UPWARD OR DOWNWARD? TP AUDIT VS CUSTOMS AUDIT
By: Mark Anthony P. Tamayo on October 10,2019
The long awaited guidelines for transfer pricing (TP) examinations was recently issued by the Bureau of Internal Revenue (BIR) under Revenue Audit Memorandum Order (RAMO) 1-2019 dated Aug. 20, 2019.
It is basically a manual of standardized procedures and techniques to be adopted by BIR officers in the conduct of their audit of taxpayers with related party or intra-firm transactions. The main purpose of a TP audit is to test the application of the arm’s-length standard and the principles under Revenue Regulations (RR) 2-2013.
RR 2-2013 essentially follows the Organization for Economic Cooperation and Development (OECD) guidelines that adhere to the internationally accepted “arm’s length” principle (ALP). Various TP methods were identified in the guidelines and these methods shall be used during a TP audit to determine which is the most appropriate to the facts and conditions of the transactions.
The test of application of ALP generally requires a comparison of the conditions of a taxpayer’s-controlled transaction with conditions of comparable uncontrolled transactions.
Coverage of RAMO 1-2019 (TP audit guidelines)
RAMO 1-2019 applies to controlled transactions where at least one party is assessable or chargeable to tax in the Philippines. The transactions, subject of review, include, among others, sale, purchase, transfer and use of tangible and intangible assets, provision of intra-group services, interest payments, and capitalization between related/associated parties.
It also covers transactions between a Philippine branch (considered a permanent establishment in the Philippines under tax treaties) and its head office or other branches. A Philippine branch is treated as a separate and distinct entity from its head office or other related branches/ subsidiaries for tax purposes.
In instances where the BIR finds that a price in a controlled transaction is not compliant with the ALP, it is mandated under the rules to make the appropriate adjustments to reflect, among others, the arm’s length price for that transaction by either substituting or imputing the price.
On supply of imported goods
Specifically, for the supply of goods, adjustments may be made by the BIR if the consideration is less than that would have been received (or receivable) in an arm’s length arrangement. A lower transfer price (as a result of the downward adjustment) results to a higher taxable income. Thus, an adjustment will be proposed if the price is deemed excessive. As a consequence, this may result in deficiency income tax (from a disallowed or lowered purchase price), plus penalties.
And as we know it, the power to conduct an audit does not belong solely to the BIR, but also to the Bureau of Customs (BoC).
For customs purposes, the price of imported goods (as declared) is generally respected as long as the same has not been influenced by the relationship of the parties. Otherwise, the BoC, either at the border (before imported goods are released from customs custody) or during post clearance audit (PCA), may disregard the declared price of the importer and proceed to apply alternative customs valuation methods in their sequential order.
The higher the price of imported goods, the higher the customs value and the corresponding customs duties and value added tax (VAT) on importation would be. It is the inherent interest of the BoC to review and challenge the correctness of declared prices of imported goods with the end goal of protecting the revenue of the government.
Upgrade or downgrade?
Both TP and customs valuation rules fundamentally require that an “arm’s length” or “fair” value be set for cross-border transactions between related parties.
The evolving quest to harmonize both rules, however, continues to present gray areas that need to be clarified.
If the purchases relate to previously imported goods (that had been the subject of an upgrade in price by the BOC that resulted in the payment of additional duty and taxes), what would be the possible consequence if, on the other hand, the BIR during audit subsequently deemed said transfer price overstated by a taxpayer?
Would the taxpayer be required to pay the deficiency taxes as a result, for instance, of a downward adjustment in transfer price? Or, does it mean that the value of the imported goods (as upgraded by the BOC) was erroneous and, therefore, could be the subject of a possible refund of duties and taxes?
On the other hand, in a scenario where the transfer price was satisfactorily defended by the taxpayer during BIR audit (but nevertheless is being raised as an issue by the BOC), can the importer-auditee now raise this as a defense to counter said valuation issue raised by the BOC?
Related to the above is the basic concern on whether the BOC will accept values determined pursuant to a TP study or information. Will the BIR do the same and accept values computed in accordance with customs valuation rules? (Please see my articles published in the Manila Times on March 10 and 15, 2018).
As the gap between the TP and customs rules presents a serious concern, supplemental guidelines, perhaps in the form of a joint BIR and BOC order, must be issued in order to harmonize and converge the application of these rules.
As RAMO No 1-2019 comes into full force, we expect more and more legal issues that must be clarified and resolved.
TP is a major concern for business entities dealing with related companies. RAMO 1-2019 alerts the taxpayers on how the BIR would undertake the testing of application of ALP to related transactions. It is necessary for taxpayers to maintain relevant TP documentations and information to serve as a defense in case of TP adjustments.
On the other hand, the BOC is mandated to strictly apply rules on valuation on imported goods. Importers are thus expected to have relevant documents to support their declared prices of imported goods.
The logical thing to do for taxpayers and importers with related party transactions is to prepare for audit to avoid significant risk of penalties. Compliance with the rules coupled with audit readiness is definitely the key.