Question & AnswerQ&A (BIR REVENUE REGULATIONS NO. 2-2013)
The objective is to implement the authority of the Commissioner of Internal Revenue to review controlled transactions among associated enterprises, determine appropriate revenues and taxable income, prescribe guidelines in establishing arm's length prices, and require maintenance of documentation to prove compliance with the arm's length principle.
These regulations apply to both cross-border transactions and domestic transactions between associated enterprises.
Associated enterprises are two or more enterprises where one participates directly or indirectly in the management, control, or capital of the other; or where the same persons participate directly or indirectly in the management, control, or capital of both enterprises.
The arm's length principle is the standard that transactions between associated enterprises should be conducted as if the parties were independent, on comparable terms and conditions, reflecting true economic value as would be in transactions between unrelated parties.
Transfer pricing refers to the pricing of cross-border or domestic intra-firm transactions between related parties or associated enterprises.
The Commissioner is authorized to distribute, apportion or allocate income or deductions among associated enterprises to clearly reflect taxable income and prevent tax avoidance through transfer pricing adjustments.
The three key steps are: 1) Conducting a comparability analysis; 2) Identifying the tested party and selecting the appropriate transfer pricing method; 3) Determining the arm's length results.
Comparability analysis examines the similarities and differences between controlled and uncontrolled transactions, considering characteristics of goods, services or intangibles, functions performed, risks assumed, and economic conditions to determine if prices or margins are comparable.
Recognized methods include: Comparable Uncontrolled Price (CUP) Method, Resale Price Method (RPM), Cost Plus Method (CPM), Profit Split Method (PSM), and Transactional Net Margin Method (TNMM).
Taxpayers must maintain contemporaneous documentation showing compliance with the arm's length principle including organizational structure, nature of business, controlled transactions, functional and risk analysis, selection and application of transfer pricing methods, and related background documents, to defend transfer pricing positions and support MAP applications.
Penalties and sanctions as provided under the Tax Code and other applicable laws apply to persons who fail to comply with or violate these regulations.
An APA is an agreement between a taxpayer and the BIR determining in advance transfer pricing criteria to be applied to controlled transactions over a fixed period, aiming to reduce risks of transfer pricing disputes and double taxation.
The tested party is the entity in a controlled transaction to which a transfer pricing method can be reliably applied and from which reliable comparable data can be found.
Comparability adjustments are accounting or function/risk adjustments to eliminate effects of differences between controlled and uncontrolled transactions to improve accuracy in determining arm's length prices, but they should only be made when such differences materially affect comparability.
MAP is a dispute resolution mechanism between tax administrations under tax treaties used to eliminate double taxation arising from transfer pricing adjustments by consultation and mutual agreement.