RMC No. 76-2020: Clarifications on the Filing of BIR Form 1709


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?

  1. For manual-filers – to be submitted at Revenue District Office (RDO)/Large Taxpayers (LT) Division where taxpayer is registered on or before the statutory due date.
  2. For eFPS-filers – to be submitted to RDO/ LT Division where the taxpayer is registered within 15 days from the statutory due date or actual date of electronic filing, whichever is later. 

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

  1. For cost-sharing arrangements, submission of formal written agreement is needed together with documents to substantiate such.
  2. All contracts are required to be submitted regardless of volume either through hardcopy or softcopy (DVD-R).
  3. Proof of payment of foreign taxes (for related party income abroad) and ruling from foreign tax authority
  • If the deadline for the payment of foreign taxes is after the deadline of filing the RPT Form, the income derived abroad should still be declared and the RPT Form, with proper statement that the related tax is not yet paid. 
  • The PH taxpayer should have a copy and details of the foreign tax paid and the rights over the same.
  • The said documents for proof of payments and the ruling should be consularized or apostilled.

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:

  • 1)  “Associate” is an entity over which the investor has significant influence.
  • 2)  “Close members of the family of a person” are those family members who may be expected to influence, or be influenced by, that person in their dealings with the entity and include:       
    • (i)  that person’s children and spouse or domestic partner;  
    • (ii) children of that person’s spouse or domestic partner; and
    • (iii) dependents of that person or that person’s spouse or domestic partner.  
  • 3)  “Compensation” includes all employee benefits, i.e., all forms of consideration paid, payable or provided by the entity, or on behalf of the entity, in exchange for services rendered to the entity. It also includes such consideration paid on behalf of a parent of the entity in respect of the entity. Compensation includes: 
    • (a)  short-term employee benefits, such as wages, salaries and social security contributions, paid annual leave and paid sick leave, profit-sharing and bonuses (if payable within twelve months of the end of the period) and non-monetary benefits (such as medical care, housing, cars and free or subsidized goods or services) for current employees;
    • (b)  post-employment benefits such as pensions, other retirement benefits, post- employment life insurance and post-employment medical care; 
    • (c)  other long-term employee benefits, including long-service leave or sabbatical leave, jubilee or other long-service benefits, long-term disability benefits and, if they are not payable wholly within twelve months after the end of the period,  profit-sharing, bonuses and deferred compensation;
    • (d)  termination benefits; and 
    • (e)  share-based payment.
  • 4)  “Control” refers to the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.
  • 5)  “Joint Control” is the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control.
  • 6)  “Joint Venture” is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement.
  • 7)  “Key management personnel” are those persons having authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly including any director (whether executive or otherwise) of that entity.
  • 8)  “Post-employment Benefit Plans” are formal or informal arrangements under which an entity provides post-employment benefits for one or more employees, such as the following:   
    • (a)  retirement benefits (e.g., pensions and lump sum payments on retirement); and
    • (b)  other post-employment benefits, such as post-employment life insurance and post-employment medical care.
  • 9)  “Related Party” is a person or entity that is related to the reporting entity, i.e., the entity that is preparing its financial statements.        
  • 10)  “Related Party Transaction” refers to the transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged.
  • 11)  “Significant influence” is the power to participate in the financial and operating policy decisions of an entity, but is not control over those policies. It may be gained  by share ownership, statute or agreement.
  • 12)  “Subsidiary” is an entity that is controlled by another entity.
  • 13)  “Venturer” is a party to a joint venture and has joint control over that joint venture.   

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:

  • (a) A person or a close member of that person’s family is related to a reporting entity if  that person:   
    • (i)   has control or joint control of the reporting entity;
    • (ii)  has significant influence over the reporting entity; or    
    •  (iii) is a member of the key management personnel of the reporting entity or of a parent of  reporting entity.

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.

  • (b)  An entity is related to a reporting entity if any of the following conditions applies: 
    • (i)    The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others).
    • (ii)   One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member).
    • (iii)   Both entities are joint ventures of the same third party.
    • (iv)   One entity is a joint venture of a third entity and the other entity is an associate of the third entity. 
    •  (v)   The entity is a post-employment benefit plan for the benefit of employees of either the reporting entity or an entity related to the reporting entity. If the reporting entity is itself such a plan, the sponsoring employers are also related to the reporting entity. 
    •  (vi)   The entity is controlled or jointly controlled by a person identified in (a). 
    • (vii)  A person identified in (a)(i) has significant influence over the entity or is a member of the key management personnel of the entity (or of a parent of the entity). 
    • (viii) The entity, or any member of a group of which it is a part, provides key management personnel services to the reporting entity or to the parent of the reporting entity.

