Transfer Pricing Guidelines

7/25/2019 Transfer Pricing Guidelines

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The New Transfer

Pricing Regulations

www.pwc.com


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TP in the Philippines In-depth look at the New TP Regulations

Key provisions of the TP Regulations

Requirements under the TP Regulations

What now?

How to set and test TP policies

Managing BIR TP audits

Best practices and pitfalls

Top i c Ou t l i n e

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14 March 2013The New Transfer Pricing Regulations


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TP i n t h e Ph i l i p p i n es

Philippine Tax Code

OECD, US Regulations, UN Manual

Philippine TP Cases

Philippine Revenue Issuances

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Ph i l i p p i n e TP l aw

Section 50. Allocation of Income and Deductions.

In the case of two or more organizations, trades or businesses(whether or not incorporated and whether or not organized in thePhilippines) owned or controlled directly or indirectly by thesame interests, the Commissioner is authorized to distribute,apportion, or allocate gross income or deductionsbetween oramong such organizations, trade or business, if he determines that suchdistribution, apportionment, or allocation is necessary in order toprevent evasion of taxes or clearly to reflect the income of any

such organizations, trades, or businesses.( Ta x Cod e, as am en d ed )


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Organisation for Economic Cooperation and Development(OECD) Transfer Pricing Guidelines

Originally issued in 1979; updated in 1995 and 2010; evolving

A r m s L en g t h Pr i n ci p l e

Transfer pricing methods

Ph i l i p p i n e TP r u l es


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O th er sou r ces/ b a si s

US

Section 482, Internal Revenue Code of 1986, as amended, provides:

- the Secretary of Treasury with the power to make allocationsnecessary to prevent evasion of taxes or to clearly reflect income;

- in respect of IP transactions, the income on the transfer or license

should be commensurate to the income attributable to theintangible

APA program to be more efficient and prompt in reviewing andconcluding APA requests

UN

TP Manual recently issued and approved (October 2012)


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Ph i l i p p i n e TP cases

CIR vs. Cyanamid Philippines, Inc. (CA, 04 February 1999)

Involves use of a third party comparable by the BIR on alleged similarity ofingredient.

BIR Allegation:

Aurofacvs. PfizersVigofac both contain an antibiotic/penicillin Minocyclinevs. Pfizers Doxycycline both antibiotics (for bacterial

infections)Courts Ruling:

The drugs are different as to:

Use - Aurofac to cure animal diseases while Vigofac is a growthpromotant.

Manufacturing process - Minocycline takes 5 steps and uses lessraw materials while Doxycycline takes 3 steps and uses readily

available raw materials.

M a i n so u r ces

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Avon Products Mfg., Inc. vs. CIR (CTA, 20 January 2005)

Involves comparison of sale to local affiliate with exportation to foreign

affiliate.

BIR Allegation:

Taxpayer underdeclared export sales as sales of its products to foreignaffiliates were lower in price vs. its sales to a local affiliate.

Courts Ruling:Lower price justified because of difference in the market. Best pricegets the business.

M a i n so u r ces

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ING Barings Securities Philippines, Inc. vs. CIR(CTA, 14 January 2005)

Involves comparison of price of services to third parties vs. service to affiliate

BIR Allegation:

Additional commission income should be imputed because price given to itsforeign affiliate is not at par with its other foreign clients.

Courts Ruling:

Not comparable because foreign affiliate performs other duties for theManila office in terms of marketing, research and execution of transactions.

M a i n so u r ces

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CIR vs. Filinvest Development Corp.

(Supreme Court, 19 July 2011)

Courts Ruling:

BIRs power to allocate gross income does not include the power toimpute theoretical interest. There must be actual or, at the very least,probable receipt or realization by the taxpayer of the income that is beingallocated.


