Philippines: One-year review of new Philippine TP regulations

With the advent of the transfer pricing regulations – Revenue Regulations No. 02-2013, dated January 23 2013 (RR No. 02-2013) – which took effect on February 9 2013, taxpayers expected the Philippine Bureau of Internal Revenue (BIR) to take action on transfer pricing matters. To date, however, the BIR has apparently kept away from undertaking any enforcement measure. Despite the numerous queries from the public on the matter, it also has not issued circulars to provide guidelines in implementing RR No. 02-2013. Further, the BIR is not entertaining applications for advance pricing agreements (APAs) and the availment of the mutual agreement procedure (MAP) found under tax treaties.

To say that the BIR is not taking action might be premature. It is known to the public that certain personnel of the BIR have been attending training sessions outside the country on transfer pricing.

Further, recent issuances suggest that at this stage, the BIR has started to develop a database on taxpayers. The BIR's Revenue Memorandum Order No. 02-2014 (RMO No. 02-2014), dated January 8 2014, provides for a revised manner of classifying taxpayers and prescribes the use of the latest Philippine Standard Industrial Classification (PSIC) in the classification. One of the objectives of RMO No. 02-2014 is to generate more accurate statistics.

More importantly, Revenue Regulations No. 02-2014, dated January 24 2014, issued by the Secretary of Finance, prescribes the use of new forms for the filing of the annual income tax returns starting with taxable year ended December 31 2013. The new forms include a portion for corporate taxpayers to enumerate their top 20 stockholders and to state their taxpayer's identification numbers, capital contribution, and percentages of ownership. These new forms also require the corporations' PSIC codes to be stated.

These issuances will enable the BIR to collect relevant information on taxpayers and, consequently, to make transfer pricing risk assessments of taxpayers and select taxpayers for transfer pricing audits.

Taxpayers may have to carefully review the information to be stated in their annual income tax returns as well as re-visit the information previously submitted to the BIR.

Notwithstanding the absence of guidelines on the implementation of RR No. 02-2013, taxpayers have started to comply with the regulations' documentation requirements. In performing the transfer pricing studies, taxpayers can rely on the OECD transfer pricing guidelines after which RR No. 02-2013 has been patterned. Most concerned in complying with the documentation requirements are taxpayers with significant cross-border transactions or taxpayers registered with investment promotion agencies and enjoying tax incentives. After-all, based on the language of RR No. 02-2013, these taxpayers seem to be the priority for any transfer pricing scrutiny.

But perhaps the application in the Philippines of transfer pricing rules may have its own peculiarities in view of the maturity level and appreciation by all parties concerned.

One concern is on whether to use local comparables or regional comparables. Taxpayers may have initially perceived RR No. 02-2013 to require the use of local comparables. They have, therefore, insisted on searching for local comparables. Since the Philippines still does not have a local database suited for transfer pricing studies, they have manually checked the audited financial statements filed by Philippine corporations with the Philippine Securities and Exchange Commission (SEC).

However, the challenge has been to ensure the quality of data and the sufficiency of the number of comparables. Uncertainty in the treatment in the audited financial statements of certain items of income and expense and other balance sheet items and insufficient disclosures in the notes could affect the quality of the data. This is true even in other tax jurisdictions.

But another factor will be the timing of the local comparable search. Almost all of the Philippine corporations have a calendar year-end and are, thus, required to file with the SEC their audited financial statements no later than 31 May of the following year. A study done for planning/setting purposes for the year ended 31 December 2013 would have likely used 2012 figures only if the study was done after May 31 2013; otherwise, 2011 figures would have been the most recent data.

Further, corporations seemingly do not regularly file consolidated financial statements with the SEC, which are normally used for transfer pricing studies in other tax jurisdictions. The lack of the consolidated financial statements could affect the results of the studies.

Certain reasons could, however, necessitate the use of local comparables. For example, since RR No. 02-2013 applies to local transactions as well, the use of local comparables might make sense for such transactions. In case where a local comparable search is conducted, taxpayers have to ensure the approach taken for the local search to be consistent with the approach mandated by the OECD transfer pricing guidelines.

Taxpayers have found that making year-end adjustments could be very difficult because they do not have answers from the BIR to their questions such as the timing of and the support for the adjustments.

