As the saying goes, “All is fair in love and war.” But this may not be necessarily so when it comes to taxation. In taxation, parties attached to each other may agree on terms that may not be fair to the other, even if such arrangement is for the good of both. Perhaps, this is what you call true love—common good over individual interest. This is the norm of loving in multinational enterprises. This is what you call love for transfer pricing.

Transfer pricing is becoming an important issue for many companies, whether Philippine-based, or foreign- based. And the requirement for a more transparent reporting has led taxing authorities to institute the necessary regulations to combat this growing concern. The problems posed by transfer pricing and the rules governing the subject are quite complex. This article is simply intended to give an overview of the basics of transfer pricing.

Transfer pricing refers to the pricing of transactions between related parties or members of an associated enterprise. It generally relates to cross-border transactions which may result in the transfer of income or expenses between or among related entities located in different jurisdictions. As the transfer price is arbitrary, depending as it does only on agreements between the controlled or related parties, it might not reflect the proper valuation as if it had been between independent parties (i.e., uncontrolled). Thus, intentionally or unintentionally, it may result in the reduction of tax liabilities in certain jurisdictions or an increase in income in other jurisdictions.

The tax concerns become more serious, considering the differences in the tax rules and tax rates prevailing in the different countries where related entities operate.

Ideally, all charges should be at an arm’s length standard. That is, transfer prices between related parties should be the same as the price that would prevail in a transaction between independent or unrelated parties. Under such circumstances, profits will be allocated to each entity commensurate to its role in the production and distribution process—the functions they perform, the assets employed, and the risks borne. This, in turn, would provide the government with the proper basis on which the taxes would be based on and not be deprived of the much-needed taxes it needs to perform its mandate of promoting the general welfare and well-being of its citizenry.

In the Philippines Section 50 of the National Internal Revenue Code of 1997 provides the legal basis to address transfer-pricing arrangements. Section 50 provides: In the case of two or more organizations, trades or businesses (whether or not incorporated and whether or not organized in the Philippines) owned or controlled directly or indirectly by the same interests, the commissioner is authorized to distribute, apportion or allocate gross income or deductions between or among such organization, trade or business, if he determines that such distribution, apportionment or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organization, trade or business.

The purpose of Section 50 is to ensure that taxpayers clearly reflect their income attributable to controlled transactions, and to prevent the avoidance and evasion of taxes with respect to such transactions. Furthermore, it places a controlled taxpayer on tax parity with an uncontrolled taxpayer by determining the true taxable income of the controlled taxpayer.

In determining the true taxable income of a controlled taxpayer, the standard to be applied in every case is that of a taxpayer dealing at arm’s length with an uncontrolled taxpayer. The arm’s length determination requires comparability with the transaction of an unrelated party. To be comparable means that none of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology (e.g., price or margin), or that reasonably accurate adjustments can be made to eliminate the effects of any such differences.

In sum, as a symbiotic relationship exists between the government and the taxpayers, with the reciprocal obligation of support and protection, it is important to have a harmonious relationship. And just like in love, it is important to put the well-being of both parties ahead of oneself, so that neither party will have a taxed heart.  

The author is an associate of BDB Law. If you have any comments or questions concerning the article, you can e-mail the author at alvin.c.go@bdblaw.com.ph or call 856-2952.

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