TRANSFER PRICING RULES

IN THE PHILIPPINES
by: Atty. Edwin R. Abella, CPA, LLM

A Presentation at the National Tax

Congress
Crowne Plaza Galleria
October 17, 2014

Presentation Outline

Evolution of Transfer Pricing (TP) in

the Philippines

Survey of the New Transfer Pricing

Regulations (RR No. 2 2013)

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Key provisions of the TP Regulations

Transfer Pricing methodologies
What requirements to be observed
in compliance with the Regulations?
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Main sources of TP rules

1.

National Internal Revenue Code (NIRC)

2.

Philippine Transfer Pricing Cases

3.

Revenue Issuances

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Main Tax Code Provision

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 the Philippines) owned
or controlled directly or indirectly by the same
interests, the Commissioner is authorized to
distribute, apportion, or allocate gross income or
deductions between or among such organizations,
trade or business, if he determines that such
distribution,
apportionment,
or
allocation
is
necessary in order to prevent evasion of taxes or
clearly to reflect the income of any such
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Other Tax Code Provisions

Section 100 Transfer for Less than Adequate and
Full Consideration. The difference between the
fair market value and the consideration received
is deemed as a gift.
Section 106(E) Authority of the Commissioner to
Determine the Appropriate Tax Base where
the gross selling price is unreasonably lower than
the actual market value.
Section 130(B) - Determination of Gross Selling Price
of Goods Subject to Ad Valorem Tax. Price at the
level of the agents or other establishments
wholly or partly owned by the manufacturer. If
the price is less than the cost to manufacture and
sell, imputation of not less than 10% profit
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Phil. Transfer Pricing

Cases
CIR v. Cyanamid Philippines, Inc., 1999
Involves use of a third party comparable
alleged similarity of ingredient
BIRs Allegations:

due to

Taxpayers Aurofac is similar with Pfizers Vigofac

because both contain an antibiotic which is penicillin
used for animals.
2.
Taxpayers
Minocycline
is
simmilar
to
Pfizers
Doxycycline because both are tetracycline antibiotics
used to combat bacterial infections in the human body.
Ruling: The drugs are different as to the:
1.

Use Aurofac is a cure for animal diseases while Vigofac is

growth stimulant.
Production process Minocycline takes 5 steps and uses less raw
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materials while Doxycycline takes 3 steps and uses more raw
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materials.

Philippine TP Cases
Avon Products Manufacturing, Inc. v. CIR, 2005
Involves comparison of sale to local affiliate with
exportation to a foreign affiliate

BIR Position:
Taxpayer underdeclared export sales because
export price is lower than the price of the
local sale.

Ruling:
Lower export price is justified because of
difference in the market. Best price gets the
business.

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Philippine TP Cases
ING Barings Securities Philippines, Inc. v. CIR, 2005
Involves comparison of price of services to third
parties v. services rendered to an affiliate.

BIRs Position:
Additional commission income should be imputed
because price given to its foreign affiliate is not
at par with its other foreign clients.
Ruling:
Not comparable because the foreign affiliate
performs other duties for the Manila office in
terms of marketing, research and execution of
transactions.

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Previous Administrative Issuances

Sec. 179 of Revenue Regulations No. 2-40

Revenue Audit Memorandum Order (RAMO 1-98)

Audit Guidelines and Procedures in the Examination
of Iterrelated Group of Companies.

Revenue
Memorandum
Order
No.
63-99

Determination of Taxable Income on Intercompany

Loans or Advances.

Revenue Memorandum Circular No. 26-08 (Interim

Transfer Pricing Guidelines) BIR formally adopted
the OECD Guidelines in resolving transfer pricing
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issues.
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The new TP Guidelines

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Revenue Regulations (RR) No. 22013

Dated January 23, 2013
Effective: February 9, 2013
Adopts the OECD (Organization for
Economic
Cooperation
&
Development) Model
Implements Section 50, NIRC
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Objectives and scope

Implement the authority of the Commissioner:
To
review controlled transactions among
associated enterprises
To
allocate or distribute their income and
deductions in order to determine the
appropriate revenues and taxable income of
the associated enterprises involved in
controlled transactions

