The Bureau of Internal Revenue wants bigger tax collections—which pretty much sums up the intent of the new regulation, RR 2-2013, issued last 23 January 2013. Understandably so. That’s their mandate.
But, before you howl in protest, the regulation only applies to associated companies like those that are part of conglomerates, multinational companies, and the like, where profits can be allocated for tax purposes between the companies under a single corporate structure. In short, it’s about controlling the excessive allocation of the profit to, say, a subsidiary that is located on a country or area where tax rates are lower.
Before it gets too complicated (and boring), let’s see what the regulation and transfer pricing is about.
According to the BIR, transfer pricing is generally defined as the pricing of cross-border, intra-firm transactions between related parties or associated enterprises. These are usually multinationals.
As an example, let us take a profitable US corporation with a subsidiary in the Philippines that manufactures parts. The parent corporation buys the parts from its subsidiary. But how much should it technically “pay” for the parts? Remember, it owns the parts manufacturer which makes it possible to dictate any price.
If the parent buys the parts below local market prices, the Philippine subsidiary will appear to be in financial trouble even if the firm as a whole takes on decent profit from the final product. The IRS will obviously not complain about it since the profit will be reported on their end but what about the BIR? Their problem is that the Philippine subsidiary will report little or no profit. This is where transfer pricing comes in.
It works this way: If the US corporation in the earlier example will buy the parts from an independent supplier in the Philippines, they will be paying the current local market price; which means the supplier will likely have reasonable profit and would pay the correspondingly higher taxes. Bigger revenue for the BIR.
So back to the question: How much should the US corporation pay for the parts from its subsidiary? Obviously, the Philippine government cannot dictate that they buy from their subsidiary using the local market price for the part. This is where the arm’s length principle (ALP) comes in.
The ALP is a methodology set out by the internationally accepted Organisation for Economic Cooperation and Development (OECD). It provides the guidelines for transfer pricing.
Basically, the transfer price should be the same as if the two companies involved were indeed two independents. Well, not exactly the same price; there is some wiggle room but there are also limitations on the amount of your jiggly maneuver. If you are way off and unreasonable, you might get the BIR’s side glance and eventual attention.
In this era of globalization, many tax authorities around the world use it so that governments can have their fair share of taxes. The Philippine government is only just jumping in on the bandwagon although this was already in discussion since way back 2003.
The thing is, it may actually backfire in some cases. Multinationals may already be allocating more profits to their subsidiaries inside economic zones because of the tax incentives. If we apply the transfer pricing scheme, subsidiaries here may end up paying less taxes to the BIR and more taxes to their home country.
It’s a different story altogether for Philippine conglomerates with subsidiaries inside economic zones, though.
See, outside the economic zones, parents of domestic companies are generally paying more than 30% on corporate taxes; inside, their subsidiaries are only paying 5% on gross income. If they allocate more profits to the subsidiaries, the subsidiaries would be paying more taxes but way less taxes for the firm overall.
With the new BIR regulation, the profit allocation should be within the boundaries of the transfer pricing methodology. In short, bigger taxes for the firm to pay overall. Bigger tax revenue for the BIR as well.
And that’s generally what this new regulation is all about. Obviously, this regulation is not that easy to implement considering the many variants of business. The BIR and the OECD, though are both ready to provide assistance to implement transfer pricing in a more or less standard manner while considering each one’s particular situation.
Still here? Anyway, this one will take a while to implement in full, but something that you should really start checking up on. Remember the motto of tax authorities the world over, “We have what it takes to take what you have.”
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