My son, Khalil, will celebrate his 17th birthday next week. He now stands at five feet and 10 inches and is in senior high school. I had Khalil when I was very young. I was then a pregnant adolescent, still navigating through college, definitely lost and amiss. It was a very difficult period in my life. Without the guidance and support of my family and friends, I am not sure if I would have been able to get through such challenging times.
It is in the middle of this reminiscence that I thought about the topic for this article. Tax is a difficult topic in itself, but recent developments in our tax landscape can easily make one feel lost and amiss. Just like difficult times in our lives, however, we have to find the support and guidance that will help us navigate through these never-ending challenges.
The Bureau of Internal Revenue (BIR) recently issued the transfer pricing (TP) audit guidelines, placing TP considerations front and center. To the uninitiated, TP refers to the setting of prices for transactions between related parties, and applies to the sale, purchase, transfer, and use of tangible and intangible assets, the provision of intra-group services, interest payments, and capitalization. The cornerstone of transfer pricing is the “arm’s-length principle,” according to which, the conditions of a transaction between related parties may not differ from those of a transaction between independent companies under similar circumstances. Hence, profits and expenses must be adjusted to reflect the conditions that would have been obtained between independent companies for comparable transactions and under comparable circumstances.
With TP audits, we can expect that noncompliance with TP regulations will give rise to deficiency income tax assessments, as the BIR may either impute additional income or disallow part of the taxpayer’s expenses. Let us note that TP is not an exact science; hence, tax authorities may claim more leeway in imposing TP adjustments and recalculating taxes payable. Companies that are part of a group must, therefore, have strong arguments — organized in their TP documentation — that intra-group transfer prices are arm’s-length and not used to artificially cut revenue or increase expenses.
For many companies, this is a difficult development. Additional costs will be incurred in ensuring proper TP documentation and maintaining proper accounting systems to support them. Studying and analyzing costs in our imperfect market can be very complicated and time-consuming. The lack of publicly available information among unrelated parties makes benchmarking especially problematic. It gets even more difficult when intangibles, such as intellectual property and services, are involved as, really, how do we begin to quantify the value of intangibles?
But let’s face it: compliance with TP regulations is fast becoming a necessity if we want to be ready for the coming TP audits. Compliance means reducing audit controversy and avoiding hefty fines. But more than that, in this day and age when the world is becoming more and more integrated, the call for more ethical TP has become stronger. Many firms face backlash for TP manipulation. Today, TP is evolving into becoming a corporate governance issue.
Interestingly, the increased focus on TP coincides with a relatively recent shift in business ideology. Just a few months back, a group of US corporate leaders voiced the need to move away from the mantra of shareholder primacy toward a new culture of shared prosperity. The Business Roundtable (BRT), an American nonprofit association whose members are chief executive officers of major companies, finally announced that profits for shareholders are no longer the only purpose of a corporation.
In its new formulation of corporate purpose, the BRT declared that “delivering value to customers, investing in employees, dealing fairly and honestly with suppliers, supporting communities and protecting the environment all have equal billing with generating long-term value for shareholders.” But, of course, no matter how big these words are, words alone will not make the change happen.
It may be difficult, but perhaps we can view our compliance with TP regulations as part of this general shift in business objectives. There will be added costs, and perhaps some revenue will be lost. Sacrifices will be necessary to prove our concern for all the firm’s stakeholders, and not just stockholders. Perhaps it is something we can do to create a world where prosperity is indeed shared.
Hopefully, in conducting the TP audits, the BIR will not rely on oversimplified assumptions and focus on short-term collection goals. Rather, we hope that the tax authorities will provide clear guidance to taxpayers on determining acceptable arm’s-length prices.
The coming TP audits may really be trying but, if effectively managed by both taxpayers and tax authorities, it may just encourage companies to trade in a way that maximizes value for the company and society. Difficulties after all, are often the catalysts for our best moments.
I may have gone through one of my most difficult times early in my life but I would not trade it for any comfort or ease, as it has also brought me one of my greatest joys.
To my Khalil, happy birthday! I know commuting without the LRT is difficult, but just take the jeep and learn to be more street smart. I pray that, as you have always inspired me, you too will always have the inspiration, strength, and hope to live a good and purposeful life. And that you may you live in a world that is more equitable and prosperous. ILY!
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.
Diana Elaine Bataller-Simbulan is a tax manager of Tax Advisory & Compliance division of P&A Grant Thornton, the Philippine member firm of Grant Thornton International Ltd.