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Ph i l i p p i n e TP Adm i n i st r a t i v e I ssu a n ces

Previously

Section 179 of Revenue Regulations (RR) No. 2 (Income Tax

Regulations 1940) Revenue Audit Memorandum Order (RAMO) No. 1-98 (Audit

Guidelines and Procedures in the Examination of InterrelatedGroup of Companies)

Revenue Memorandum Order (RMO) No. 63-99 (Determination ofTaxable Income on Intercompany Loans or Advances)

BIR formally adopted the OECD Guidelines in resolving transfer

pricing issues through RMC No. 26-08 (Interim Transfer PricingGuidelines)

U n t i l


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The N ew T r a n sf er Pr i c i n g Gu i d el i n es

Objectives and Scope

Key Terms, Provisions

Application of Arms Length Principle

TP Methods

TP Documentation

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Reven u e Regu l a t i o n s (RR ) N o . 2 -20 13

T r a n sf er Pr i c i n g Gu i d el i n es

23 January 2013

Effective: 9 February 2013

Th e N ew TP Gu i d el i n es RR 2 -2013

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Ob j ect i v es a n d scop e

Implement the authority of the Commissioner

- to review controlled transactions among associated enterprises

- to allocate or distribute their income and deductions in order todetermine the appropriate revenues and taxable income of theassociated enterprises involved in controlled transactions;

Prescribe guidelines in determining the appropriate revenues andtaxable income of the parties; and

Require the maintenance or safekeeping of TP documentation


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Som e K ey T er m s

Comparable uncontrolled transaction A comparable uncontrolledtransaction is a transaction between two independent parties that is

comparable to the controlled transactions under examination. Can be internalcomparable or external comparable.

Control refers to any kind of control, direct or indirect, whether or not

legally enforceable, and however exercisable or exercised.

Independent enterprises or parties two enterprises are independententerprises with respect to each other if they are not associated enterprises


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Advance Pricing Arrangements (APA) -Agreement entered intobetween the taxpayer and the BIR to determine in advance anappropriate set of criteria to ascertain the transfer prices of controlled

transactions over a fixed period of time

Unilateral APA, or Bilateral/Multilateral APA

Not mandatory, but may reduce the risk of TP reexamination and

double taxation

Separate guidelines will be issued

Mutual Agreement Procedure (MAP)

As per Article 25 of the OECD Model Tax Convention

Separate guidelines will be issued

Som e K ey Fea t u r es


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A r m s l en g t h p r i n ci p l e

Paragraph 1 of Article 9 (Associated Enterprises) of the OECD ModelTax Convention on Income and Capital authoritative statement of thearms length principle

Paragraph 2 of Article 7 (Business Profits) provides that whenattributing profits to a PE, the PE should be considered as a distinctand separate enterprise engaged in the same or similar activities and

under the same or similar conditions application of the arms lengthprinciple

Requires the transaction with a related party to be madeunder comparable conditions and circumstances as a

transaction with an independent party


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App l i ca t i o n o f a r m s l en g t h p r i n ci p l e

ComparabilityAnalysis

Identify the

tested party andthe appropriateTP method

Determine thearms lengthresults

3-step approach:


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Comp a r a b i l i t y

Comparability

Analysis

Comparison of prices or margins obtained by related parties withthose adopted by independent parties engaged in similar transactions

All economically relevant characteristics of the situations comparedshould be similar so that:

- None of the differences can materially affect prices or margins

- Adjustments can be made to eliminate the effects of differences

Factors Affecting Comparability

1. Characteristics of Goods, Services or Intangible Properties2. Analysis of Functions, Risks and Assets3. Commercial and Economic Circumstances


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Fa ct o r s A f f ect i n g Com pa r a b i l i t y

Comparability

Analysis

1. Characteristics of Goods, Services or Intangible Properties

Specific characteristics are important in determining values in theopen market

Include, among others: (for goods) physical features, quality and

reliability, availability and volume of supply (in case of transfer ofgoods); (for services) nature and extent of services; (for IP) form oftransaction, type, duration and degree of protection, and anticipatedbenefits.


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Comparability

Analysis

2. Analysis of Functions, Risks and Assets

Economics dictate that level of return should be directly correlated tofunctions performed, assets owned, and risks assumed

Crucial step is to identify the economically significant functions, risksand assets, of a related party, with that of independent companies

But not all, only those significant in determining the value of thetransactions/margins


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Comparability

Analysis

3. Commercial and Economic Circumstances

The markets and economic conditions in which the entitiesoperate/where the transactions are undertaken should likewise becomparable

Government policies and regulations may also have an impact

Business strategies


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Tested Party and

TP Method

Tested party: entity in which a transfer pricing method can be most

reliably applied to, and from which the most reliable comparables canbe found.

