Year-end reminders, transfer pricing edition

In a few days, we will be celebrating Christmas and New Year. While everyone is excited for the upcoming holidays, thinking about vacation and what to do during the break, for most accountants, this is the time of the year when they are busy doing final adjustments to accounting records, completing transactions and closing financial books of account.

For entities that have intercompany transactions, this could also be the time of year when transfer pricing policies/arrangements are revisited.

Under Revenue Regulations No. 2-2013, also known as The Philippine Transfer Pricing Guidelines, the term transfer pricing is defined “as the pricing of cross- border, intra- firm transactions between related parties or associated enterprises.” For instance, if a subsidiary sells goods or services to its parent company, the cost of the goods and services sold is the transfer price.

To demonstrate that their transfer prices are consistent with the arm’slength principle, taxpayers are required to maintain contemporaneous documentation. 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. Thus, at the end of every financial year, associated enterprises, or those companies that participate directly or indirectly in the management, control, or capital of other companies, must check whether or not their intercompany arrangements were conducted under arm’s- length conditions and were properly applied and reported in the financial records and tax returns. If the associated enterprise finds out that there are discrepancies between its transfer pricing policies ( or those that were actually charged by/ to the company) and the arm’s-length transfer price, it is generally allowed to take up transfer pricing adjustments in order to reflect the true arrangement and the arm’s- length charging of the related parties.

While there are no specific rules in the Philippines on year- end transfer pricing adjustments, the Transfer Pricing Guidelines of the Organisation for Economic Co-operation and Development (OECD), which has some persuasive effect in the Philippines, generally allows taxpayers to adjust their intercompany transactions’ transfer price as compensating adjustments to achieve compliance with the arm’s-length principle. Under the OECD Transfer Pricing Guidelines, compensating adjustment is defined as “an adjustment in which the taxpayer reports a transfer price for purposes that is, in the taxpayer’s opinion, an arm’s-length price for a controlled transaction, even though this price differs from the amount actually charged between associated enterprises. This adjustment would be made before the tax return is filed.”

Compensating adjustments may facilitate the reporting of taxable income in accordance with the arm’s- length principle, recognizing that information about comparable uncontrolled transactions may not be available at the time associated enterprises establish their related party transactions. Thus, for the purpose of lodging a correct tax return, a taxpayer is permitted to make an adjustment that would reflect the difference between the arm’s- length principle and the actual price recorded in its financial books.

Consequently, transfer pricing adjustments should generally be acceptable to the Bureau of Internal Revenue (BIR) as long as taxpayers are able to show that such adjustments were made to reflect an arm’s- length charge for their intercompany transactions. As these transfer pricing adjustments may also entail adjustments to tax returns, it is advisable for them to be made prior to the closing of the books of account and filing of the tax returns. Otherwise, the BIR may impose its own adjustments on taxpayers’ tax returns if it determines, during a tax investigation, that the taxpayers’ income and expenses are not at arm’s-length.

In case of adjustments to revenue and costs, among other tax considerations, there are income tax and value-added tax ( VAT) implications. For instance, if the taxpayer determines at the end of the year that there is a need for an additional charging of sales to its related party customer, these could be recorded as a transfer pricing adjustment which must be reported in the relevant income tax and VAT returns. For income tax, the adjustment could be reflected in the annual income tax return to be filed on or before the 15th day of the fourth month after the close of the taxable year, while for VAT, this could be included in the quarterly return that must be filed on or before that 25th day after the close of the taxable quarter (i.e., April 15 and Jan. 25, respectively, for taxpayers applying the calendar year period).

In terms of documentation, it is advisable that these transfer pricing adjustments are supported by proper documents. This may include, among others, invoices/official receipts, credit/ debit memos, and/or a provision in the agreement or contract which indicates the parameters with respect to the allowable adjustments, such as when these adjustments will be applied (e.g., at year end) and under what circumstances (e.g., if the agreed margin is not met). If the issuing party is a local entity, the supporting billing documents must be duly registered with the BIR.

While the development of transfer pricing rules in the global scene is expeditiously growing, the strict and strong implementation of transfer pricing rules in the Philippines has yet to be seen. Nevertheless, it is apparent that the BIR is now starting to scrutinize transfer pricing issues during tax investigations and impose transfer pricing adjustments on transactions that they deem not compliant with the arm’s length principle. With this, it would be helpful for taxpayers to exercise caution in terms of dealing with their intercompany engagements. With the new year fast approaching, including a review of transfer pricing arrangements in your company’s annual year- end requirements checklist would be a good start.

The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.