Prescribe guidelines in determining the appropriate

revenues and taxable income of the parties; and

Require the maintenance or safekeeping of TP

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documentation
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Key Terms under the TP Guidelines

Comparable transaction A transaction that is
comparable to the controlled transaction under
examination taking into consideration factors
such as the nature of the property or services
provided, functional analysis of the transactions
and parties, contractual terms, and economic
conditions.
Comparable uncontrolled transaction A
transaction between two independent parties
that is comparable to the controlled transactions
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under examination. Can be internal comparable
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Key Terms (continued)

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
independent
enterprises with respect to each other if
they are not associated enterprises.
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Some Key Features of Phil. TP

Advance
Pricing
arrangements
(APA)

Agreement entered into between the taxpayer and

the BIR to determine in advance an appropriate set of
criteria to ascertain the transfer prices of controlled
transactions over a fixed period of time.

Unilateral APA or Bilateral/Multirateral APA

Not mandatory but may reduce the risk of TP
reexamination and double taxation
Separate guidelines will be issued

Mutual Agreement Procedure (MAP)

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As per Article 25 of the OECD Model Tax Convention

Separate guidelines will be issued
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Basis of the TP Guidelines

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.
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Arms length principle

Paragraph 1, Article 9 (Associated Enterprises)

of the OECD Model Tax Convention on Income
and Capital authoritative statement of the
arms length principle.
Par. 2, Art. 7 (Business Profits) provides that
when attributing profits to a PE, the PE should
be considered as a distinct enterprise
engaged in the same or similar activities and
under the same or similar conditions
application of the arms length principle.

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Application of arms length

principle
3-step approach:

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Application of arms length

principle
Application of arms length principle
Comparability

Comparison of prices or margins obtained by related parties with

those adopted by independent parties engaged in similar
transactions

All economically relevant characteristics of the situations

compared should 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 Properties
2) Analysis of Functions, Risks and Assets
3) Commercial and Economic Circumstances
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Application of arms length

principle

Factors Affecting Comparability

1. Characteristics of Goods, Services or

Intangible Properties
Specific characteristics are important in
determining values in the open market
Include, among others: (or goods) physical
features, quality and reliability,
availability and volume of supply (in case
of transfer of goods); nature and extent of
services; (for IP) form of transaction, type,
duration and degree of protection, and
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anticipated benefits.
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Application of arms length

principle
Factors Affecting Comparability
2. Analysis of Functions, Risks and Assets
Economics dictates that level of return
should be directly correlated to functions
performed, assets owned, and risks
assumed
Crucial
step
is
to
identify
the
economically significant functions, risks
and assets, of a related party, with that of
independent companies
But not all, only those significant in
determining
the
value
of
the
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transactions /margins
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Application of arms length

principle
Factors Affecting Comparability
3. Commercial and Economic Circumstances

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The markets and economic conditions in

which the entities operate/where the
transactions are undertaken should
likewise be comparable
Government policies and regulation
may also have an impact
Business strategies
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APPLICATION OF ARMS LENGTH PRINCIPLE

Determination of the Tested Party

Tested Party: entity in which a transfer
pricing method can be most reliably applied
to, and from which the most reliable
comparables can be found.

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BIR requires sufficient and verifiable

information on such entity.

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Selection
and
ofPRINCIPLE
the TP
APPLICATION
OFApplication
ARMS LENGTH
Methods (TPM)

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
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APPLICATION OF ARMS LENGTH PRINCIPLE

Transfer Pricing Methods:
1. Comparable Uncontrolled Price
Method
2. Resale Price Method
3. Cost Plus Method
4. Profit Split Method
5. Transactional Net Margin Method

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APPLICATION OF ARMS LENGTH

PRINCIPLE
TP METHODS
Comparable Uncontrolled Price (CUP)

Compares the price (or amount) charged for property

or services transferred in a controlled transaction to
the price charged for property or services transferred in
a comparable uncontrolled transaction in comparable
circumstances.
A reliable method where an independent enterprise
sells or buys the same product or service as that sold
between the two related parties concerned.
Standard of comparability under the CUP Method is
very high
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APPLICATION OF ARMS LENGTH

PRINCIPLE
TP METHODS
Resale Price Method (RPM)

Evaluates the arms length character of a

controlled transaction by reference to the
gross profit margin realized in comparable
uncontrolled transactions.