BIR requires su f f i c i en t and v er i f i a b l e i n f o r m a t i o n on such

entity.


D et er m i n a t i o n o f t h e Test ed Pa r t y


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Aimed at finding the most appropriate and reasonable method for a

particular case

No specific preference for any one method

Should produce the most reliable results, taking into account the

quality of available data and degree of accuracy of adjustments In all cases, the taxpayers should be able to explain why a specific

TPM was selected

Tested Party and

TP Method


Sel ect i o n a n d App l i ca t i o n o f t h e TP M et h o d s ( TPM )


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Tested Party and

TP Method

Comparable Uncontrolled Price

Resale Price

Cost Plus

Profit Split

Transactional Net Margin


TP M et h o d s


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Manufacturer Co.

Sales to Distributor Co. 100 (transfer price)

Less: manufacturing costs (50)Gross profit 50Less Operating expenses (30)Net Profit 20

Distributor Co.

Sales to third parties 200Less: Purchases from Manufacturer Co. (100)Gross Profit 100Less Operating expenses (40)Net Profit 60

Tested Party and

TP Method


App l i ca t i o n o f TP M et h o d s


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Com pa r a b l e U n co n t r o l l ed P r i ce (CU P)

Manufacturer Co.Sales to Distributor Co. 100* (transfer price)xxx

Distributor Co.

Sales to third parties 200Less Purchases from Manufacturer Co. (100)

*In CUP- issue is the price adopted between manufacturer anddistributor, which is 100

Tested Party and

TP Method


TP M et h o d s


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CU P

Compares theprice charged for property or services transferred in a

controlled transaction to the price charged for property or servicestransferred in a comparable uncontrolled transaction in comparablecircumstances.

A reliable method where an independent enterprise sells or buys the

same product or service as that sold between the two related partiesconcerned.

Most suitable for evaluating transactions involving products/services

with very similar characteristics (in terms of type, physical features,quality and quantity transacted, etc) and undertaken in similarmarket or economic conditions, such as widely traded commodities.

Tested Party and

TP Method


TP M et h o d s


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CU P

Standard of comparability under the CUP Method is very high

A comparability analysis under the CUP method shall take intoaccount the following, among others:

- Product characteristics such as physical features and quality;

- The nature and extent of such services provided;- Whether the goods sold are compared at the same points in thesupply or production chain;

- Product differentiation in the form of patented features such as

trademarks, design, etc.;- Volume of sales;- Timing of sale

Tested Party and

TP Method


TP M et h o d s


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Resa l e Pr i c e M et h od (R PM )

Manufacturer Co.

Sales to Distributor Co. 100 (transfer price)Less: manufacturing costs (50)Gross profit 50

Distributor Co.Sales to third parties 200Less: Purchases from Manufacturer Co. (100)Gross Profit 100*

*In Resale Price- issue is the gross margin of 50% obtained byDistributor Co. (100/200)

Tested Party and

TP Method


TP M et h o d s


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RPM

Evaluates the arm's length character of a controlled transaction by

reference to the gross profit margin realized in comparableuncontrolled transactions

Most useful where it is applied to operations that do not addsignificant value to the goods or services in which they deal e.g.

distributors

As gross profit margins represent the gross compensation (after costof sales) for specific functions performed, assets used and risksassumed, product differences are less critical than under the CUPmethod.

Tested Party and

TP Method


TP M et h o d s


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Cost P l u s M et h od (CPM )

Manufacturer Co.

