Singapore: Transfer pricing in Singapore: A review and update

Given Singapore's pro-business policies and relatively low tax rate, some multinationals have the perception that transfer pricing should not be an area of concern for its Singapore operations. Despite this notion, the reality is quite different. Over the past few years, the Inland Revenue Authority of Singapore (IRAS) has increased its focus on transfer pricing and companies have been subject to transfer pricing consultation and audit. Some of these have resulted in upward adjustments to income, additional tax, and in some instances, even penalties.

In February 2006, IRAS released a circular on the concepts and application of transfer pricing (2006 Circular). The circular echoes the OECD transfer pricing guidance of that time, albeit with a few differences (such as the best method concept). Over the course of the next four years, other transfer pricing-related circulars followed, as well as formal legislation of the arm's-length principle into the Singapore Income Tax Act. We have summarised all of these items below:

• 2006 – Transfer Pricing Guidelines;

• 2008 – Transfer Pricing Consultation;

• 2008 – Supplementary Administrative Guidance on APA;

• 2009 – Transfer Pricing Guidelines for Related-Party Loans and Related-Party Services; and

• 2010 – Amendment in the Singapore Income Tax Act with respect to the arm's-length principle (Section 34(D) – Transactions Not At Arm's-Length).

The transfer pricing guidance in the 2006 Circular is applicable to all related-party transactions – between two Singapore parties or between a Singapore party and an offshore counterparty. It is equally applicable to legal entities and/or permanent establishments, such as branches. There are no official volume or dollar thresholds, under which transfer pricing or documentation is not applicable.

Although there are no formal requirements to file documentation, it is IRAS' expectation that taxpayers exert reasonable efforts to undertake a sound transfer pricing analysis, to demonstrate that the related-party transactions are conducted at arm's-length. When reasonable efforts have been exercised, the transfer prices would be considered, prima facie, as arm's-length. Accordingly the burden of proof would then reside with IRAS. Adequate and timely documentation will go towards demonstrating a reasonable effort. IRAS warns that scant documentation for significant or complex transactions may result in reviews and challenges.

After the release of the 2006 Circular, IRAS seemed to have allowed a grace period for taxpayers to adapt and comply with the new transfer pricing rules. Consequently, there is no discernible difference in their transfer pricing audit focus before and after.

The landscape started to change in mid 2008, when IRAS released the Consultation Circular (2008 Circular). This Circular aims to foster taxpayers' transfer pricing awareness and compliance through taxpayer to tax authority consultations (hence its name), and to emphasise the importance of transfer pricing documentation. In selecting candidates for the transfer pricing consultation process, IRAS uses analytics to highlight companies that may be high risk or behind the curve on transfer pricing compliance. Based on anecdotal observations, commodity trading companies, perhaps because of their low margin-high volume business model, were the first batch selected for consultation. This was followed by a more diverse set of companies in the distribution, chip fabrication, and electronics manufacturing industries. More recently, service companies and companies in the financial service industry have also been under scrutiny.

IRAS' first step in the consultation process is to send out transfer pricing questionnaires to assess the taxpayer's transfer pricing compliance. These questionnaires are usually quite lengthy (about seven to eight pages), with detailed questions on transfer pricing arrangements, business operations, financials, and availability of supporting documentation. Depending on the response received, IRAS may initiate further rounds of questioning and even embark on a field visit to the taxpayer. At the end of the process, IRAS will provide the taxpayer with its opinion of the taxpayer's transfer pricing approach and documentation. If the taxpayer's transfer pricing deviates from IRAS' opinion of arm's-length pricing, it is possible that there will be an upward adjustment to income and additional taxes. Further, IRAS has the power to impose penalties from 100% of the tax undercharged (for an incorrect return) to 400% of the tax undercharged (for serious fraudulent tax evasion). However, in practice, penalties arising from transfer pricing controversy are relatively infrequent.

Outside of the foregoing approach, corporate tax auditors in IRAS have also been increasingly raising transfer pricing questions as part of their routine corporate tax query process and audits. It is not uncommon for corporate tax queries to contain questions asking taxpayers to prove that a certain related-party transaction is conducted in an arm's-length manner. This again highlights the importance of having a sound transfer pricing analysis, to provide a meaningful response should the need suddenly arises.

A common red flag may be where the company shows persistent losses or low profitability, especially if most of the transactions are with related parties. It is the perception of IRAS (and many other tax authorities) that losses, especially those which persistent for a number of years, are unlikely to be consistent with arm's-length behaviour. However, it may be these losses are the result of the group's commercial policy – that because of factors which are non-transfer pricing related. For example, a market penetration strategy, initial teething problems and other start-up costs and industry downturn. In our experience, IRAS can be receptive to such economic arguments, assuming sufficient evidence is assembled to demonstrate what an independent company would have done or achieved in such circumstances.

