By: Mark Anthony P. Tamayo on October 17,2019

MULTINATIONAL companies engaged in related party transactions normally set up their respective transfer pricing (TP) policies for the purpose of achieving their specific operating profit margin targets. It is common though that the target would materially fall outside of the arm’s-length range at year-end. This is due to myriad reasons relating to unexpected changes in, among others, market developments, regulations, competition, or in economic circumstances at the regional or country specific level.

The resulting deviations between the projection and actual year-end financial results may invariably require retroactive (post) price, or true up adjustments to the transfer prices for purposes of reporting their taxable income in accordance with the “arm’s length principle” (ALP).

Under TP rules, the ALP requires that prices in transactions between related parties be set at a level that would have occurred in the same transactions had they taken place between unrelated parties.

To ensure compliance with the ALP, Bureau of Internal Revenue (BIR) revenue officers are tasked, under the recently issued Revenue Audit Memorandum Order (RAMO) 1-2019 (TP Audit Guidelines), to closely scrutinize related party transactions with the end goal of issuing deficiency income tax assessments. (Please see my article published in the Manila Times on Oct. 10, 2019).

RAMO 1-2019 implements Section 50 of the Tax Code, as amended, which gives the BIR Commissioner the power to allocate income and expenses between or among related parties and taxpayers, or make transfer pricing adjustments to reflect the true taxable income of taxpayers.

While retroactive adjustments serve to avoid (or at least lessen) the risk from an income tax perspective, it is worthy to stress that they may likewise have a concomitant risk from a customs perspective.

Thus, proper evaluation of the nature of the retroactive adjustment/s must be promptly conducted in order to determine whether the same would create an underlying impact on the declared price on past importations vis-à-vis the customs duties and taxes previously paid.

Unfortunately, the impact of such adjustment/s is usually highlighted and addressed only during customs audit.

Effects of a retroactive price adjustment

Goods imported into the Philippines is valued, for customs purposes, based on their transaction value (TV). Section 701 of the Customs Modernization and Tariff Act (CMTA) defines TV as the “price actually paid or payable” for the goods when sold for export to the Philippines, subject to certain dutiable elements.

The TV system seeks to capture the total payment, directly or indirectly, made (or to be made) by the buyer to (or for the benefit of) the seller for the imported goods.

Thus, in a retroactive upward price adjustment (actual operating profit margin exceeds the target), determination should be made whether any additional payment/s by the buyer to its related supplier/s would relate to previous import transactions.

The procedures to be taken to effect and implement the effects of the retroactive adjustments must be carefully evaluated.

Notably, where the adjustments are recorded in the accounts of the taxpayer and a debit or credit note issued (in respect to the adjustment in price of previously imported goods), such adjustments may be considered to have an impact on the “price actually paid or payable” for customs valuation purposes.

As a consequence, any adjustment that is linked to the price paid for previously imported goods could imply that the originally declared values of said goods at the time of importation may not have been correct and thus, need to be adjusted.

In the case of an upward adjustment, the declared price of the goods previously imported should be adjusted to the extent of the additional payment/s made. This would correspondingly result to the payment of additional duties and taxes.

Remedial measure

In case the retroactive adjustment would result to a deficiency exposure, the importer may disclose the exposure and settle the same through the Bureau of Customs’ (BoC) Prior Disclosure Program (PDP). The PDP is a compliance and revenue measure, whereby importers are accorded the chance to report plain errors or innocent mistakes in the goods declaration.

Importers could avail of the PDP either before or after receipt of an audit notification letter (ANL).

For PDP availment prior to receipt of ANL, there is a waiver of the administrative fine imposable (i.e., 125 percent of the revenue loss in case of negligence) and the applicant would just have to pay the basic deficiency duties and taxes due, plus 20 percent interest.

For PDP availment after receipt of ANL, the applicant would have to pay the basic deficiency duties and taxes with a reduced penalty of 10 percent, plus 20 percent interest.

Proactive measure

As an alternative to the PDP route, the importer may adopt a more proactive measure by exploring the filing of a provisional goods declaration (PGD) at the time of importation.

The lodging of a PGD is allowed under the CMTA on instances where an importer does not have all the information, or supporting documents required to complete a goods declaration at the time of importation.

As a requirement, however, an undertaking must be executed to complete such additional information or supporting documents within a period of 45 days (extendable for another 45 days) counted from lodging of the PGD.

A PGD is subject to a tentative assessment of duties and taxes and shall be deemed completed upon final readjustment and submission of the additional information or documentation.

Since retroactive adjustments typically take place after the importation of concerned goods, the filing of a PGD could be explored by the importer at the time of importation.

Closer scrutiny on related party transactions

Both the BIR and BoC have clear authorities to challenge the prices relating to cross border transactions between related parties. The presence of a link between the parties in a transaction serves to alert these government agencies to the fact that there may be a need to have a deeper inquiry surrounding their transactions.

It is necessary, therefore, that companies address and comply with both TP and customs rules. These rules are distinct from each other and yet inseparable.

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