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:     

  • (a) purchases or sales of goods (finished or unfinished);    
  • (b) purchases or sales of property and other assets;    
  • (c) rendering or receiving of services;              
  • (d) leases;           
  • (e) transfers of research and development;   
  • (f) transfers under license agreements;  
  • (g) transfers under finance arrangements (including loans and equity contributions in cash or in kind);    
  • (h) provision of guarantees or collateral; 
  • (i) commitments to do something if a particular event occurs or does not occur in the future, including executory contracts, i.e., contracts under which neither party has performed any of its obligations or both parties have partially performed their obligations to an equal extent (recognized and unrecognized); and
  •  (j) settlement of liabilities on behalf of the entity or by the entity on behalf of that related party.

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:

  • (a)  The required disclosures on transactions and outstanding balances shall be made separately for each of the following categories:       
    • (i)     the parent;     
    •  (ii)    entities with joint control or significant influence over the entity;        
    • (iii)   subsidiaries;      
    • (iv)   associates;             
    • (v)    joint ventures in which the entity is a joint venture;      
    • (vi)   key management personnel of the entity or its parent; and
    • (vii)  other related parties.
  • (b)  For each of said category, the following information shall be provided:     
    • (i)     the amount of the transactions;              
    •  (ii)    the amount of outstanding balances, including commitments, and their terms and conditions, including whether they are secured, and the nature of the consideration to be provided in settlement, and details of any guarantees given or received;         
    • (iii)   provisions of doubtful debts related to the amount of outstanding balances;                           
    • (iv)   the expense recognized during the period in respect of bad or doubtful debts due from related parties.

Section 6. Procedures and Guidelines

In filing out BIR Form No. 1709, the taxpayer is hereby directed to observe the following:

  • 1)  BIR Form No. 1709 shall be completely and truthfully accomplished by the taxpayer or its authorized representative/s, and shall be attached to the ITRs for the current taxable year and subsequent years, making it an integral part of the latter.
  • 2)  The nature of transaction and the accounts affected shall be described in detail.
  • 3)  The “business overview of the ultimate parent company” referred to in Part IV (A) of BIR Form No. 1709 shall include the profile of the multinational group of which the taxpayer belongs, along with the name, address, legal status and country of tax residence of each of the related parties with whom intra-group transactions have been entered into by the taxpayer, and ownership linkages among them.
  •  4)  On the other hand, the “functional profile” referred to in Part IV (B) of BIR Form No. 1709 shall include a broad description of the business of the taxpayer and the industry in which it operates, and of the business of the related parties with whom the taxpayer  has transacted;
  • 5)  The following are required to be attached to BIR Form No. 1709:                             
    • a)  certified true copy of the relevant contracts or proof of transaction;   
    • b)  withholding tax returns and the corresponding proof of payment of taxes  withheld and remitted to the BIR;           
    • c)  proof of payment of foreign taxes or ruling duly issued by the foreign tax authority where the other party is a resident; and              
    • d)  certified true copy of Advance Pricing Agreement, if any; and     
    • e)  any transfer pricing documentation.
  • 6)  No spaces shall be left unanswered. If one or some portions are not applicable, such fact shall be so stated.

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)

REPUBLIC OF THE PHILIPPINES

DEPARTMENT OF FINANCE

BUREAU OF INTERNAL REVENUE

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:

  • (1)       cross-border transactions between associated enterprises; and
  • (2)       domestic transactions between associated enterprises.    

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.

  • Step 1:            Conduct a comparability analysis.
  • Step 2:            Identify the tested party and the appropriate transfer pricing method.
  • Step 3:             Determine the arm’s length results.

 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:

  • (1)       none of the differences (if any) between the situations being compared can materially affect the price or margin being compared, or
  • (2)       reasonably accurate adjustments can be made to eliminate the effect of any such differences.

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:     

  • in the case of transfer of goods: the physical features, the quality  and reliability and volume of supply of the goods;
  • in the case of provision of services: the nature and extent of the services; and
  • in the case of intangible property: the form of transaction, the type of intangible , the duration and degree of protection, and the anticipated benefits from the use of the property.

(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:

  • (i)        the respective strengths and weaknesses of each of the transfer pricing  methods;
  • (ii)       the appropriateness of the method considered in view of the nature of the controlled transaction, determined in particular through a functional analysis;
  • (iii)      the availability of reliable information (in particular on uncontrolled comparables) in order to apply the selected method and/or other methods; and
  • (iv)      the degree of comparability between controlled and uncontrolled transactions, including the reliability of comparability adjustments that may be needed to eliminate material differences between them.

(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:

  • (i)        Extension of the transfer pricing methods. The comparable may be with enterprises in another industry segment or group of segments; and
  • ii)       Use of a combination or mixture of the transfer pricing methods or other methods or approaches.

(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:

  •  (i)        characterization of the business;
  • (ii)       availability of comparable data; and
  • (iii)      the extent to which the PLI is likely to produce a reliable measure of arm’s  length profit.

(2)       Commonly used PLI include:

  • (i)        Return on costs: cost plus margin and net cost plus margin.
  • (ii)       Return on sales: gross margin and operating margin.
  • (iii)      Return on capital employed: return on operating assets.