Sales to Distributor Co. 100 (transfer price)Less: manufacturing costs (50)Gross profit 50*Less Operating expenses (30)

Net Profit 20

*In Cost Plus- issue is the gross margin of 100% obtained by

Manufacturer Co. [(100-50) / 50]

Tested Party and

TP Method


TP M et h o d s


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Cost P l u s M et h od (CPM )

Focuses on the gross mark-up obtained by a supplier who transfersproperty or provides services to a related purchaser;

This method attempts to value the functions performed by thesupplier of the property or services;

Most useful where semi-finished goods are sold between relatedparties or where the related party transaction involves the provisionof services;

Tested Party and

TP Method


TP M et h o d s


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CPM

The starting point in a cost plus method is the cost incurred by the

supplier of property or services in a controlled transaction forproperty transferred or services provided to a related purchaser;

An appropriate mark-up is added to this cost to find the price that thesupplier should be charging the buyer;

The cost base used in determining costs and the accounting policiesshould be consistent and comparable between the controlled anduncontrolled transaction;

The costs referred to in the cost plus method are the aggregation ofdirect and indirect costs of production.

Tested Party and

TP Method


TP M et h o d s


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Resale price method

Reseller

Thirdparty

Supplier

Transferprice

Arms LengthSales

Arms LengthCosts

Cost plus method

Value functions performed byreference to gross margins


TP M et h o d s


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(Check: Resale Price Margin = $100 - $ 80 = 20%)

$ 100

Determined fromcomparable

company

Example of resale price method:

Sale price to third parties $100

Resale price margin 20%

Arms length price = $100 - ($100 x 20%)

= $ 80

Tested Party and

TP Method


TP M et h o d s


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(Check: Cost plus mark-up = $110 - $100 = 10%)$100

Determined fromcomparable

company

Example of cost plus method:

Services costs $100

Cost plus mark-up 10%

Arms length price = $100 + ($100 x 10%)

= $110

Tested Party and

TP Method


TP M et h o d s


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Pr o f i t Sp l i t M et h o d

Manufacturer Co.

Sales to Distributor Co. 100 (transfer price)Less: manufacturing costs (50)Gross profit 50

Distributor Co.

Sales to third parties 200

*In Profit Split- the combined gross profit of 150 (200 sales less 50

manufacturing costs) is to be split on the basis of the relativecontribution of each member to the gross profit / basis of the valueof the contribution of each member

Tested Party and

TP Method


TP M et h o d s


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Seeks to establish a price for a controlled transaction by determining

the division of profits that independent enterprises would have expectedto realize

Applicable where transactions are very interrelated

- Provides an alternative in cases where no comparable transactions between

independent parties can be identified, such as when transactions are veryinterrelated that they cannot be evaluated separately

The method is based on the concept that profits earned in a controlledtransaction should be equitably divided among related parties involvedin the transaction(s) on an economically valid basis.

Tested Party and

TP Method


TP M et h o d s


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Approaches in the allocation of profit or loss:1)Residual Profit Split Approach

use other method to establish returns for basic functions

Split residual between parties

2) Contribution Profit Split Approach

Split profit between parties

Tested Party and

TP Method


TP M et h o d s


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T r a n sa ct i on a l N et M a r g i n M et h od ( TNM M )

Manufacturer Co.

Sales to Distributor Co. 100 (transfer price)Less: manufacturing costs (50)Gross profit 50 ROC= _20__ = 25%Less: Operating expenses (30) (50+30)Net Profit 20

Distributor Co.

Sales to third parties 200Less: Purchases from Manufacturer Co. (100) ROS= _60_ = 30%

Gross Profit 100 200Less Operating expenses (40)Net Profit 60

Tested Party andTP Method


TP M et h o d s


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T N MM

Examines the net profit margin relative to an appropriate base (i.e.

costs, sales, or assets) attained by the member of a group ofcontrolled taxpayers from a controlled transaction

Similar principle to RPM and CPM just uses later point in incomestatement

Tends to be used frequently in practice, because of informationconstraints on the use of the other methods

TNMM is usually appropriate to use when the gross profit of thebusiness is not easy to determine such that either the cost-plus

method, or the resale price method, cannot be used.



TP M et h o d s


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TNMM Selection of Pr o f i t L ev el I n d i ca t o r ( PL I )

PLI measures the relationship between profits and sales, costs

incurred or assets employed

Right choice of a PLI ensures better accuracy in the determination ofthe arms length price of a controlled transactions

Presented in the form of a generally recognized or utilized financialratio

- Return on Costs

- Return on Sales- Return on Capital Employed



TP M et h o d s


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Com p a r a b i l i t y A d j u st m en t s :

Intended to eliminate the effects of differences that may existbetween situations being compared and that which could materially

affect the conditions being examined in the methodology.

