B-BTAX313

Module 6
Related party transactions and
transfer pricing
Accountancy Department
College of Business Administration and Accountancy
De La Salle University - Dasmariñas
 Table of Contents

• TP-related tax provisions and BIR issuances – Slides 4 to 29

• Penalties for Non-Compliance – Slide 30
• How to Mitigate Transfer Pricing Assessment Risk – Slide 31
 Course and Topic Learning Outcome/s

CLO1. Explain the principles and requirements related to Philippine corporate taxes.
CLO2: Understand the common tax management issues in a corporate setting and
identify the related tax risks.
CLO4. Formulate recommendations on how to mitigate tax risks or take advantage of
opportunities for tax savings and recovery.

TLO4. Identification of tax risks associated with transactions between related parties
and transfer pricing, and formulation of recommendations on mitigating such risks
 Transfer pricing or “TP” defined
• TP is generally defined as the pricing of cross-border, intra-firm transactions
between related parties or associated enterprises.
• Typically, a transfer price occurs between a taxpayer of a country with high income
taxes and a related or associated enterprise of a country with low income taxes. In
the Philippines, "intra-firm/inter-related" transactions account for a substantial
portion of the transfer of goods and services, however, the revenue collection from
related-party groups continue to go on a downtrend.
• The revenues lost from intra-related transactions can be attributed to the fact that
related companies are more interested in their net income as a whole (rather than as
individual corporations), as such there is a desire to minimize tax payments by taking
advantage of the loopholes in our tax system.
 Transfer pricing or “TP” defined
• While TP issue typically occurs in cross-border transactions, it can also occur in
domestic transactions. One context where TP issue occurs domestically is where one
associated enterprise, entitled to income tax exemptions, is being used to allocate
income away from a company subject to regular income taxes.
• In the Philippines, there is a domestic TP issue when income are shifted in favor of a
related company with special tax privileges such as Board of Investments or “BOI”
Incentives and Philippine Economic Zone Authority or “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.
 Authority of the Commissioner to Allocate
Income and Deductions
• Pursuant to Section 50 of the Tax Code, the Commissioner is authorized to distribute,
apportion or allocate gross income or deductions between or among two or more
organizations, trades or businesses (whether or not incorporated and whether or not
organized in the Philippines) owned or controlled directly or indirectly by the same
interests, if he determines that such distribution, apportionment or allocation is
necessary in order to clearly reflect the income of any such organization, trade or
business.
• Thus, the Commissioner is authorized to make TP adjustments, in line with the
purpose of Section 50 to ensure that taxpayers clearly reflect income attributable to
controlled transactions and to prevent the avoidance of taxes with respect to such
transactions.
 TP-related BIR issuances

• Revenue Memorandum Circular or “RMC” No. 026-08 dated

March 24, 2008 – Revision of final draft of Revenue Regulations
on TP and BIR’s subscription to the OECD TP Guidelines.
 TP-related BIR issuances

• Revenue Regulations or “RR” No. 02-13 dated January 23, 2013, also
known as the “Philippine TP Guidelines” or “TP Regs” – Seek to
provide guidelines in applying the arm’s length principle or “ALP” for
cross-border and domestic transactions between associated enterprises.
These guidelines are largely based on the arm’s length methodologies as
set out under the Organisation for Economic Cooperation and
Development or “OECD” TP Guidelines.
 Arm’s Length Principle or “ALP”