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:

  • (1)       adjustments that are questionable when the basis for comparability criteria is only  broadly satisfied;
  • (2)       excessive adjustments or adjustments that too greatly affect the comparable as such indicates that the third party being adjusted is in actually not sufficiently comparable;
  • (3)       adjustments on differences that do not materially affect the comparability;
  • (4)       highly subjective adjustments, such as on the difference in product quality.

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:   

  • (1)       Product characteristics such as physical features and quality;
  • (2)       If the product is in the form of services, the nature and extent of such services provided;
  •  (3)       Whether the goods sold are compared at the same points in the supply or  production chain;
  •  (4)       Product differentiation in the form of patented features such as trademarks,  design, etc;
  • (5)       Volume of sales if it has an effect on price;
  • (6)       Timing of sale if it is affected by seasonal fluctuations or other changes in market conditions;
  • (7)       Whether cost of transport, packaging, marketing, advertising, and warranty are included in the deal;
  • (8)       Whether the products are sold in places where the economic conditions are the same; and
  • (9)       Whether a business strategy is adopted in the controlled transaction that would produce material difference on the price of the controlled transaction as against the price in an uncontrolled transaction.

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:

  • (1)       Functions or level of activities performed by the seller and the risks undertaken (e.g., whether the reseller is merely a forwarding agent or, a distributor who assumes full responsibility for marketing and advertising the product by risking its own resources in these activities);
  • (2)       Whether similar assets are employed in the controlled and uncontrolled transactions, (e.g., a developed distribution network);
  • (3)       Although broader product differences are allowed as compared to the CUP  method, product similarities are still significant to some extent particularly when there is a high value or unique intangible attached to the product;
  • (4)       If the resale price margin used is that of an independent enterprise in a comparable transaction, differences in the way business is managed may have an impact on profitability;
  • (5)       The time lapse between original purchase and resale of the product as a longer time lapse may give rise to changes in the market, exchange rates, costs, etc.;  
  • (6)       Whether the reseller is given exclusive rights to resell the products;
  • (7)       Differences in accounting practices where adjustments must be made to ensure that the components of costs in arriving at gross margins in the controlled and uncontrolled transactions are the same;
  • (8)       Whether cost of transport, packaging, marketing, advertising, and warranty are included in the deal;
  • (9)       Whether the products are sold in places where the economic conditions are the same; and    
  • (10)     Whether a business strategy is adopted in the controlled transaction that would produce material difference on the resale gross margin of the controlled transaction as against the resale gross margin in an uncontrolled transaction.

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:

  • (1)       Functions or level of activities performed by the seller and the risks undertaken;
  • (2)       Whether similar assets are employed in the controlled and uncontrolled  transactions;
  • (3)       Although broader product differences are allowed as compared to the CUP method, product similarities are still significant to some extent;
  • (4)       If the gross margin used is that of an independent enterprise in a comparable transaction, differences in the way business is managed may have an impact on  profitability;         
  • (5)       Differences in accounting practices where adjustments must be made to ensure that the components of costs in arriving at gross margins in the controlled and   uncontrolled transactions are the same;
  • (6)       Whether cost of transport, packaging, marketing, advertising, and warranty are  included in the deal;
  • (7)       Whether the products are sold in places where the economic conditions are the same; and
  • (8)       Whether a business strategy is adopted in the controlled transaction that would  produce material difference on the cost plus mark-up of the  controlled transaction as against the cost plus mark-up in an uncontrolled transaction.

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.

  • (i)        In the first stage, each participant is allocated sufficient profit to provide it with a basic return appropriate for the type of transactions in which it is engaged. Ordinarily, the basic return would be determined by reference to the market return achieved for similar types of transactions by independent parties. Thus, the basic return would generally account for the value, with reference to comparable independent market data, of the contribution or functions performed by each party and not account for the return that would be generated by any unique and valuable assets possessed by the participants.
  •  (ii)       In the second stage, any residual profit (or loss) remaining after the first stage division would be allocated among the parties based on an analysis of the facts and circumstances that might indicate how this residual would would have been divided between independent parties (i.e. taking into consideration the value of unique assets used by the parties, usually intangible assets). The remaining profit which is attributable to such unique assets is allocated between the parties based on the relative contributions of the parties to the creation of such assets, taking into consideration how  independent parties would have divided such residual profits in similar circumstances.

            (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:

  • (1)       Organizational structure
  • (2)       Nature of the business/industry and market conditions
  • (3)       Controlled transactions
  • (4)       Assumptions, strategies, policies
  • (5)       Cost contribution arrangements (CCA)
  • (6)       Comparability, functional and risks analysis
  • (7)       Selection of the transfer pricing method
  • (8)       Application of the transfer pricing method
  • (9)       Background documents
  • (10)     Index to documents

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

Secretary of Finance

Recommending Approval:

(Original signed)

KIM S. JACINTO-HENARES

Commissioner of Internal Revenue

(Manual encoding credits: Magaleno Abdon, July 2020)

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