Most useful where it is applied to operations

that do not add significant value to the goods
or services in which they deal e.g.
distributors.

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APPLICATION OF ARMS LENGTH

PRINCIPLE
TP METHODS
Cost Plus Method (CPM)

Focuses on the gross mark-up obtained by a

supplier who transfers property or provides
services to a related purchaser
Most useful where semi-finished goods are sold
between associated enterprises or where the
controlled transaction involves the provision of
services
Also useful in cases involving the manufacture,
assembly, or other production of goods that are
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APPLICATION OF ARMS LENGTH PRINCIPLE

TP METHODS
Profit Split Method

Seeks to establish a price for a controlled

transaction by determining the division of profits
that independent enterprises would have expected
to realize
Provides an alternative in cases where no
comparable transactions between independent
parties can be identified such as when transactions
are very interrelated or in situations involving a
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unique intangible
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APPLICATION OF ARMS LENGTH

PRINCIPLE
TP METHODS
Profit Split Method
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
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APPLICATION OF ARMS LENGTH

PRINCIPLE
TP METHODS
Transactional Net Margin Method (TNMM)

Examines the net profit margin relative to an

appropriate base (i.e. costs, sales, or assets)
attained by the member of a group of
controlled taxpayers from a controlled
transaction
Similar principle to RPM and CPM just uses
later point in income statement
Tends to be used frequently in practice,
because of information constraints on the use
of the other methods
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APPLICATION OF ARMS LENGTH

PRINCIPLE
TP METHODS
TNMM Selection of Profit Level Indicator (PLI)

PLI measures the relationship between profits and

sales, costs incurred or assets employed

Right choice of a PLI ensures better accuracy in the

determination of the arms length price of a
controlled transactions
Presented in the form of a generally recognized or
utilized financial ratio
Return on Costs
Return on Sales
Return on Capital Employed
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APPLICATION OF ARMS LENGTH

PRINCIPLE
Comparability Adjustments:

Intended to eliminate the effects of differences that

may exist between 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 the comparison
Neither routine nor mandatory

Arms Length Results:

Could be a specific figure or ratio (e.g., price or

margin), or a range of ratios, provided comparables
are reliable

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APPLICATION OF ARMS LENGTH

PRINCIPLE
Arms Length Results:
NOTE:

If controlled transaction is within the arms length

range- no adjustment needed
If the relevant condition of the controlled
transaction falls outside the 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 length range is different from the one asserted
by the BIR)

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APPLICATION OF ARMS LENGTH

PRINCIPLE
TP Documentation:
Purposes
of
documentation:

maintaining

TP

Defend taxpayers transfer pricing analysis;

Prevent transfer pricing adjustments arising from
tax examinations; and
Support taxpayers application for MAP.

TP
documentation
generally
demonstrates
compliance with the arms length principle
All TP transactions regardless of the amount
involved, must be properly documented

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APPLICATION OF ARMS LENGTH PRINCIPLE

TP Documentation:

Contemporaneous requirement it exists or is

brought into existence at the time the taxpayer
develops
or
implements
any
intercompany
arrangement, or reviews these arrangements when
preparing tax returns;

TP documents should be submitted to the BIR when

required or requested to do so;

Retention PeriodTP document must be retained

within retention period under the Tax Code (i.e. 3
years)

No TP - specific penalties on non-compliance

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of the

APPLICATION OF ARMS LENGTH

PRINCIPLE
TP Documentation:
Documentation Details

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Organizational Structure
Nature of the business/industry and
conditions
Controlled transactions
Assumptions, strategies, policies
Cost contribution arrangements (CCA)
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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market

APPLICATION OF ARMS LENGTH

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

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Related Party Agreements

TP Policy
Invoices
Cost Structure (i.e., basis, etc.)
Benchmarking of arms length
profits/margins
Internal Memo
Global/Local TP Report
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Thankyou!

Have a nice day!

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