• The TP Regs expressly adopts the ALP, which is the internationally accepted
standard for determining the appropriate transfer prices of controlled
transactions of associated enterprises. The principle requires that a transaction
with a related party should be made under comparable conditions and
circumstances as a transaction with an independent party. Essentially, a
taxpayer’s income from a related party transaction must be equivalent to what
would be earned by a similarly situated taxpayer from a transaction with a
third party.
 Arm’s Length Principle or “ALP”
• In the application of the ALP, the TP Regs provides for a three-step approach,
namely:
1. Conduct a comparability analysis
2. Identify the tested party and the appropriate TP method; and
3. Determine the arm’s length result.
• The regulations adopt the OECD ALP 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 arm’s 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.
 TP Documentation requirement
• The TP Regs explicitly requires taxpayers to maintain and keep adequate and specific TP
documentation to demonstrate that their transfer prices are consistent with the ALP. More importantly,
the documentation must be contemporaneous, i.e., they must exist or are brought into existence at the
time the associated enterprises develop or implement any arrangement that might raise TP issues or
review these arrangements when preparing tax returns.
• The information or details that should be included in the documentation are, but not limited to, the
following:
 Organizational structure
 Nature of the business/industry and market conditions
 Controlled transactions
 Assumptions, strategies, policies
 Cost Contribution Arrangements
 Comparability, functional and risk analysis
 Selection of the TP method
 Application of the TP method
 Background documents
 Index to Documents
 TP Documentation requirement
• While TP documentation does not have to be submitted with the tax returns,
these must be retained by taxpayers and submitted to the BIR when required
or requested to do so. Moreover, they must be retained and preserved within
the period specifically provided in the Tax Code as the retention period,
which is three years from the filing of the Annual Income Tax Return. It will,
however, be to the best interests of the taxpayer to maintain documentation
for purposes of the Mutual Agreement Procedure or “MAP” and possible TP
examination.
• The TP Regs do not have a safe harbor provision that would exempt taxpayers
with insignificant related party transactions from the documentation
requirements. Hence, the documentation requirements prescribed above
would seem to apply to all taxpayers involved in controlled or related party
transactions.
 Advance Pricing Arrangement or “APA”

• Another feature is the opportunity for an APA, which is an agreement entered

into between the taxpayer and the BIR to determine in advance an appropriate
set of criteria (e.g., TP method and comparables set to be used) to ascertain
the transfer prices of controlled transactions over a fixed period of time.
• The purpose of an APA is to reduce the risk of TP examination and double
taxation. The APA may either be unilateral (an agreement between the
taxpayer and the BIR), or Bilateral/Multilateral (an agreement among the
taxpayer, the BIR and one or more countries, and is authorized under the
MAP Article of Philippine tax treaties). The APA is not a mandatory
requirement; it can be undertaken by a taxpayer on a voluntary basis. The BIR
will issue separate guidelines on the application of APA and MAP processes.
 TP-related BIR issuances

• Revenue Audit Memorandum Order or “RAMO” No. 001-19

dated August 20, 2019, also known as the “TP Audit Guidelines” –
Provides a framework and guide for TP examinations, specifically
in the conduct of audit of taxpayers with related party and/or intra-
firm transactions.
• Every TP issue is unique, and teams should exercise their
judgement on how to best apply these guidelines.
Salient features of the TP Audit Guidelines
• The TP Audit Guidelines apply to the examination of the following transactions:
o Controlled transactions between related/associated parties, where at least one
party is assessable or chargeable to tax in the Philippines. These include, among
others:
 Sale, purchase, transfer and utilization of tangible and intangible assets
 Provision of intra-group services
 Interest payments
 Capitalization
o Transactions between permanent establishment (PE) and its head office or
other related branches. Under the Guidelines, the PE will be treated as a
separate and distinct enterprise from its head office or other related
branches/subsidiaries for tax purposes.
Salient features of the TP Audit Guidelines
• The TP Audit Guidelines were issued primarily to test the application of ALP
on related party transactions. Related party transactions to be tested/audited
cover cross-border and domestic, including intra-firm transactions. Intra-firm
transactions apply to taxpayers with different tax regimes (ITH, 5% GIT,
regular corporate tax).
• The test of application of the ALP is performed by applying the TOP method
which is the most appropriate to the facts and conditions. The TP methods are
consistent with the methods identified in the Philippine TP Guidelines.
• The TP audit shall also cover business restructuring within a multinational
group, intra-group services, intangible asset transactions, cost contribution
arrangements as well as interest payment transactions.
Salient features of the TP Audit Guidelines
• In the conduct of TP audit, the BIR will be examining several documents such as the
taxpayer’s TP policy and TP documentation. The BIR will also require the taxpayer to submit
within five (5) working days from receipt of notice, various information/proofs, in prescribed
formats, on the following:
o Related Party Transactions
o Segmented Financial Statements
o Supply Chain Management Analysis
o Function, Assets and Risks Analysis or “FAR” Analysis
o Characteristics of Business and
o Comparability Analysis.
• Where the revenue officer has found that a price in a controlled transaction is not at arms’
length, he may make an adjustment to reflect the arm’s length price or interest rate for that
transaction by substituting or imputing the price, or interest, as the case may be.
 TP-related BIR Issuances
• RR No. 19-2020 dated July 8, 2020 and effective July 25, 2020 - Requiring the
submission of a 3-page Information Return on Related Party Transactions (Domestic
and/or Foreign) or BIR Form No. 1709 or “RPT Form”, replacing BIR Form No.
1702H – Information Return on Transactions with Related Foreign Persons, series of
1992, to be attached, together with its supporting documents, to the Annual Income
Tax Return.
• RMC No. 076-20 dated July 29, 2020 – Clarifies Certain Issues on the Filing of BIR
Form No. 1709 and its Attachments
• RMC No. 098-20 dated September 15, 2020 – Clarifying the Submission of BIR
Form No. 1709 and its Attachments (Extended deadlines due to the continuing
adverse impacts of COVID-19 pandemic)
RR 19-2020 Guidelines and Procedures
• Taxpayers, with RPTs, whether international or domestic, and who may either be a
reporting entity or a related party, are required accomplish and submit BIR Form No.
1709 as an attachment and integral part of the Income Tax Returns (ITRs) for the
current taxable year and subsequent years.
• The nature of transaction and the accounts affected shall be described in detail.
• The "business overview of the ultimate parent company" referred to in Part IV(A) of
BIR Form No. 1709 shall include the profile of the multinational group of which the
taxpayer belongs, along with the name, address, legal status and country of tax
residence of each of the related parties with whom intra-group transactions have
been entered into by the taxpayer, and ownership linkages among them.
• On the other hand, the "functional profile" referred to in Part IV(B) of BIR Form No.
1709 shall include a broad description of the business of the taxpayer and the
industry in which it operates, and of the business of the related parties with whom
the taxpayer has transacted;
RR 19-2020 Guidelines and Procedures
• No spaces shall be left unanswered. If one or some portions are not applicable, such
fact shall be so stated. The nature of transaction and the accounts affected shall be
described in detail.
• The required disclosures on transactions and outstanding balances shall be made
separately for each of the following categories:
i. the parent;
ii. entities with joint control or significant influence over the entity;
iii. subsidiaries;
iv. associates;
v. joint ventures in which the entity is a joint venturer;
vi. key management personnel of the entity or its parent; and
vii.other related parties.
 RR 19-2020 Guidelines and Procedures

