Who said that the world is unfair?

(First of 2 parts)

Let us be honest at some point, we all thought that life is never fair and so is the world. When a person observes others, one tends to sort out what one sees into acceptable or unacceptable; evaluates oneself through one’s perceived standards; and looks at himself/herself and makes efforts to meet his/her own standards. That is okay

Imperfections stir change which makes people work for what they want. While most people are quiet about it, there are also people who use their power to get hold of what they want whatever it may cost, disregarding whatever the effects are. That, too, is okay if done within legal limits. In other words, almost everything is okay for as long as no law is violated. One may say the same thing in relation to paying taxes.

We know that tax evasion is not acceptable while tax avoidance is acceptable. Hence, companies come up with strategic plans to minimize their taxes without evading taxes. There is nothing wrong with tax planning as it does not violate any law. But allow me to digress. While tax avoidance allows profits to be artificially and legally shifted to low tax or no tax jurisdictions, tax planning that is so aggressive is also generally used to take advantage of the imperfections of the law and make use of them to exploit tax benefits to generate higher profits. Aggressive tax planning scheme is committed through tax planning structures which can be done via shifting interest payments and royalty payments to jurisdictions granting lower taxes, and strategic transfer pricing.

The pricing for the sale of goods or services from one entity to a related party may be the result of strategic transfer pricing (TP) planning. This strategic TP usually occurs when entities are in different tax jurisdictions and impacts the overall profitability of the related parties. It is often a result of an aggressive tax planning which aims to get reduced profits for jurisdictions with a higher tax rate, or increased profits for jurisdictions with a lower tax rate.

The international tax system has been undergoing reparations through initiatives to address aggressive tax planning and promote fairness, especially to those who cannot access the benefits of the tax laws of other jurisdictions. Consequently, international tax authorities established inclusive and impactful projects leading to the implementation of the Global Tax Transparency Standards in 2009 and the Base Erosion and Profit Shifting (BEPS) Project in 2013.

Locally, the Bureau of Internal Revenue (BIR) also promulgated issuances to address the dramatic increase in globalization of trade which has led to harmful tax practices and resulted in massive losses of tax revenues of the government.

In 2013, Revenue Regulations (RR) No. 02-2013 was issued to provide guidelines on how to apply the Arm’s Length Principle (ALP) for cross-border and domestic transactions between related parties. It is adopted so that the BIR can make the necessary adjustments to the taxable profits of the related parties to reflect the true value of the transaction. The issuance also requires taxpayers to show that their transfer prices are consistent with the ALP through a TP documentation. This documentation allows taxpayers to defend their transfer price, prevent TP adjustments arising from tax examinations, and support their applications for Mutual Agreement Procedures (MAP). It was also emphasized that taxpayers who have not prepared the said documentation may find their application for MAP rejected, or that the TP issue would be more difficult to resolve.

Nevertheless, as everyone knows, the BIR did not actively implement RR No. 02-2013.

In 2019, Revenue Audit Memorandum Order (RAMO) No. 01-2019 was issued by the BIR. This serves as a guide on how the BIR will conduct its TP audits. Under this RAMO, TP audits will be done through the following steps: 1) Preparation. 2) Implementation.  And 3) Reporting. However, from the point of view of the taxpayers, the issuance of RAMO No. 01-2019 triggered more questions instead of throwing light on the gray areas brought about by RR No. 02-2013.

For now, we understand that the BIR will not issue a separate Letter of Authority (LOA) specifically for TP audits. Rather, TP audits will be part of the regular tax audits of the BIR. RAMO No. 01-2019 supplements the BIR’s audit guidelines for regular tax audits. The request for documents in a regular tax audit will now include requests for the agreements and contracts between related parties. The request also includes the duly filled-up annexes of RAMO No. 01-2019 as part of the preparation phase.

In doing the TP audits, the BIR may also refer to the audited financial statements of the taxpayers. These financial statements provide initial information on the related-party transactions of the taxpayer.

RAMO No. 01-2019 does not provide guidance as to the amount of the transaction to be subjected to TP audit. The BIR is silent whether they will provide a threshold as well.

RR No. 02-2013 emphasizes the need of a TP documentation. RAMO No. 01-2019 provides that the BIR will review the taxpayer’s TP documentation in the course of its implementation phase. The implementation stage will start after the BIR has decided which related-party transactions to further investigate.

During regular tax audits, if the taxpayer fails to provide documents requested by the BIR, the BIR might resort to the issuance of a subpoena duces tecum. However, for TP audits from the perspective of the taxpayers, absent thresholds on the amount of the transaction to be subjected to TP audits, taxpayers will face a situation where getting a TP documentation for each related-party transaction may cost more than the amount of the transactions.

Lysa Mae D. Atian is an assistant manager from the Tax Group of KPMG R.G. Manabat & Co. (KPMG RGM&Co.), the Philippine member firm of KPMG International. KPMG RGM&Co. has been recognized as a Tier 1 tax practice and Tier 1 transfer pricing practice by the International Tax Review.

This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.

The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or KPMG RGM&Co. For comments or inquiries, please email [email protected] or [email protected].