Not to correct differences that have no material effect on thecomparison

Neither routine nor mandatory

ARM S L ENGTH RESU L TS:

Could be a specific figure or ratio (e.g., price or margin), or a range ofratios, provided comparables are reliable



Determine thearms length

results

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NOTE:

If controlled transaction is within the arms length range noadjustment needed

If the relevant condition of the controlled transaction falls outsidethe arms length range asserted by the BIR, the taxpayer should present

proof/substantiation that : the conditions of the controlled transaction satisfy the arms

length principle, and

the result falls within the arms length range (i.e., arms lengthrange is different from the one asserted by the BIR)


A r m s l en g t h r esu l t s


Determine thearms length

results

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TP D o cum en t a t i o n

Purposes of maintaining TP documentation:

Defend taxpayers transfer pricing analysis;

Prevent transfer pricing adjustments arising from taxexaminations; and

Support taxpayers application for MAP

TP documentation generally demonstrates compliancewith thearms length principle

All TP transactions regardless of the amount involved, must beproperly documented


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G 2 2013


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Contemporaneous requirement it exists or brought into existenceat the time the taxpayer develops or implements any intercompanyarrangement, or reviews these arrangements when preparing tax returns

TP documents should be submitted to the BIR when required orrequested to do so

Retention Period TP documents must be retained within theretention period under the Tax Code (i.e., 3 years, under Section 235)

No TP-specific penalties on non-compliance of therequirement/provisions in the TP Guidelines


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Th N TP G id l i RR 2 2013


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Documentation Details

Organizational Structure

Nature of the business/industry and market conditions

Controlled transactions

Assumptions, strategies, policies

Cost contribution arrangements (CCA) no further discussion under thenew TP regulations

Comparability, functional and risk analysis

Selection of transfer pricing method

Application of the transfer pricing method

Background documents

Index to documents


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W h a t n ow ?

How to set and test TP policies

Managing audits

Best practices and pitfalls

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H t t d t t TP l i i


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TP L i f e Cy cl e

1) Planning / Price Setting

TP policies, agreements planning

Negotiations

2) Implementation

Ensure that implementation is compliant with agreements/policies

3) Review and Testing

2 different methodologies may be used

4) Price Setting

Go back to price setting

H ow t o set a n d t est TP po l i ci es

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H t t d t t TP l i i


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B e n c hm a r k i n g

Consists of a search for comparable companies/transactions, toprovide a range of profits/prices against which the tested partyprofit/prices are benchmarked.

Information sourced from publicly-available sources

Interquartile range is generally accepted by the tax authorities inpractice

Local comparables are strongly preferred Advisable for comparable company sets to be updated at least once

every two years to reflect the most recent available data.

H ow t o set a n d t est TP po l i ci es

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M a n a g i n g B I R a u d i t s


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TP I n v est i g a t i o n s

Documentation file

First line of defense which can save company money and strengthenrelationship with BIR

A regular audit may include TP even if this is not explicitly stated inthe letter

Questions regarding the level of intercompany trade, trading terms,historic profit trends/level of sales, royalties, management servicesprovided/received

Transfer pricing adjustments are huge!

TP person

Centralized information relayed to identified persons

M a n a g i n g B I R a u d i t s

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Best p r a ct i ces an d p i t f a l l s


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W h a t el se?

Documentation and safekeeping

Updates when needed

Document changes in operations, terms, agreements, policiesWeigh risks and rewards

Reliance on group TP does not always cut it

Sync documentation and practice Sometimes implementation is different from policy

TP processes covered

Negotiations, discussions, practice, implementation documented


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Documentation may include any and all evidence of the reasonablenessof determined transfer price/policy:

Related Party Agreements

TP policy

Invoices

Cost Structure (i.e., basis, etc.)

Benchmarking of arms length profits/margins

Internal Memo

Global/Local TP Report


W h a t el se?

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2013 Isla Lipana & Co. All rights reserved. In this document, PwC refers to Isla Lipana &

Documents

Transfer Pricing Guidelines