Eight months have passed since the issuance by the Finance Secretary of Revenue Regulations No. 02-2013 (RR No. 02-2013), dated Jan. 23, 2013, which provide for the transfer pricing guidelines or the guidelines in applying the arm’s length principle in related-party transactions. Discussions and inquiries on the matter have been made since the issuance. Maybe due to the novelty of the regulations, taxpayers have come to view RR No. 02-2013 as very general in nature. They have expected the Bureau of Internal Revenue (BIR) to issue circulars to clarify its scope, coverage, and the manner of implementation. It certainly makes sense for taxpayers to wait for more detailed guidelines before incurring the seemingly substantial costs for complying with RR No. 02-2013.
But with 2013 reaching its last quarter, and with many taxpayers having Dec. 13 as their year end, it may be proper to review RR No. 02-2013 again, specifically with respect to its documentation requirements.
Under RR No. 02-2013, taxpayers must keep documentation to demonstrate that their transfer prices are consistent with the arm’s length principle. RR No. 02-2013 also implements the authority of the commissioner of Internal Revenue to make transfer pricing audits and, consequently, to distribute, apportion or allocate gross income or deductions.
RR No. 02-2013 gives an indication on how the transfer pricing audit shall proceed. It says that if the relevant condition of the related-party transaction (e.g., price or margin) is within the arm’s length range, no adjustment should be made. If it falls outside the arm’s length range asserted by the BIR, the taxpayer should present proof or substantiation that the related-party transaction satisfies the arm’s length principle. If the taxpayer is unable to establish this fact, the BIR must determine the point within the arm’s length range to which it will adjust the relevant condition (e.g., price or margin) of the related-party transaction. Thus, in order to have proof or substantiation that its related-party transaction is at arm’s length and to prevent transfer pricing adjustments, a taxpayer must have the transfer pricing documentation.
This documentation may be prepared even without any additional guidelines from the BIR. RR No. 02-2013 is sufficient or complete enough for taxpayers to prepare the documentation. Further, RR No. 02-2013 is patterned after the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines. At one point with respect to the transfer pricing methods, RR No. 02-2013 even refers the reader to the OECD Transfer Pricing Guidelines for further guidance and examples. Thus, a taxpayer could prepare the documentation even at present with only RR No. 02-2013 and the OECD Transfer Pricing Guidelines as his reference.
One reason drives the preparation of the documentation for the current year’s related-party transactions. RR No. 02-2013 requires the documentation to be contemporaneous. Under RR No. 02-2013, the documentation is contemporaneous if it exists or is brought into existence at the time the related parties develop or implement any arrangement that might raise transfer pricing issues or review these arrangements when preparing tax returns.
If the documentation for 2013 transactions will be prepared only three years later during the time of the transfer pricing audit for 2013, the taxpayer may no longer argue that its documentation is contemporaneous in compliance with RR No. 02-2013.
Even if the taxpayer is allowed during the audit to present “recently-prepared†documentation, the length of time it takes to prepare the documentation might work against him. This is in view of the BIR’s practice in general tax audits and most probably in transfer pricing audits as well of imposing deadlines on the submission of supporting documents. Or assuming the taxpayer has the time to prepare it, he may not find sufficient data/information on comparable independent transactions that have taken place three years earlier.
In all these cases then, a taxpayer might not be able to defend his transfer pricing. Thus, having the documentation contemporaneous to the related-party transaction should help him stand in good stead.
However, even if he decides to have contemporaneous documentation, he will deal with the issue on the timing for its completion. Note that the definition of RR No. 02-2013 of the term “contemporaneous†has two reference points. Which one should the taxpayer adopt? A middle ground will be before his taxable year ends. This is to enable him to make any price adjustments that may be required by the documentation to bring without much hassle his condition (e.g., price or margin) within the arm’s length range. Adjustments made after the closing of the books might result in a discrepancy in the figures in his financial statements and in his income tax return. In addition, there could be issues with the auditors on the booking of these adjustments.
Especially for the initial year of complying with RR No. 02-2013, taxpayers should be open to the idea of making transfer pricing adjustments. This is true especially for taxpayers who, prior to the issuance of RR No. 02-2013, have never considered transfer pricing issues. These taxpayers include those who have not even charged at all for their sale of goods/services to related parties.
But making transfer pricing adjustments before or after the closing of the books is not guaranteed to be easy. Other tax concerns could crop up – e.g., impact on other taxes such as customs duties and taxes and value-added tax (VAT) in case of importations from offshore related parties; withholding taxes on additional outbound remittances; withholding taxes on additional income payments to be received; and necessity to have additional supporting documents for reporting income or claiming deductions or for achieving the desired tax treatment such as VAT zero-rating. It does not help that RR No. 02-2013 does not contain guidelines on the effect of these adjustments.
Especially also for the initial year, having the documentation completed ahead of time will allow taxpayers to review the corresponding intercompany agreements from a transfer pricing perspective. If there is no written intercompany agreement, it is advisable to have one executed right away. With the BIR’s practice in regular tax audits of requiring the submission of contracts to support a taxpayer’s tax treatment of his transactions, it is likely that the BIR will also require the submission of the intercompany agreement in a transfer pricing audit. Any discrepancy between the intercompany agreement and the transfer pricing documentation could invite more questions from the BIR. As much as possible, the intercompany agreements should mirror the actual transactions undertaken by the related parties because a transfer pricing documentation should be based on actual conduct of the related parties and not on some theoretical scenario. Further, a well-written intercompany agreement could explain the business consideration or substance commonly found in comparable independent transactions, thereby minimizing questions from the BIR.
In summary, while RR No. 02-2013 appears to provide a general framework on transfer pricing, it should nevertheless be part of a taxpayer’s compliance with tax reporting requirements. Later on, it should be an item in any taxpayer’s policy-making, tax planning, tax risk management, and ultimately in good tax governance.
Maria Carmela M. Peralta is a principal from the tax group of Manabat Sanagustin & Co. (MS&Co.), the Philippine member firm of KPMG International.
This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.
The view and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or MS&Co. For comments or inquiries, please email manila@kpmg.com or rgmanabat@kpmg.com.
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