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Narrowing the scope for transfer pricing reporting

COVID-19 (coronavirus disease 2019) has taken the world by storm, with the pandemic requiring unprecedented community quarantines, lockdowns, and business disruption.

With the objective of reducing costs and tempering negative operating results, taxpayers have been reevaluating discrepancies between forecast and actual operating results and reviewed contractual arrangements and supply chain processes. Particularly for taxpayers engaged in related-party transactions, it was imperative to review the current business model, allocation of risks, and cost reimbursement or sharing arrangements.

Because of this, taxpayers who are engaged in related party transactions (RPTs) were taken aback when Revenue Regulations (RR) 19-2020 were issued. RR 19-2020 requires the submission of BIR Form 1709 (or the RPT Form) and supporting documents which include contemporaneous transfer pricing documentation (TPD). Taxpayer concerns include the cost, logistics and manpower required to prepare the RPT Form and supporting documents.

However, taxpayers required to file the RPT Form and to prepare TPDs were provided some relief when Revenue Regulations 34-2020 were issued. The RR streamlined the guidelines and procedures for submitting the RPT Form and TPD, helping narrow the scope in determining the taxpayers who are mandated to prepare the RPT Form and TPD.

As opposed to previous regulations, the new regulations limited the requirement for preparing and submitting the RPT Form only to selected taxpayers. These include: (a) large taxpayers, or those who have been officially classified and notified to be as such by the BIR; (b) taxpayers enjoying tax incentives, such as an income tax holiday and a preferential income tax rate; (c) taxpayers incurring net operating losses for three consecutive years, including the current year; and (d) taxpayers who are engaged in RPTs with taxpayers falling under the first three classifications.

Earlier regulations have stated that the RPT Form aims to effectively implement Philippine Accounting Standards 24 on the disclosure of RPTs. Given this objective, all RPTs, regardless of amount and volume, were required to be disclosed in the RPT Form.

However, the new regulations now exclude payments of compensation and benefits to key management personnel (KMP) among the RPTs to be reported. Dividends and branch profit remittances have also been excluded from the reportable RPTs. Moreover, KMPs are no longer required to submit the RPT Form.

The new 1709 Form requires taxpayers to confirm if they prepared TPD in the format prescribed under the TP regulations.

The previous regulations provide for the simultaneous submission of the RPT Form and TPD. Under the new regulations, only the taxpayers who are required to file the RPT Form and who meet certain materiality thresholds are mandated to prepare TPD. These thresholds include:

• Annual gross sales revenue for the subject taxable period in excess of P150,000,000.00 and the total amount of RPTs with foreign and domestic related parties in excess of P90,000,000.00. In this particular instance, both thresholds must have been breached;

• RPT involving sale of tangible goods in the aggregate amount exceeding P60,000,000.00 within the taxable year; and

• RPT involving service transaction, payment of interest, utilization of intangible goods or other RPTs in the aggregate amount exceeding P15,000,000.00 within the taxable year.

When required to prepare TPD during the immediately preceding taxpayer year for exceeding the given thresholds, a taxpayer shall also be required to prepare a TPD for the current year.

Although mandated to prepare a TPD, taxpayers who are covered by the TPD requirement are now required to submit their TPD within 30 calendar days from receiving a request from the BIR Commissioner or his duly authorized representatives, subject to a non-extendible period of 30 calendar days based on meritorious grounds.

While only a selected group of taxpayers is now required to prepare and file the RPT Form, a question arises on whether there is still a need to prepare a TPD for those who do not meet such thresholds.

To answer this question, we have to consider the legal basis of all the TP-related issuances: Section 50 of the Tax Code, granting the Commissioner the power to distribute or allocate income and expenses from intercompany transactions to clearly reflect the income of the related parties.

Such power, if exercised by the Commissioner, does not make a distinction on the taxpayers who can be subject to the redistribution of income or reallocation of expenses. Thus, there still appears to be a requirement to ensure that intercompany transactions clearly reflect the income of related parties. This requirement can be satisfied by providing a justification, whether in the form of a TPD or any alternative documentation, that RPTs have been entered on an arm’s length basis.

We also have to consider that financial reporting standards have evolved through the years. Under current accounting standards, all taxpayers are required to disclose in their financial statements, their assumptions and estimates in determining uncertain tax treatment. With respect to RPTs, it is still prudent to have a contemporaneous TPD or any alternative documentation which supports the basis for intercompany pricing policies. Maintaining a contemporaneous TPD or any alternative documentation therefore minimizes, if not eliminates, uncertain tax positions that have to be disclosed in the financial statements.

Thus, taxpayers who do not meet the materiality thresholds and are therefore not required to prepare and submit a TPD should still ensure that there is some justification, whether through a TPD or otherwise, that their transfer pricing practices are conducted on an arm’s length basis.

Without such justification, a taxpayer faces the possibility that the basis of its pricing policies for its RPTs may be questioned by the BIR during an audit. A possible TP adjustment may be issued, resulting in a deficiency tax assessment against the taxpayer.

In addition, the lack of justification may lead regulators to question the reasonableness of the company’s tax position as reflected in its financial statements due to the uncertain tax position of its pricing practices with its related parties.

Concerned taxpayers should immediately focus on complying with the minimum requirements of preparing and submitting their RPT Form on time. It should be emphasized that no further extension on the submission of the RPT Form has been provided in RR 34-2020.

After submitting their RPT Forms, taxpayers should proceed to collate copies of the agreements and other proof of transactions, proof of withholding and remittance of consequent taxes as well as TPD.

Since tax examination usually begins with the BIR’s review of tax returns and financial statements, taxpayers should ensure the consistency of figures disclosed in the financial statements and RPT Form. The nature, transaction and outstanding balances should be updated to align with supporting documents. If the taxpayer is not mandated to submit Form 1709 and prepare a TPD, such must also be disclosed in the financial statements.

It is hoped that narrowing transfer pricing reporting to select taxpayers will further encourage compliance. This is particularly key since the taxable year 2020 is the first compliance period, and the objective of the requirement to submit the RPT Form is to improve and strengthen the BIR’s transfer pricing risk assessment and audit.

By this time, taxpayers should hav already been discussing the appropriate disclosures in their financial statements, finalizing the details to be disclosed in the RPT Form, and preparing the supporting documents, including the TPD.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.


Auresana B. Ines is a Tax Senior Manager of SGV & Co.

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