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Transfer pricing: related party transactions now made known
14 Jul 2020Humanity has a natural desire to know about its ancestry and to keep the family name alive. Over and above the inclination of man to keep records of births and relationships, genealogy has been critical to chronology, particularly in the early years of human history.
In ancient law, genealogical records were essential to establish tribal relationships for the division of land. As the ancient law prohibited marriage within certain degrees of consanguinity or affinity, it was necessary to have a record and knowledge of genealogical relationships.
Similarly, in the business world, the proper reporting of related party transactions (RPTs) to government authorities serves an important purpose — to mitigate, if not to eliminate, the possibility of tax evasion.
In Revenue Regulations (RR) No. 19-2020, the Bureau of Internal Revenue (BIR) acknowledges that transactions around the world have become more complex and have been subject to abuse by taxpayers with intent to evade taxes by concluding transactions at unreasonable prices, resulting in the reduction of the tax base. This usually happens between related parties. Significant risks arise when RPTs are not conducted at arm’s length and are used as a conduit to channel funds from the company to another related party. It includes the risk of material misstatement in the financial statements resulting from inappropriate accounting, and non-identification or nondisclosure.
Philippine Accounting Standards (PAS) 24 on Related Party Disclosures must be effectively implemented to address such risks. As such, RR No. 19-2020 requires the submission of BIR Form No. 1709 and its supporting documents in compliance with the guidelines prescribed by the related revenue issuances on submitting the necessary attachments to the Annual Income Tax Returns. BIR Form No. 1709 — Information Return on Related Party Transactions (Domestic and/or Foreign) replaces BIR Form No. 1702H — Information Return on Transactions with Related Foreign Persons.
Under RR No. 19-2020, RPT refers to the transfer of resources, services, or obligations between a reporting entity and a related party, regardless of whether a price is charged. Examples of RPTs are purchases of sales of goods (finished or unfinished), rendering or receiving of services, leases, transfer of research & development, and settlement of liabilities on behalf of an entity.
An entity is related to a reporting entity if any of the following conditions apply: (1) the entity and the reporting entity are members of the same group; (2) one entity is an associate or joint venture of the other entity; and (3) the entity, or any member of a group of which it is a part, provides key management personnel services to the reporting entity or the parent of the reporting entity.
In all cases, the substance of the relationships between entities, and not merely the legal form, should be taken into account.
On the other hand, a person or close member of that person’s family is related to a reporting entity if that person: (i) has control or joint control of the reporting entity; (ii) has significant influence over the reporting entity; or (iii) is a member of the key management personnel of the reporting entity or a parent of the reporting entity.
RR No. 19-2020 mandates the reporting entity or a related party to observe two crucial requirements. First, there must be separate disclosures on transactions and outstanding balances for various categories, such as the parent, entities with joint control or significant influence over the entity, and key management personnel and other related parties. Second, the following information shall be provided for the said categories: (1) the amount of the transactions; (2) the amount of outstanding balances, including commitments, and their terms and conditions; (3) provisions for doubtful debts related to the number of outstanding balances; and (4) the expense recognized during the period for bad or doubtful debts due from related parties.
The procedures and guidelines for filling out BIR Form No. 1709 include: (1) the “business overview of the ultimate parent company” referred to in Part IV (A) of the form shall include the profile of the multinational group to which the taxpayer belongs; (2) the “functional profile” referred to in Part IV (B) of the form shall include a broad description of the taxpayer’s business operations, as well as the business of the related parties with whom the taxpayer has transacted; and (3) the required attachments are (a) certified true copy of the relevant contracts or proof of transaction; (b) withholding tax returns and the corresponding proof of payment of taxes withheld and remitted to the BIR; (c) proof of payment of foreign taxes or ruling duly issued by the foreign tax authority where the other is a resident; and (d) certified true copy of advance pricing agreement or any transfer pricing (TP) documentation.
Previously, under RR No. 2-2013 or the Transfer Pricing Guidelines of 2013, TP documentation was not required to be submitted with the tax returns. However, as stated in the new guidelines, a certified true copy of the advance pricing agreement or any TP documentation must be attached to BIR Form No. 1709. Hence, taxpayers having RPTs, but without any TP documentation, are advised to start preparing such documents that would justify that the RPTs are done at arm’s length. Such preparations may be done internally or outsourced to a third-party service provider.
RR No. 19-2020 shall take effect after 15 days following its publication in a newspaper of general circulation, which took place on July 10. Nonetheless, taxpayers must be alert to subsequent BIR issuances that could discuss the covered period for fiscal years, if any.
The regulations enjoin tax examiners to examine RPTs thoroughly and ensure that revenues are not understated and that expenses are not overstated in the financial statements.
With RR No. 19-2020, it is hoped that RPTs will be subject to proper taxes that could, in turn, support the government’s efforts to ease the impact of the current pandemic. Therefore, it is crucial to accurately record and report RPTs, especially from a tax perspective.
In the same vein, having an account of pedigrees of ancestors and relatives helps us understand and appreciate our history and heritage. Those who were inspired to record such accounts believed that their God, Jehovah, is the great Genealogist or Keeper of records of creation, beginnings, birth, and descent. He is “the Father, to whom every family in heaven and on earth owes its name.” — Ephesians 3:14,15.
Let’s Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.
Renato R. Balisacan, Jr. is a manager of the Tax Advisory & Compliance division of P&A Grant Thornton, the Philippine member firm of Grant Thornton International Ltd.
As published in BusinessWorld, dated 14 July 2020