The payment and receipt of management fees or intra-group service fees also continue to be an area of focus for IRAS. For inbound management fee expenses, the most common concerns raised are:

• Whether the company would purchase the services if it was obliged to obtain them from an unrelated party; if the services in question do not add commercial or economic value to the business, IRAS may argue a tax deduction is not appropriate; and

• If the benefit of services can be substantiated, then the next consideration is whether the fees itself are priced at arm's-length.

For outbound management fee revenue, the focus is mainly on the second point. Where a cost based approach is used in determining the management fees, the adequacy of the cost base and the arm's-length nature of the mark-up (especially where the IRAS safe harbour for routine support services may not be applicable) are key items which typically scrutinised.

IRAS provides support for controversy avoidance and risk management through mutual agreement procedures (MAPs) and advance pricing agreements (APAs). Singapore has an extensive double tax treaty network which allows for these mutual proceedings in more than 70 countries. Hence, relative to the size of its corporate taxpayers, IRAS has processed a good number of MAPs and APAs. As of March 31 2013, IRAS has 13 MAPs at different stages of review, and 38 ongoing APAs.

Whilst MAPs are more a reactive approach to situations where transfer pricing adjustments have already been made in the counterparty's jurisdiction, APAs are an increasingly popular companies for taxpayers in Singapore to proactively reduce tax uncertainty for their intercompany transactions, especially if they assess their transfer pricing risk as high. Because of the relatively low tax rate, many companies have structured their operations such that profits would flow to Singapore (although typically this is backed with evidence of substance and value created by the functions performed, risks assumed and assets borne by the Singapore entity). Bilateral APAs have been used in such instances to protect income in Singapore. While increased time and resources are required to support an APA application, if the amount of effort required is incremental to the effort that may be required to defend a transfer pricing audit, an APA would be a better route. As a result of these efforts, the company would be able to gain certainty over the uncertainty that exists in transfer pricing.

It has been more than eight years since Singapore first introduced transfer pricing guidelines and almost five years since the last transfer pricing circular has been issued. During this eight-year period, there have been many international developments on transfer pricing, including expansions to the original OECD transfer pricing guidelines, and OECD papers (some of which are still in draft form) on the attribution of profits to permanent establishments, business restructuring, documentation, country-by-country reporting, and intangibles. In addition there are five action items on the OECD Base Erosion and Profit Shifting Action Plan which are specific to transfer pricing. Given the foregoing, there is some speculation that IRAS guidance will need to keep pace. Accordingly, it is possible that updated and expanded transfer pricing guidance or requirements may be in the pipeline, to encourage documentation and good transfer pricing practices.

Biography
		Geoffrey Soh KPMG in Singapore 16 Raffles Quay #22-00 Hong Leong Building Singapore 048581 Tel: +65 6213 3035 Fax: +65 6224 6461 Email: geoffreysoh@kpmg.com.sg Geoff is head of transfer pricing with KPMG in Singapore with more than 16 years of experience providing transfer pricing advisory to clients. Before joining KPMG Singapore, Geoff worked for more than five years in KPMG Vancouver's transfer pricing practice. He transferred to Singapore in 2003, to develop KPMG's transfer pricing practices in the region. Geoff has managed more than 800 international transfer pricing engagements. His projects have encompassed the transfer pricing compliance, tax planning, audit defense, and alternative dispute resolution aspects of transfer pricing. He has been involved in MAPs and APAs involving tax authorities from a number of countries. Geoff has presented at a number of regional transfer pricing conferences and has published articles on Singapore and Canadian transfer pricing developments. He has been cited by International Tax Review's World Tax guide for transfer pricing in Singapore.

Biography
		Felicia Chia KPMG in Singapore 16 Raffles Quay #22-00 Hong Leong Building Singapore 048581 Tel: +65 6213 2525 Fax: +65 6220 9419 Email: fchia@kpmg.com.sg Felicia is a director with KPMG's global transfer pricing practice in Singapore. Other than Singapore, Felicia has also worked in the US, in KPMG's office in Silicon Valley. In her 10 years of experience with KPMG, she has completed and led numerous transfer pricing planning and documentation projects to determine proper arm's-length compensation for tangible and intangible property and services. Felicia's experience also covers a range of restructuring projects such as the planning and implementation of a centralised hub-and-spoke structure, cost allocation studies for global/regional headquarters, assistance in negotiating unilateral and bilateral APAs involving Singapore, the US, China, and Japan, as well as audit defense and transfer pricing risk analysis projects. Felicia has written a number of articles and is a frequent speaker on transfer pricing matters.