Some issues regarding the transfer pricing regulations

First of two parts

On March 24, 2008, the Bureau of Internal Revenue (BIR) issued Revenue Memorandum Circular (RMC) No. 26-2008, entitled “Interim Transfer Pricing Guidelines”.  RMC 26-2008 states that the BIR is revising the final draft of the revenue regulations on transfer pricing. However, in order to preclude any issue that may arise in the interim, the BIR, as a matter of policy subscribes to the Transfer Pricing Guidelines issued by the Organization for Economic Cooperation and Development (OECD). Accordingly, until the revenue regulations are issued, any and all concerns shall be resolved in accordance with the OECD Transfer Pricing Guidelines. 

It remains to be seen when the transfer pricing regulations will be issued. Taxpayers, as well as transfer pricing consultants here and abroad, have been expecting the release of the regulations since 2006 when it was heard that the draft of the regulations was being made. Nevertheless, even at this stage, taxpayers might find it helpful to be aware of some of the issues that might arise regarding the regulations.

But what exactly is meant by transfer price and transfer pricing regulations?  The preface to the OECD Transfer Pricing Guidelines states that transfer prices are the prices at which an enterprise transfers physical goods and intangible property or provides services to associated enterprises. The OECD Transfer Pricing Guidelines apply the definition of the term “associated enterprise” found under the OECD Model Tax Convention. Under the said Model Tax Convention, two enterprises are associated if one of the enterprises 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 both enterprises [Article 9(1)(a) and (b)]. Putting together these definitions, in layman’s terms, the transfer price is the price charged in the transactions between/among related parties (for example, a parent company and its subsidiary or a corporation and its affiliate). Transfer pricing regulations provide guidelines for the determination of transfer prices. The regulations usually include documentation requirements to be complied with by related parties to prove that efforts were exerted to determine that the transfer prices are arm’s length. 

Based on the draft of the transfer pricing regulations, RMC No. 26-2008 and BIR’s Revenue Audit Memorandum Order (RAMO) No. 1-98  (entitled “Audit Guidelines and Procedures in the Examination of Interrelated Group of Companies”), the Philippine transfer pricing regulations will most likely adopt the OECD Transfer Pricing Guidelines. The OECD groups member countries such as the United States, United Kingdom, Netherlands, and Germany and provides a forum where governments can compare and exchange policy experiences, among other things. It produces internationally agreed instruments, decisions, and recommendations to promote rules of the game in many areas such as taxation (OECD 2008 Annual Report). Many countries, including non-OECD member countries, have generally based their transfer pricing requirements on the OECD Transfer Pricing Guidelines.  Needless to say, different countries may differ in their interpretation and application of the guidelines.

The OECD Transfer Pricing Guidelines focus on the application of the arm’s length principle to evaluate the transfer pricing of associated enterprises. The arm’s length principle is the international transfer pricing standard that OECD member countries have agreed should be used for tax purposes by multinational enterprise groups and tax administrations.  

It may be said that what drives the application of the arm’s length principle is tax, specifically the effect of transfer pricing on tax collection.  The OECD guidelines have recognized that when unrelated parties deal with each other, the conditions of their commercial and financial relations (e.g. the price of goods transferred or services provided and the conditions for such transfer or rendition of services) ordinarily are determined by market forces. When related parties deal with each other, their commercial and financial relations may not be directly affected by external market forces in the same way.  When transfer pricing does not reflect market forces and the arm’s length principle, the tax liabilities of the related parties and the tax revenues could be distorted (OECD Guidelines, Chapter I, Paragraphs 1.2 and 1.3).

It should be noted, however, that even without the transfer pricing regulations, the Philippines has subscribed to the arm’s length principle. The National Internal Revenue Code allows the Commissioner of Internal Revenue to allocate income and deductions among related parties. Specifically, Section 50 of the said code provides that in case of two or more organizations, trades or businesses (whether or not incorporated or organized in the Philippines), owned or controlled directly or indirectly by the same interests, the Commissioner of Internal Revenue is authorized to distribute, apportion, or allocate gross income or deductions between or among such organization, trade or business, if he determines that such distortion, apportionment or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organization, trade or business.  The BIR has stated that the purpose of Section 50 is to ensure that taxpayers clearly reflect income attributable to controlled transactions [related party transactions] and to prevent the avoidance of taxes with respect to such transaction.  It places a controlled taxpayer in tax parity with an uncontrolled taxpayer by determining the arm’s length price of inter-company transactions (RAMO 1-98).

To be concluded

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(Maria Carmela M. Peralta  is a Director for Tax and Corporate Services of  Manabat Sanagustin & Co., CPAs, a member firm of KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. Carmela is presently seconded to KPMG Singapore specializing in Transfer Pricing. This article is for general information only and is not intended to be, nor is it a substitute for, informed professional advice. While due care was exercised to ensure the quality of the information contained in this article, readers should carefully evaluate its accuracy, completeness and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances. For comments or inquiries, please email [email protected] or [email protected]).