In the absence of guidelines, it may be advisable for taxpayers to consider first the type of related-party transactions to be affected by the proposed adjustments. Is it a sale of goods or purchase of goods? Is it a sale of services or purchase of services? The adjustments may have a significant impact on withholding taxes, value-added taxes, and customs duties.

For example, any adjustments that could require additional payments from a Philippine corporation to an offshore related-party for purchase of services could involve additional withholding tax liabilities maybe at the rates provided under the Philippine tax laws. Tax treaty relief might no longer be available.

Adjustments on the purchase price of imported goods for a local distributor, for example, could impact on the distributor's compliance with the customs laws. Add to this is the fact that in non-transfer pricing audits, the BIR could compare the purchase amounts reflected in the tax returns/financial statements to those generated from declarations made with the customs authorities. Any discrepancy could lead the BIR to impose deficiency taxes.

Taxpayers also have to check the substantiation to effect the adjustments not only for transfer pricing purposes but for financial accounting purposes as well.

As mentioned-above, taxpayers registered with investment promotion agencies and enjoying tax incentives could be the main target for transfer pricing scrutiny.

It is possible that while a taxpayer is enjoying the income tax holiday (ITH) incentive and is exempted from the 30% regular corporate income tax for a certain period, additional tax might be assessed because of transfer pricing adjustments made by the BIR. Since the taxpayer is still liable for the withholding taxes on certain income payments made, the taxpayer may be assessed with deficiency withholding taxes because of transfer pricing adjustments made with respect to the income payments. The withholding tax is considered payment of the income tax due from the payee but collected through the payor as the withholding agent. And the BIR has not yet clarified whether the transfer pricing regulations impact only on a corporation's 30% regular corporate income tax liability or also on its withholding tax liability.

Taxpayers may also have to check the materiality of their income payments and consider the transfer pricing issues of these payments.

With the very basic transfer pricing regulations and in the absence of the MAP and APA framework, taxpayers are challenged to spot opportunities to minimize transfer pricing risks or at least the compliance costs not only for transfer pricing purposes but for regular tax audits.

Newly-established shared services centers availing of the ITH should still consider preparing transfer pricing studies for the shared services. It appears that the need becomes more urgent when migration costs they will incur are substantial only during the ITH period. While transfer pricing studies could support the mark-up adopted during the subsequent years after the ITH period, the BIR during regular audits could take note of the substantial revenues reported during the ITH period as stated in absolute amounts. A substantial decrease in revenues will be a red flag for audit.

In addition, certain items to be considered in coming up with the search strategy (for example plant, property, equipment – net) may vary significantly from year to year during the early part of a corporation's life as the corporation is in the process of growing/maximising its operations. It is advisable to consider projections for the next four or five years to plan when a full-blown study or an update is required.

In determining how to prioritise compliance with the documentation requirements of RR No. 02-2013, one should consider also other tax rules. Recently, the BIR has disallowed the subcontract costs as a deduction for purposes of computing the 5% preferential tax rate being enjoyed by export enterprises registered with the Philippine Economic Zone Authority (PEZA). Foreign investors with an intention to set up wholly-owned subsidiaries to be registered with PEZA may have to consider this in structuring their Philippine operations and avoid subcontracting a portion of their operations even to related parties. In this way, they could minimise their subcontract costs and maximise the availment of the 5% preferential tax rate.

A recent Supreme Court decision has stated that the BIR cannot impute interest income for non-interest bearing intercompany advances. The reason for the non-imputation is based on the provision in the Civil Code that no interest shall be due unless it has been expressly stipulated in writing. It appears that the BIR has accepted this decision as there have been no other instances yet when the BIR acted in a contrary manner.

Taxpayers could use this decision as a basis for not charging interest for intercompany advances or for prioritising other related-party transactions for the preparation of the transfer pricing documentation.

However, taxpayers may have to consider also the transfer pricing rules affecting the offshore related parties involved in these intercompany advances.

