Is This the Current Thinking on Documentation
Is This the Current Thinking on Documentation
by: Maria Carmela M. Peralta
From the time Revenue Regulations (RR) No. 02-2013, otherwise known as the transfer pricing regulations, were issued in 2013, there have been at least two items that taxpayers have waited for the Bureau of Internal Revenue (BIR) to provide guidance on. These two items impact on the cost of compliance with transfer pricing rules.
RR No. 02-2013 requires taxpayers to maintain the transfer pricing documentation to prove that they have exerted efforts to determine the arm’s-length price for their related-party transactions.
The documentation will have, among other things, the functional analysis and the comparable search. The functional analysis will show the functions performed, risks assumed, and assets used by the related parties in connection with the related-party transaction under review. The comparable search will show the steps for selecting companies considered comparable to the tested party (to put it simply, the entity for which the comparable companies are being looked for) and the resulting arm’s-length range.
However, RR No. 02-2013 is silent on the matter of updating the documentation. RR No. 02-2013 states that the documentation must be contemporaneous. The documentation is contemporaneous “if it exists or is brought into existence at the time the associated enterprises [the related parties] develop or implement any arrangement that might raise transfer pricing issues or review these arrangements when preparing tax returns”. To be contemporaneous means having the documentation covering each taxable year completed no later than the filing deadline of the annual income tax return for that particular year. For each taxable year, there should be a documentation. However, many Philippine companies have prepared their documentation for a taxable year long after the filing deadline.
But the relevant matter that impacts cost is whether the BIR will require strictly every year the preparation of the documentation from scratch. Doing a full-blown comparable search involves many steps, including checking the websites and audited financial statements of maybe 100 to 300 companies.
In practice though, companies have resorted to mere updating of the documentation made for a prior year. Specifically, they will maintain the functional analysis and the comparables in a prior year’s documentation and will obtain the most recent audited financial statements of the comparables (probably only six to 12 companies) and recalculate the arm’s-length range. The cost of updating is not much in terms of time and money.
Moreover, RR No. 02-2013 does not expressly require that the comparable companies be Philippine companies. In other words, comparable companies can be generated from a regional search (e.g., Asia-Pacific region).
Nevertheless, the BIR has been perceived to prefer Philippine companies as comparables since it has access to the audited financial statements of local companies filed with the Philippine Securities and Exchange Commission (SEC). Also, the BIR is known not to have subscribed yet to a transfer pricing database allowing regional searches. Hence, in general, Philippine companies have always used local comparables. This meant purchasing audited financial statements from the SEC. For multinational groups of companies, this practice could mean additional cost in terms of time and money because they may have prepared already for their subsidiaries/affiliates in the region documentation that uses regional comparables.
The recently issued RR No. 19-2020, dated 08 July 2020, prescribes BIR Form No. 1709 to be attached to the annual income tax return and to be accompanied by, among other things, the documentation. BIR Form No. 1709 contains disclosures on related-party transactions. To clarify matters about the form, the BIR has issued Revenue Memorandum Circular (RMC) No. 76-2020, dated 29 July 2020.
RMC No. 76-2020 does not have an express statement on the acceptability of regional comparables. Nevertheless, by stating in the said RMC that a taxpayer can use the documentation of the other transacting related party (which may cover foreign related parties) or even the master file (which is a requirement in other tax jurisdictions for a group of companies), it appears that the BIR may now accept regional comparables.
This is a welcome development especially for taxpayers mandated to file BIR Form No. 1709 within the next two months. There are challenges in conducting local searches. To date, there is no local transfer pricing database that should make local searches and the calculations easy. In addition, the SEC iView, the SEC website which allows anyone to access and print for a cost audited financial statements of companies, has been unavailable since December 2019. Thus, to get audited financial statements, taxpayers need to check first their availability in the SEC Express System (another website) and purchase them from the SEC and wait for their delivery by the SEC. There is no guarantee, however, that the SEC Express System will be operational all the time. During the enhanced community quarantine (ECQ) and from time to time after the ECQ, it was inaccessible. Further, there have been delays in delivery.
Note though that the RMC also states that the local documentation is preferred since it provides more detailed information on the related-party transactions. Thus, it may be prudent for a taxpayer to still prepare its documentation but leveraging on the regional documentation and providing more detailed information.
As to the updating of the documentation every year, it seems that this need not be the case. RMC No. 76-2020 states that the old documentation shall suffice. This is the case if there are no significant changes in the business model, the factors or conditions considered in drafting the said documentation and the nature of the related-party transactions. Likewise, this is a welcome development especially for taxpayers mandated to file BIR Form No. 1709 within the next two months.
But it is hoped that the BIR could further clarify this matter. In order to achieve comparability between the tested party and the comparable companies, the financial and other data of the comparable companies should pertain to the same taxable year of the tested party under review. A comparable company in a prior year’s documentation may remain to be comparable for the current year. But its financial performance may have changed significantly in the current year. Should not the taxpayer take this into account for purposes of the current year’s documentation? This question becomes more relevant for 2020 in view of the potential impact of the pandemic on financial performance.
It is submitted that an old documentation may be used for purposes of BIR Form No. 1709 if there is no change in the nature of the related-party transaction and in the functional analysis. But there should be an updating at least of the financial and other data of the comparable companies to ensure comparability.
This is because in any comparable search, the concept of comparability between a tested party and the comparable companies is basic. RR No. 02-2013 states that the arm’s length principle is based on a comparison of the prices or margins adopted or obtained by related parties with those adopted or obtained by independent parties engaged in similar transactions. For such price or margin comparisons to be meaningful, all economically relevant characteristics of the situations being compared should be sufficiently similar so that: (i) none of the differences (if any) between the situations being compared can materially affect the price or margin being compared, or (ii) reasonably accurate adjustments can be made to eliminate the effect of any such differences.
Maria Carmela M. Peralta is a Principal and Head of the Tax Group of KPMG R.G. Manabat & Co. (KPMG RGM&Co.), the Philippine member firm of KPMG International. KPMG RGM&Co. has been recognized as a Tier 1 tax practice and Tier 1 transfer pricing practice by the International Tax Review.
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