What’s new on transfer pricing?

What’s new on transfer pricing?

by Benedicta Du-Baladad

In recent months, I have noticed an unusually increased and genuine interest of business establishments, both from multinationals and local conglomerates, to put in place a transfer pricing policy for transactions with related parties. This is indicated both by the number of inquiries we receive and the number of current engagements for the conduct of studies, whether for the purpose of justifying existing pricing policies or formulating a transfer pricing model for inter-company transactions.

Transfer pricing, from an international tax perspective, is something that fascinates me. Way back in the early 1990s, I was writing articles about it when I was yet with the tax authorities. My fascination for transfer pricing inspired me to toil extra hours to undertake special studies on this subject when I was in Harvard.

But the development of transfer pricing awareness in this country has been slow compared to other countries. Among our neighboring countries, Malaysia, Thailand, Taiwan, Korea, Japan, India, Australia, New Zealand, and recently China, have all adopted their transfer pricing rules. The Philippines has not.

And it makes me wonder what is driving this recent trend to have in place a transfer pricing document that would ensure a more transparent and arm’s length dealing with related parties. Is it tax driven? Are the transfer pricing efforts in other countries permeating the local affiliates of multinational enterprises? Or is it the increasing pressure for good governance?

Philippine Accounting Standards (PAS 24), Related Party Disclosures, requires specific disclosures for related-party transactions. Those include disclosure on information about the parent company and its affiliates, the nature of the relationship, the nature of the transaction and amount of outstanding balances. In addition, PAS 24 allows a disclosure that related party transactions were made at arm’s length only if such can be substantiated. Absent such disclosure, it may be presumed that related party transactions are not made at arm’s length.

In the tax arena, a draft of the transfer pricing regulations was initiated as early as 2003, with the enhanced version presented by the Bureau of Internal Revenue (BIR) for public consultation around two years ago in 2006. But nothing has been officially issued up to this date.

A BIR official, however, indicated that this would soon be released after resolving some minor issues raised by the Department Of Finance. And this may be sometime after the amnesty period, which ends on March 6.

The transfer pricing regulations is meant to provide the guidelines for related party transactions to ensure that such are made at arm’s length and sufficient documentation is available to substantiate those transactions. Notwithstanding the absence of such regulations, assessments involving transfer pricing issues are continuously being made by the different investigating units of the BIR. The legal basis is anchored on Section 50 of the Tax Code which gives the Commissioner the power to allocate income and expenses between related parties if the income reported does not reflect the true taxable income. This Section 50 is a replica of Section 482 of the US Tax Code, the same provision relied upon by US for all its transfer pricing rules. The demands for a more transparent financial reporting and the recent development in the area of tax enforcement must have induced this business behavior to be more prudent in dealing with related parties, which then led to more requests for a transfer pricing study.

A transfer pricing study is a rigorous process. It requires a full understanding of the entities involved, their relationship, the transactions, the business environment where th ey operate, the industry, the trend and a lot more factors. It requires various analyses including among others functional, risk, geographical, political, and market analysis.

Overall, the essence of a tran sfer pricing s tudy is to be able to show that a transaction with a related party is that which would have been made if it was with an unrelated party or that — it is comparable to transactions made between two unrelated parties. In short, it is made at arm’s length.

Comparability and benchmarking test, therefore, is a necessary ingredient of the study. To be able to do this, one must have access to a database of information that could provide the study with sufficient basis for comparability, not only with local data but with regional and worldwide data as well. The international best practice for tax administrators and transfer pricing specialists in many countries in this regard is to subscribe to electronic databases that contain information about hundreds of thousands of public and private companies, both local and international, similar to the database that we subscribe to for the conduct our benchmarking and comparability analysis for our transfer pricing studies.

Having said that, while it could not be ascertained with exactness as to when the BIR will adopt and implement the transfer pricing regulations, I believe that pressure arising from the adoption by China and other neighboring countries of their transfer pricing rules would force the BIR to release it earlier than expected. International tax planners tend to attack countries with the weakest set of rules and the BIR surely knows this.

Besides, all indicators point towards a more transparent way of doing business. This, in addition to other tax-related considerations, will lead towards a sustained demand for an arm’s length standard in dealing with related parties.

(The author is the head of the tax division of Punongbayan & Araullo, member of Grant Thornton International. For comments and inquiries, please e-mail the author or call 886-5511.)