Tax Articles

Transfer Pricing Audit Looms

By Atty. Irwin C. Nidea Jr.

Transfer pricing audit is inevitable. Tax authorities now have the preliminary information that they need to choose what companies to audit. BIR Form 1709, which has been submitted together with the annual income tax return, is a powerful tool for the BIR to determine what are suspicious related party transactions. The question now is, how will the BIR perform the audit, and what should a taxpayer expect?

Before the release of revenue regulations and circulars in 2020 and 2021 requiring the submission of transfer pricing documentation and BIR Form 1709, the BIR first issued guidelines in conducting a transfer pricing audit in 2019 (RAMO 1-2019). But some requirements in the said RAMO may have been amended by recent issuances.

According to RR 34-2020, it will all begin when a company receives a letter of authority (LOA) for the audit of all internal revenue taxes. No special LOA will be released just for transfer pricing audit. So, when a taxpayer receives an LOA for the audit of all internal revenue taxes, it must submit a transfer pricing documentation, when required.

But a company is not mandated to submit a transfer pricing documentation if it does not reach the relevant thresholds as required under RR 34-2020– annual gross sales/revenue for the taxable period exceeding Php 150 Million and the total amount of related party transactions with foreign and domestic related parties exceeding Php 90 Million; if the transactions involve the sale of tangible goods in the aggregate amount exceeding Php 60 Million or if the transactions involve a service transaction, payment of interest, utilization of intangible goods or other related party transaction in the amount exceeding Php 15 Million. Will the company still be required to justify its transfer pricing policy?

Unfortunately, yes. The most recent transfer pricing issuance, i.e., RMC 54-2021, states under Q and A No. 23 that the BIR will conduct an initial transfer pricing risk assessment, identify high-risk taxpayers, and make an informed decision whether or not to conduct a transfer pricing audit of a particular entity or transaction. This notwithstanding, the BIR still retains the right to conduct transfer pricing audit against taxpayers with related party transactions irrespective of whether or not they are required to file BIR Form 1709 or prepare a Transfer Pricing Documentation.

So, even if a company is not required to file BIR Form 1709 or prepare a transfer pricing documentation, the BIR still has the right to perform a transfer pricing audit. If the LOA that a company receives specifies the submission of the documents required under RAMO 1-2019, then it will be caught flat footed for it may have no transfer pricing policy or documentation to submit.

This is the reality for some companies that received LOAs for taxable year 2019 and prior years. Even though thresholds on who are required to submit transfer pricing documentation and file BIR Form 1709 have only been issued in 2020 and 2021, some companies that received LOA for 2019 and prior years, are being required to submit the contents of a transfer pricing documentation as enumerated under RAMO 1-2019. The following information are required by the BIR to be submitted within 5 days from notice: information about the related party transactions; segmented financial statements, functions, assets and risks (FAR) analysis, characteristics of a business, comparability analysis, transfer pricing method used, comparables used, determination of the fair prices/profits in the related party transactions.

This means that the BIR has already started transfer pricing audit. But many taxpayers have only begun preparing their transfer pricing documentation in 2020 because it is only at this time that the BIR has categorically required the submission of transfer pricing documentation. Does the BIR have basis in doing a transfer pricing audit for 2019 and prior years? Unfortunately, yes. Section 50 of the 1997 Tax Code and Revenue Regulations 2-2013 prescribe that related party transactions must always be at arm’s length. It has always been the rule. But it has never been enforced.

What is the consequence if a company is not able to submit the documents required under RAMO 1-2019? Aside from imposing penalties, the BIR can impute the transfer price that it finds reasonable, and it is now up to the taxpayer to contest the same.

For taxable year 2020 onwards, a taxpayer has 30 days (extendible for another 30 days on meritorious grounds), to submit a complete transfer pricing documentation once it receives an LOA requiring the submission of the same. Taxpayers that has prepared transfer pricing documentation will not be on the defensive. The burden is with the BIR to prove that the company’s related party transactions are not within arm’s length.

Transfer pricing will be a staple revenue source of the BIR in the years to come. If you want your company to be part of that revenue source, do not prepare for the inevitable.