(First of two parts)
Finally, on July 29 the Bureau of Internal Revenue (BIR) issued the much-awaited Revenue Memorandum Circular (RMC) No. 76-2020 to clarify issues on the filing of BIR form no. 1709.
BIR form no. 1709 is the “information return on transactions with related party” or referred to in the RMC as the Related-Party Transaction form (RPT form). It covers foreign and domestic related-party transactions.
The recently issued Revenue Regulations (RR) No. 19-2020, dated July 8, requires the RPT form to be attached to annual income tax returns. RR No. 19- 2020 explains that through the years, transactions around the world have become more com- plex 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. This is usually the case for transactions between related parties (e.g., transactions between a parent company and its subsidiary or between corporation and its affiliate or sister company).
Per RR No. 19-2020, the submission of the RPT form will follow the guidelines prescribed for the submission of the other required attachments to the annual income tax returns (e.g., audited financial statements). However, RR No. 19-2020, which took effect on July 25, created a lot of questions that only the BIR could answer.
One major question was whether the RPT form would be required for annual income tax returns covering taxable years prior to the effectivity of RR No. 19-2020. RMC No. 76- 2020 is explicit in requiring the said form for annual income tax returns for fiscal year ending March 31 and to all annual income tax returns to be submitted after such date. Nevertheless, RMC No. 76-2020 provides for an extension of time from July 30 up to Sept. 30 for corporations with fiscal year ending March 31.
RMC No. 76-2020 explained the rationale for the issuance of RR No. 19-2020. The RMC says that with the information gathered in the RPT form and its attachments, the BIR will be able to perform a transfer pricing risk assessment and make an informed decision at the early stage on whether or not to conduct a thorough review/audit of a particular entity or transaction. According to RMC No. 76-2020, in this way, and given its limited resources, the BIR will be able to focus its audit and commit its resources only on the most important transfer pricing issues.
Indeed, requiring disclosures on related-party trans- actions for the purpose of performing a transfer pricing risk assessment is understandable. It will be impossible for the BIR to conduct a transfer pricing audit of each and every related-party transaction. This is because BIR examiners need to invest time in each transfer pricing audit. As mandated by Revenue Audit Memorandum Order (RAMO) No. 01-2019, also known as the Transfer Pricing Audit Guidelines, and by also RMC No. 76-2020, BIR examiners should conduct a functional analysis, and thereafter, a comparability analysis (the comparable searches). Multiple meetings between the BIR examiners and taxpayers should be conducted for the BIR examin- ers to understand the operations of the group of companies and the nature of the related-party transactions. Conducting a comparable analysis typically cannot be completed in a matter of four weeks. Besides, it is also recognized that BIR examiners still need training to conduct transfer pricing audits.
Hence, the BIR needs to have a transfer pricing risk assessment to identify which taxpayer or related-party transaction to scrutinize for transfer pricing purposes. There are related-party transactions that potentially have the higher risks of eroding the tax base, and consequently, reducing the income tax payments to the government. These involve cross-border transactions and domestic transactions where one party enjoys income tax exemptions.
Nevertheless, one look at the RPT form raises concerns on how the information required may help in a transfer pricing risk assessment or how taxpayers will comply with this requirement.
Actually, the underlying question is how does the BIR intend to do a transfer pricing risk assessment? In other words, will the BIR merely consider the RPT form and its attachments in making such an assessment? Thus, when it knocks on the door of the taxpayers to do transfer pricing audits, it knows already which related-party transaction to audit and it will perform the next steps starting with the functional analysis. Or in the alternative, when conducting transfer pricing audits, will the BIR still ask taxpayers the same questions raised by RPT form and even ask for copies of the duly-filed RPT form and its attachments? This latter scenario seems likely as this is what is contemplated in the Transfer Pricing Audit Guidelines (RAMO No. 1-2019). This is not to mention the BIR’s practice during tax investigations of asking from taxpayers copies of documents even of those already filed with the BIR.
In this context, it may be worthwhile to evaluate if the following information required in the RPT is still relevant in a transfer pricing risk assessment:
• Addresses of the foreign/local related parties.
• Their taxpayer’s identification numbers.
• The filing of tax treaty relief applications.
• Local or foreign taxes withheld.
• Provisions on doubtful accounts.
• Expenses recognized.
• Terms and conditions of the transactions.
• Dividends.
• Redemption of shares.
• Compensation and benefits (including post-employment benefits) of the taxpayer’s key management personnel.
Likewise, the need to evaluate is also true for the following required attachments to the RPT form:
• Relevant contracts or proof of transaction.
• Withholding tax returns and the corresponding proof of payment of taxes withheld and remitted to the BIR.
• Proof of payment of foreign taxes or ruling duly is- sued by the foreign tax authority where the other party is a resident.
The objective of a transfer pricing risk assessment is to determine which related-party transactions could materially erode tax base and consequently reduce the income tax payments to the government. With the RPT form appearing to be the first step only in a transfer pricing risk assessment, the inclusion of the above enumerated information and attachments may be more than what is necessary.