RR No. 02-2013 does not impose penalties for the mere failure to prepare the documentation. However, it requires the documentation to be contemporaneous. It also mandates taxpayers to submit to the BIR the documentation when required or requested to do so. Taxpayers preparing the documentation on a timely basis will be able to manage the increasingly strict procedural requirements of the BIR in conducting tax audits. Existing rules for regular tax audits will most likely apply to transfer pricing audits. Recent amendments introduced to the BIR rules for handling tax audits have somehow shortened the time allowed for taxpayers to submit documents or prepare their defenses. Having contemporaneous documentation will assist taxpayers in meeting the time limits for submission of documentation and strengthen the defense of their transfer pricing analysis.

While taxpayers await the BIR's issuance of additional guidelines for implementing the transfer pricing regulations, taxpayers should be mindful of the documentation and other requirements under the regulations. Taxpayers will be able to anticipate the transfer pricing concerns that might impact them and perhaps more properly and proactively handle these concerns even before the BIR starts its transfer pricing audits.

Biography
		Maria Carmela Peralta KPMG in the Philippines The KPMG Center, 9/F 6787 Ayala Avenue Makati City 1226 Philippines Tel: +63 (2) 885 7000 loc 320 Fax: +63 (2) 894 1985 Email: mperalta@kpmg.com Carmela is a principal in the tax division and has more than 15 years of experience in the tax practice. She provides tax services to various multinational and local companies from different industries, including transfer pricing services, tax advisory services, and assistance in handling tax assessments. She was seconded to the transfer pricing team of KPMG Singapore for one year starting in February 2008. Since her return to KPMG Philippines in February 2009, she has been designated as KPMG Philippines' country service line leader for transfer pricing. She has spoken in numerous seminars on transfer pricing and has written articles on the topic. She is the lead organizer for KPMG Philippines' publication/newsletter on transfer pricing addressing common questions, issues and concerns raised by taxpayers.

Biography
		Eugene Pulga KPMG in the Philippines The KPMG Center, 9/F 6787 Ayala Avenue Makati City 1226 Philippines Tel: +63 (2) 885 7000 loc 380 Fax: +63 (2) 894 1985 Email: epulga@kpmg.com Eugene is a senior manager in KPMG Philippines. Eugene has been in the tax practice for more than 10 years. He was first a part of KPMG Philippines for two years and spent almost 10 years with the Philippine member firm of EY. He joined back in KPMG Philippines in November 2013. He has provided tax services to various multinational and local companies from different industries such as banking, consumer, automotive, telecommunications, power, and business processing outsourcing. He has provided tax advisory services covering a variety of concerns as well as tax advocacy services covering various requests for confirmatory ruling and other tax applications. He has also handled national and local tax assessments.

Biography
		Rey Taduran Llesol KPMG in the Philippines The KPMG Center, 9/F 6787 Ayala Avenue Makati City 1226 Philippines Tel: +63 (2) 885 7000 loc 574 Fax: +63 (2) 894 1985 Email: rllesol@kpmg.com Rey is a senior supervisor in KPMG Philippines. Rey has provided tax services to various multinational and local companies from different industries, including transfer pricing services, tax structuring, tax advisory services, assistance in handling tax assessments, tax treaty relief applications, among others. He has also been included in the trade and customs practice of KPMG Philippines. Rey is part of KPMG Philippines' core transfer pricing team, taking part in the development and marketing of the service line, taking into account Philippine perspective of the transfer pricing rules and the global mindset adopted by multinational clients. His work has helped clients still developing their transfer pricing policy and those with history in transfer pricing compliance.

Biography
		Valerie Jill Reyes KPMG in the Philippines The KPMG Center, 9/F 6787 Ayala Avenue Makati City 1226 Philippines Tel: +63 (2) 885 7000 loc 318 Fax: +63 (2) 894 1985 Email: valeriejillreyes@kpmg.com Valerie is a senior supervisor in KPMG Philippines. Valerie has worked as an associate for an auditing firm in 2009, auditing various clients in the real estate industry. She has also worked as an assistant manager for the legal division of Union Bank of the Philippines in 2010, attending to the legal needs of the said bank. She joined KPMG Philippines in 2011 and assists in providing tax services to various multinational and local companies from different industries, including tax advisory services, assistance in handling tax assessments, requests for Bureau of Internal Revenue rulings, including tax treaty relief applications, and transfer pricing services. Her engagements cover tax advice on cross-border transactions ranging from acquisition of companies, restructuring of operations, setting up and outbound and inbound payments.