TO: Atty.

Stephen Yu
FROM: Maria Ludica B. Oja
DATE: January 13, 2017
SUBJECT: TRANSFER PRICING

Transfer Pricing Defined

Transfer pricing is the general term for the pricing of cross-border, intra-firm
transactions between related parties or associated enterprises. This may be
seen in transactions within multinational enterprises, facilitating the transfer
of their goods and services, including capital and tangibles.

Transfer pricing therefore refers to the setting of prices for transactions

between associated enterprises involving the transfer of property or services.
These transactions are also referred to as controlled transactions, as
distinct from uncontrolled transactions between companies that are not
associated and can be assumed to operate independently (on an arms
length basis) in setting terms for such transactions.

As a consequence of globalization, transfer pricing has become the most

significant issue in international taxation. This is owing to practices that
ensures larger margins of profits to related parties, which in turn results to
losses of tax revenues for governments. Hence there is a need to address the
problem.

Applicability of Transfer Pricing in the Philippines

In order for the government to address the downtrend of revenue collection

from related-party groups concerning inter-related transfers, the Philippines
has come up with a rule on transfer pricing which is patterned after the US
Tax Code and which heavily relies on the Organization for Economic Co-
operation and Development (OECD) Guidelines.

The statutory rule on transfer pricing is found in Section 50 of the National

Revenue Code (NIRC). This provision allows the Commissioner on Internal
Revenue (CIR) to allocate income and deductions between related parties as
means to prevent tax evasion or to clearly reflect the amount of income
earned by each party. Thus, the Commissioner is authorized to make transfer
pricing adjustments, in line with the purpose of Section 50.

Revenue Regulation 2-2013 set forth the guidelines on Transfer Pricing in

January 23, 2013. This was promulgated by the Secretary of Finance
pursuant to its authority to promulgate rules and regulation. The regulations
particularly prescribed the guidelines in applying the arms length principle
for cross-border and domestic transactions between associated enterprises.
The guidelines are largely based on the arms length methodologies set out
under the OECD Transfer Pricing Guidelines.

RR 2-2013 is applicable to both cross border transactions between

associated enterprises; and domestic transactions between associated
enterprises. It also prescribes guidelines in determining the appropriate
revenues and taxable income of the parties in the controlled transaction by
providing for the methods of establishing an arms length price and requires
the maintenance or safekeeping of the necessary documents for the
taxpayers to prove that efforts were exerted to determine the arms length
price or standard in measuring transactions among associated enterprises.

Applicability of Transfer Pricing in Domestic Transactions

These Regulations apply to:

(1) Cross-border transactions between associated enterprises; and
 (2) Domestic transactions between associated enterprises.

The TP Regulation applies to both domestic and cross-border transactions of

associated enterprises. The regulations recognize that, while transfer pricing
typically occurs in cross-border transactions, it can also occur in domestic
transactions with the goal of lowering tax obligations.

In the Philippines, there is a domestic pricing issue when income is shifted in

favor of a related company with special tax privileges such as Board of
Investments (BOI) Incentives and Philippine Economic Zone Authority (PEZA)
fiscal incentives or when expenses of a related company with special tax
privileges are shifted to a related company subject to regular Income Taxes
or in other circumstances, when income and/or expenses are shifted to a
related party in order to minimize tax liabilities.

Arms Length Principle

The arms length principle is the internationally recognized standard for

transfer pricing between associated enterprises. The BIR adopted the use of
arms length principle as the most appropriate standard to determine transfer
prices of related parties.

The arms length principle requires the transaction with a related party to be
made under comparable conditions and circumstances as a transaction with
an independent party. It is founded on the premise that where market forces
drive the terms and conditions agreed in an independent party transaction,
the pricing of the transaction would reflect the true economic value of the
contributions made by each entity in that transaction. Essentially, this means
that if two associated enterprises derive profits at levels above or below the
comparable market level solely by reason of the special relationship between
them, the profits will be deemed as non-arms length. In such a case, tax
authorities that adopt the arms length principle can make the necessary
adjustments to the taxable profits of the related parties in their jurisdictions
so as to reflect the true value that would otherwise be derived on an arms
length basis.

In the application of the arms length principle, RR 2-2013 provides for a

three-step approach, namely:
Step 1. Conduct a comparability analysis;
Step 2. Identify the tested party and the appropriate transfer pricing method;
and
Step 3. Determine the arms length result.
These steps should be in line with the key objective of transfer pricing
analysis which is to present a logical and persuasive basis to demonstrate
that the transfer prices between associated enterprises conform to the arms
length principle.

The regulations adopt the OECD arms length pricing methodologies without
any specific preference for any one method. These include the Comparable
Uncontrolled Price Method, Resale Price Method, Cost Plus Method, Profit Split
Method and the Transactional Net Margin Method. In determining the arms
length result, the most appropriate method for a particular case shall be
used. This should be the method that produces the most reliable results,
taking into account the quality of available data and degree of accuracy of
adjustments.

The process to arrive at the appropriate arms length price typically involves
the following processes or steps:
1. Comparability analysis;
2. Evaluation of transactions;
3. Evaluation of separate and combined transactions;
 4. Use of an arms length range or a central point in the range; 34 Use of
multiple year data;
5. Losses;
6. Location savings and location rents;
7. Intentional set-offs; and
8. Use of customs valuation.

Documentation Requirement

Taxpayers must demonstrate that their transfer prices are consistent with
the arms length principle. The main purpose of keeping adequate
documentation is for taxpayers to be able to (i) defend their transfer pricing
analysis, (ii) prevent transfer pricing adjustments arising from tax
examinations, and (iii) support their applications for MAP. Taxpayers who
have not prepared adequate documentation may find their application for
MAP rejected or that the transfer pricing issue would be much more difficult
to resolve.

A. Retention Requirement - The BIR does not require transfer pricing

documents to be submitted when the tax returns are filed. However,
such documents should be retained by the taxpayers and submitted to
BIR when required or requested to do so.

B. Retention Period - In general, transfer pricing documents must be

retained preserved within the period specifically provided in the Tax
Code as the retention period, unless a different period is otherwise
legally provided. However, it is to the best interest of the taxpayer to
maintain documentation for purposes of MAP and possible transfer
pricing examination.

C. Contemporaneousness - The transfer pricing documents must be

contemporaneous. 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.

D. Documentation Details the details of transfer pricing documents

include, but are not limited to, the following:
1) Organizational structure
2) Nature of the business/industry and market conditions
3) Controlled transactions
4) Assumptions, strategies, policies
5) Cost contribution arrangements (CCA)
6) Comparability, functional and risk analysis
7) Selection of the transfer pricing method
8) Application of the transfer pricing method
9) Background documents
10) Index to documents

Deadline to prepare documentation

Transfer pricing documentation must be contemporaneous. Intercompany
agreements must be prepared prior to the related-party transactions they
document. The Bureau of Internal Revenue does not require documentation
to be submitted when the tax returns are led. Documentation should be kept
by taxpayers, and is required to be submitted upon the BIRs request.

Deadline to submit documentation

Documentation must be available at any time during an investigation.
Sources:

Revenue Regulations No. 2-2013, citing UN Practical Manual on Transfer

Pricing for Developing Countries
An Introduction to Transfer Pricing , UN Tax Committees Subcommittee on
Practical Transfer Pricing Issues. Retrieved from http://www.un.org/
International Transfer Pricing- Philippines, PricewaterhouseCoopers. Retrieved
from http://www.pw.com/gx/en
Digest of RR 2-2013, Bureau of Internal Revenue