• For each of said category, the following information shall be provided:

i. the amount of the transactions;
ii. the amount of outstanding balances, including commitments, and their terms
and conditions, including whether they are secured, and the nature of the
consideration to be provided in settlement, and details of any guarantees given
or received;
iii. provisions for doubtful debts related to the amount of outstanding balances;
iv. the expense recognized during the period in respect of bad or doubtful debts
due from related parties.
 RR 19-2020 Guidelines and Procedures
• The following are the required attachments to BIR Form No. 1709: the amount of the
transactions;
o certified true copy of the relevant contracts or proof of transaction;
o withholding tax returns and the corresponding proof of payment of taxes
withheld and remitted to the BIR;
o proof of payment of foreign taxes or ruling duly issued by the foreign tax
authority where the other party is a resident; and
o certified true copy of Advance Pricing Agreement, if any; and
o any TP documentation.
 RR 19-2020 Guidelines and Procedures
• RR No. 19-2020 provides definitions of relevant terms which were adopted from the
Philippine Accounting Standards (PAS) 24 Related Party Disclosures.
• The RR also provides for the rules in determining whether a person or entity is a
related party, whereby the substance of relationships between entities shall be taken
into account and not merely the legal form.
• Any violation of the provisions of this issuance shall be subject to penalties provided
in Section 250 and other pertinent provisions of the NIRC, as amended.
Related Parties and Related Party Transactions

