, in case of a manufacturer/service-provider, or RPM, in ase of a distributor, cannot be used. Since the net margin figure is always available, TNMM may be used instead, applying the same formula as those for CPM (for manufacturer/service-provider) or RPM (for distributor) but rather using net margin in lieu of the gross margin/profit.
SECTION 11. ADVANCE PRICING ARRANGEMENTS and MUTUAL AGREEMENT PROCEDURE.– An advance Pricing Arrangement (APA) is a facility available to taxpayers who are engaged in cross-border transactions. It is an agreement entered into between the taxpayer and the Bureau to determine in advance an appropriate set of criteria (e.g. method, comparables and appropriate adjustments thereto) to ascertain the transfer prices of controlled transactions over a fixed period of time. The purpose of an APA is to reduce the risk of transfer pricing examination and double taxation.
There are two kinds of APA: (i) Unilateral APA; and (ii) Bilateral or Multilateral APA. A unilateral APA is an agreement involving only the taxpayer and BIR, while a bilateral/multilateral APA is an agreement involving the Philippines and one or more of its treaty partners. A Bilateral or Multilateral APA is authorized under the Mutual Agreement Procedure (MAP) Article of the 37 Philippine tax treaties.
It is not a mandatory requirement for taxpayers to avail of an APA for their controlled transactions. If a taxpayer avails of an APA, it may choose freely between a unilateral and bilateral/multilateral APA. If a taxpayer does not choose to enter into an APA and its transactions are subject later on to transfer pricing adjustments, it may still invoke the MAP Article to resolve double taxation issues.
The Philippine tax treaties article on MAP provides a mechanism for the Philippine competent authority to mutually arrive at a satisfactory solution with the competent authority of the treaty partner to eliminate double taxation issues arising from transfer pricing adjustments.
The Bureau shall issue separate guidelines on the application of APA and MAP processes.
SECTION 12. DOCUMENTATION.– Taxpayers must demonstrate that their transfer prices are consistent with the arm’s length principle. The main purpose of keeping adequate documentation is for taxpayers to be able to (i) defend their transfer pricing analysis, (ii) prevent transfer pricing adjustments arising from tax examinations, and (iii) support their applications for MAP. Taxpayers who have not prepared adequate documentation may find their application for MAP rejected or that the transfer pricing issue would be much more difficult to resolve.
a. Retention Requirement- The BIR does not require transfer pricing documents to be submitted when the tax returns are filed. However, such documents should be retained by the taxpayers and submitted to BIR when required or requested to do so.
b. Retention Period- In general, transfer pricing documents must be retained preserved within the period specifically provided in the Tax Code as the retention period, unless a different period is otherwise legally provided. However, it is to the best interest of the taxpayer to maintain documentation for purposes of MAP and possible transfer pricing examination.
c. Contemporaneousness- The transfer pricing documents must be contemporaneous. It is contemporaneous if it exists or is brought into existence at the time the associated enterprises develop or implement any arrangement that might raise transfer pricing issues or review these arrangements when preparing tax returns.
d. Documentation Details- The details of transfer pricing documents include, but are not limited to, the following:
SECTION 13. PENALTIES.– The provisions of the Tax Code and other applicable laws regarding the imposition of penalties and other appropriate sanctions shall be applied to any person who fails to comply with or violates the provisions and requirements of these regulations.
SECTION 14. TRANSITORY PROVISION.– Transactions entered into prior to the effectivity of these Regulations shall be governed by the laws and other administrative issuances prevailing at the time the controlled transactions were entered into.
SECTION 15. SEPARABILITY CLAUSE.– If any part or provision of these Regulations shall be held to be unconstitutional or invalid, other provisions hereof which are not affected thereby shall continue to be in full force and effect.
SECTION 16. REPEALING CLAUSE.– All existing rules, regulations and other issuances or portions thereof inconsistent with the provisions of these Regulations are hereby modified, repealed or revoked accordingly.
SECTION 17. EFFECTIVITY.- This Regulations shall take effect after fifteen (15) days following publication in a newspaper of general circulation.
(Original signed)
CESAR V. PURISIMA
Recommending Approval:
KIM S. JACINTO-HENARES
(Manual encoding credits: Magaleno Abdon, July 2020)
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