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Tax audits for conglomerates

Tax audits for conglomerates by: Eleanor Lucas Roque

Doing business in today’s cutthroat environment is becoming more and more complicated. 

To stay ahead of the competition, a company’s focus on delivering quality products and services is no longer enough. Companies are now compelled to devise new ways of conducting business and reengineering their processes and operations.  Costs have to be continually reduced while profit margins have to be increased.  To top it all, competition seems to be declaring a price war at every turn, almost shrinking any elbow room for profit margins. 

To adapt to the growing complexities of doing business, companies have adopted all forms of strategies aimed at harnessing economies of scale. Examples of these are vertical and horizontal integrations aimed at obtaining efficiencies through synergies. In fact, conglomerates or groups of related companies engaged in diversified business activities controlled and managed by a parent company have appeared as early as the 1920s and have increasingly grown in popularity with each economic downturn and upturn cycle.

As corporate structures become more complex, taxation of conglomerates and related companies has become more intricate and arduous.  The tax authorities are also forced to keep up with the changing modes of doing business in their effort to capture more taxes and prevent revenue erosion.
Various countries have already adopted transfer pricing policies and regulations for multinational and related companies. Companies which are set up to be solely cost centers are subject to scrutiny more meticulously than a new bacteria at a laboratory.

In relation to this, on March 26, 2010, the Bureau of Internal Revenue (BIR) issued Revenue Memorandum Order (RMO) No. 36-2010. The RMO provided the guidelines in the audit of conglomerates and interrelated taxpayers and amended an earlier RMO on the audit of selected taxpayers by the National Investigations Division (NID).

Under RMO 36-2010, special audit teams headed by the Assistant Commissioners of the Large Taxpayers (LT)-Regular, LT- Excise and Enforcement Services (ES) shall be assigned to conduct the audit of identified conglomerates. The revenue officers under each special audit team shall be tasked to undertake a simultaneous, joint, and coordinated examination of the books of accounts of the related companies assigned to them.

The move to consolidate audit for related taxpayers is a necessary result of growing transactions between related taxpayers.

However, due to the lack of clear guidelines for related party transactions, some taxpayers who desire to comply with the BIR requirements are left in a quandary on what rules or policies to adopt. Considering that the transfer pricing regulations have not yet been approved, most taxpayers are confused as to the type of documentations they must produce in case of a transfer pricing audit which a coordinated group audit is most likely to concentrate on. 

In certain instances, the BIR has approved cost sharing arrangements which are pure reimbursement-at-cost type of arrangements allowed between related parties.

However, in the tax audit of conglomerates, will the tax authorities allow the same? If not, will they insist on an arm’s length pricing for all related party transactions?

This is not the first time that the BIR has issued guidelines for the joint and coordinated examination of related parties. Presumably, the BIR has gathered enough data during its previous conduct of similar investigations. The BIR may consider establishing clear guidelines for related party transactions first before conducting consolidated tax audits.

In fact, the RMO requires that within thirty (30) days from the date of completion, each audit team shall submit recommended set of guidelines, standards and procedures to be adopted in the audit and tax treatment of related parties and inter-company transactions. It shall include among others:

  •  Tax issues and tax planning schemes of related parties;
  •  Tax treatment for controlled transactions including, but not limited to,  transfer pricing, cost-sharing arrangements, inter-company loans and advances, provisions of goods and services, agency and/or resale arrangements, etc.; and
  •  Audit procedures, rules and regulations for related party transactions.

It may be unfair to the taxpayers for them to be audited or assessed for deficiency taxes for transactions which the BIR is still evaluating such as transfer pricing, cost-sharing arrangements, inter-company loans and advances, provisions of goods and services, agency and/or resale arrangements. In such a case, it is also possible that there  will be no uniform treatment of similar transactions and that resolutions of tax issues will it depend on the individual position of the audit team on certain tax issues.

Note also that the investigation will cover all internal revenue taxes for taxable year 2009 only.

Considering that the audit will be conducted on various companies which are part of the group, there may be instances when the companies do not have the same fiscal years. 

What then will happen if an income booked in fiscal year 2009 of Company A is taken up as an expense in fiscal year 2008 in Company B? Would this mean that there may be an income adjustment for Company A with no corresponding expense adjustment for Company B? More importantly, will the BIR allow transfer pricing adjustments for both parties involved? Or will the adjustment be limited to upward adjustments of income in Company A without a downward adjustment in expenses for Company B?

Generally, if adjustments in both sides are allowed, this will result in a tax neutral position, making the audit exercise unnecessary. Thus, it may be more reasonable to limit the audit to group of companies where the related parties are enjoying tax incentives and where the possibility of shifting income to the company with lower tax rate will be more prevalent.

Further, the RMO did not specify the extent of ownership for an affiliate to be part of the consolidated audit.  Usually, for profit shifting to be done, one company must be controlled directly or indirectly by another.

However, the RMO also provides that any entity whereby another entity owns less than the majority of the voting stock of another will be considered an affiliate.  This may mean that companies which are owned by a conglomerate at a small percentage (say 10 percent), may be part of the consolidated audit. 

Finally, all investigations must be completed and the reports of investigations submitted not later than six (6) months from the issuance of the Letter of Authority (LA). Considering that this will involve various companies with presumably more complex transactions, the period given to complete the investigation will definitely be tight. 

The RMO, however, did not specify the effects if the investigations were not completed within the deadline. 

Will there be penalties or sanctions for the members of the special audit team? Will the taxpayer be able to breathe a sigh of relief and consider the tax investigation terminated? Are there instances when the investigations may go beyond the deadline?

Admittedly, the audit of conglomerates will be difficult for both sides with so many complex transactions and common issues yet to be resolved. Hopefully, this round of consolidated audits will result in more definite policies from the BIR that will guide the taxpayers in their way of doing business and thereby, increase tax compliance among the taxpayers.

This article is not intended to be a substitute for professional advice.  For comments and inquiries, you may e-mail the author at  For other tax concerns, please check out our other tax services.