In determining whether a person or entity is a related party, the following rules shall be
considered:
a) A person or a close member of that’s person’s family is related to a reporting
entity if that person:
i. has control or joint control of the reporting entity;
ii. has significant influence over the reporting entity; or
iii. is a member of the key management personnel of the reporting entity or of
a parent of the reporting entity
Related Parties and Related Party Transactions
b) An entity is related to a reporting entity if any of the following conditions
applies:
i. the entity and the reporting entity are members of the same group (which
means that each parent, subsidiary and fellow subsidiary is related to the
others.)
ii. One entity is an associate or joint venture of other entity (or an associate or
joint venture of a member of a group of which the other entity is a
member).
iii. Both entities are joint ventures of the same third party.
iv. One entity is a joint venture of a third party and the other entity is an
associate of the third party.
Related Parties and Related Party Transactions
v. The entity is a post-employment benefit plan for the benefit of employees
of either the reporting entity related to the reporting entity. If the reporting
entity is itself such a plan, the sponsoring employers are also related to the
reporting entity.
vi. The entity is controlled or jointly controlled by a person identified in (a).
vii. A person identified in (a)(i) has significant influence over the entity or is a
member of the key management personnel of the entity (or of a parent of
the entity).
viii.The entity, or any member of a group of which it is a part, provides key
management personnel services to the reporting entity or to the parent of
the reporting entity.
Related Parties and Related Party Transactions
Related party transactions shall include, but not limited, to the following:
a) purchases or sales of goods (finished or unfinished)
b) purchases or sales of property and other assets
c) rendering or receiving of services
d) leases
e) transfers of research and development
f) transfers under license agreements
g) transfers under finance arrangements (including loans and equity contributions in cash or in kind)
h) commitments to do something if a particular event occurs or does not occur in the future, including executory
contracts, i.e., contracts under which neither party has performed any of its obligations or both parties have
partially performed their obligations to an equal extent (recognized and unrecognized)
i) settlement of liabilities on behalf of the entity or by the entity on behalf of that related party
j) cost-sharing arrangements
k) Dividends and redemption of shares
Related Parties and Related Party Transactions
• The RPT Form is required to be attached only to the AITR. Since the law took effect
on July 25, 2020, the RPT Form is now required to be submitted as an attachment to
the AITR for fiscal year ended March 31, 2020, tentative or otherwise, irrespective
of the date of filing of said AITR, and to all AITRs to be submitted after such date.
• The RPT Form and its required attachments shall be filed manually unless there is
another revenue issuance mandating their filing electronically.
• All taxpayers with related party transactions are required to attach a TPD, local or
otherwise, regardless of the amount and volume of related party transactions. The
TPD should include the date of creation or preparation so as to ensure its
applicability to the RPTs conducted in the taxable year concerned.
Related Parties and Related Party Transactions
• What the BIR requires is the TPD prepared prior to or at the time of the transaction,
or after the transaction but not later than the date of filing of the tax return for the
fiscal/calendar year in which the transaction takes place.
• If there are significant changes in the business model, the factors or conditions
considered in drafting the TPD, and the nature of the RPTs, then, the TPD has to be
updated. Otherwise, the old TP shall suffice.
• All contracts are required to be attached, regardless of volume. In lieu of hard copies
of the required documents, scanned copy of original documents may be submitted.
 Penalties for Non-Compliance
• In case of a deficiency income tax assessment arising from a TP adjustment, the penalties under the Tax
Code shall apply, such as the 25% (50% in fraud cases) surcharge and 12% interest per annum on the
basic deficiency tax due. There is no penalty relief provided in the regulations, unlike in other countries
where the penalty is reduced if TP documentation has been prepared by the taxpayer or the taxpayer
sought assistance in the preparation of documentation from an independent third party.
• A penalty of not less than ₱1,000 but not more than ₱25,000 shall be imposed for failure to file the RPT
Form and its attachments due to reasonable cause and not to willful neglect pursuant to Section 50 of
the Tax Code. In case of repetition of such offense, the maximum of the penalty, i.e., ₱25,000
prescribed therefor shall be imposed pursuant to Section 274 of the Tax Code.
• If, after receiving valid summons to produce the said attachments, the taxpayer still fails or neglects to
produce the same, the partner, president, general manager, branch manager, treasurer, officer-in-charge,
and the employees responsible for the violation shall, upon conviction, be punished by a fine of not less
than ₱5,000 but not more than ten thousand pesos ₱10,000 and suffer imprisonment of not less than one
(1) year but not more than two (2) years, pursuant to Section 266 of the Tax Code.
 How to Mitigate TP Assessment Risk
• Compliance or adherence to the TP-related BIR issuances is still the best way
to avoid TP issues in the event of a BIR examination.
• However, since TP studies and documentation are usually conducted by
external tax advisors, compliance with the TP guidelines would require
taxpayers to pay hefty professional fees.
• Taxpayers with high volume of related party transactions may streamline the
scope of TP study and documentation by prioritizing the transactions with
high risk of being questioned by the BIR to lessen the costs associated with
the said services in the short run.
• Perform internal assessments before proceeding with proposed transaction
with a related party.