QuestionsQuestions (BIR REVENUE REGULATIONS NO. 2-2013)
RR No. 2-2013 aims to implement the CIR’s authority to review controlled transactions among associated enterprises, allocate income and deductions to clearly reflect taxable income, prescribe guidelines to determine arm’s length prices (based largely on OECD methodologies), and require taxpayers to maintain documentation to prove efforts to determine arm’s length results. Its scope covers both cross-border and domestic transactions between associated enterprises.
Transfer pricing is the pricing of cross-border (and, as stated in the text, potentially domestic) intra-firm transactions between related/associated enterprises. It matters because it can lead to tax revenue losses when income and/or deductions are shifted to reduce tax liabilities, undermining the proper reflection of income.
The CIR is authorized to distribute, apportion, or allocate gross income or deductions between or among organizations, trades, or businesses owned/controlled by the same interests if such allocation is necessary to clearly reflect income. This supports transfer pricing adjustments to prevent tax avoidance in controlled transactions.
Associated enterprises are those where one participates directly/indirectly in the management, control, or capital of another, or where the same persons participate directly/indirectly in management/control/capital. “Control” includes any kind of direct or indirect control, legally enforceable or not, and it is deemed present if income or deductions have been arbitrarily shifted between enterprises.
It requires that transactions with related parties be priced as if they were between independent parties under comparable conditions. The text notes alignment with OECD and Philippine treaty concepts (notably Article 9) and explains the premise that profits should not be artificially higher/lower solely due to the special relationship.
Step 1: conduct a comparability analysis; Step 2: identify the tested party and the appropriate transfer pricing method; Step 3: determine the arm’s length results.
The text requires examining: (1) characteristics of goods/services/intangibles; (2) functions, risks, and assets (functional analysis); and (3) commercial and economic circumstances (including markets, competition, geographic location, government policies/regulations, and business strategies).
Because economic theory links the level of return to functions performed, assets used, and risks assumed. For example, an entity providing warranty services or using valuable intangibles should have higher return than a similar entity without those functions/assets/risks.
The tested party is the entity to which a transfer pricing method can be applied most reliably and from which the most reliable comparables can be found. The Bureau requires sufficient and verifiable information about that entity.
The method must provide the most reliable arm’s length result. Selection should consider: (i) strengths/weaknesses of each method; (ii) appropriateness given the controlled transaction nature (via functional analysis); (iii) availability of reliable data/comparables; and (iv) degree of comparability including reliability of adjustments.
No. The text states there is no specific preference. Taxpayers should use the method that produces the most reliable results given the quality of data and the degree/accuracy of needed adjustments.
PLI measures the relationship between profits and sales/costs/assets and helps improve accuracy in determining the arm’s length profit. Examples: return on costs (cost plus/net cost plus margin), return on sales (gross margin/operating margin), and return on capital employed (return on operating assets).
It states that while a single most reliable ratio may be possible in some cases, it is generally difficult, so transfer pricing analysis often yields a range. If the controlled transaction falls within the arm’s length range, no adjustment is made; if outside, the taxpayer must substantiate compliance or the Bureau will adjust to a point within the range (potentially using central tendencies like median/mean when comparability defects remain).
Comparability adjustments eliminate the effects of differences between the controlled transaction and comparables that could materially affect the condition examined (price/margin). Avoid adjustments that are questionable due to broadly satisfied criteria, excessive adjustments that imply insufficient comparability, adjustments for differences without material effect, and highly subjective adjustments (e.g., product quality differences).
CUP benchmarks whether the controlled price equals the price in a comparable uncontrolled transaction under comparable circumstances (often highly sensitive to product/service characteristics). RPM benchmarks gross profit margin for resellers (used when a purchased product is resold to an independent party; best when reseller adds little value). CPM benchmarks cost-plus mark-up for suppliers/service providers (used for manufacturing/production or intra-group services; tests whether supplier’s mark-up on costs meets arm’s length standard).
PSM is an alternative when no comparable transactions can be identified—typically when transactions are highly interrelated or involve unique intangibles. It allocates combined profits (often operating profit) among associated enterprises based on what independent enterprises would have expected, using approaches such as residual profit split (basic return first, residual allocated based on unique intangibles) or contribution profit split (allocation based on relative contributions).
TNMM evaluates arm’s length pricing by comparing net profit margins of the tested entity from controlled transactions to those from uncontrolled transactions or comparable independent entities, using a PLI based on net margin to costs/sales/assets. A weakness is that net margin can be influenced by many factors that do not directly or substantially affect gross margins/prices (e.g., efficiency of assets, personnel capabilities, competitive position), requiring reliable adjustments to ensure comparability.
APAs determine in advance criteria (method, comparables, adjustments, assumptions) for transfer pricing over a fixed period to reduce risk of examination/double taxation. Types: unilateral APAs (BIR + taxpayer) and bilateral/multilateral APAs (PH + one or more treaty partners via MAP). They are not mandatory; taxpayers may still invoke MAP if no APA was obtained.
Taxpayers must demonstrate consistency with the arm’s length principle. BIR does not require documents to be filed with returns, but they must be retained and submitted when required/requested. Documents should be retained within the Tax Code retention period (and it is best to keep them for MAP/examination). They must be contemporaneous—created/updated at the time arrangements are implemented or reviewed when preparing tax returns. They should include: organizational structure, nature of business/market conditions, controlled transactions, assumptions/strategies/policies, CPAs/CCAs if applicable, comparability and functional/risk analysis, selection and application of TPM, background documents, and an index to documents.