Transfer pricing and tax avoidance: What does the CITIRA bill say?

Government investment promotion agencies offer tax incentives to attract investors. Many companies, especially those in priority and emerging sectors, benefit from such incentives in the course of doing business. In some cases, companies engage in related-party transactions, such as transactions between a parent company and a subsidiary, or between affiliates. However, according to a Department of Finance (DoF) and Bureau of Internal Revenue (BIR) analysis, such practices may give rise to abusive transfer pricing schemes, deemed to cost the Government billions in lost revenue each year.

Specifically, the DoF identifies transfer pricing abuses to include the corporate practice of shifting profits from a high-tax country to tax havens, as well shifting profits from a corporate taxpayer to its related party located in special economic zones. Because of such practices, the DoF is pushing for the legislative approval of the Comprehensive Tax Reform Program (CTRP), which will prevent income from being shifted among related parties through the inappropriate pricing of related party transactions.

Under Section 50 of the Tax Code (the Philippine Transfer Pricing provision), the Commissioner of Internal Revenue has the authority to review controlled transactions among associated enterprises and distribute, apportion or allocate their income and deductions to reflect the true taxable income of such enterprises.

In the 17^th Congress, a bill was introduced which included a proposal to amend Section 50 of the Tax Code under the current administration’s Tax Reform for Attracting Better and High-Quality Opportunities (formerly known as the TRABAHO Bill or the then CTRP Package 2). The TRABAHO Bill was approved on third reading by the House of Representatives but was not passed by the Senate in the 17^th Congress.

The TRABAHO Bill has since been renamed the Corporate Income Tax and Incentives Rationalization Act (the CITIRA Bill or the now CTRP Package 2). The CITIRA Bill has been re-filed in the 18^th Congress to pursue, among others, the amendment of Section 50. As of this writing, the CITIRA Bill has been approved on third reading by the House of Representatives and has been endorsed to the Senate for its consideration and approval.

FINE LINE BETWEEN TAX AVOIDANCE AND EVASION
The proposed amendment to the current transfer pricing provision emphasizes the prevention of tax avoidance. The proposed amendment defines tax avoidance for purposes of transfer pricing.

Corporate taxpayers often weigh their options when planning to implement their business transactions. In doing so, they may resort to tax avoidance strategies to reduce the amount of tax payable. Tax avoidance per se is not illegal. On the other hand, the intentional and deliberate non-payment of taxes, in an attempt to reduce or eliminate a taxpayer’s liability, is called tax evasion, which is illegal.

An Organization for Economic Cooperation and Development (OECD) Economics Department working paper by Johansson, Skeie and Sorbe reported that all G20 and OECD member countries have implemented transfer pricing rules to prevent related-party taxpayers from manipulating the price of their transactions for tax purposes. Some of these member-countries have anti-avoidance rules against international tax planning by multinational enterprises. The general anti-avoidance rules prohibit an aggressive approach to tax avoidance, with a common thread of adherence to the principle of substance over form. Tax benefits may not be availed of when a related-party transaction lacks economic substance or has no reasonable commercial purpose.

The anti-avoidance rules of the G20 and OECD member countries are generally designed to achieve the following goals: identification of such a scheme or arrangement; quantification of the actual tax benefit or advantage gained from the scheme; and performance of a test to assess if the company gains a clear tax advantage through the scheme. It should be noted, however, that there are differences in the rules for various countries.

STRENGTHENING THE TRANSFER PRICING PROVISION
The CITIRA Bill proposes that the time is ripe for the Philippines to adopt similar anti-avoidance rules to counteract the potential abuse of tax incentives by corporate taxpayers. From a current Philippine tax perspective, the BIR may impose an adjustment to transfer prices affecting the recognition of income or expenses of taxpayers based on its industry-specific arm’s length standards. This imposition may result in deficiency taxes and even possible interest and penalties to be assessed against the taxpayer.

With the proposed transfer pricing amendment to Section 50 of the Tax Code, the CITIRA Bill will vest the Commissioner of Internal Revenue with dual roles: first, to distribute, apportion, allocate, and impute income and deductions; and second, to disregard and counteract tax avoidance arrangements necessary to clearly reflect the income of a corporate taxpayer. The CITIRA Bill also aims to empower the Commissioner to consider the transaction or arrangement as void for income tax purposes.

Under the proposed amendment, tax avoidance will become more clearly defined to include actions that directly or indirectly alter either the incidence of any income tax, or relieve, avoid, postpone, or reduce any liability to pay current or future income tax. Companies with transfer pricing arrangements should note that tax avoidance is presumed to exist in situations where the transaction or arrangement can be proven to be motivated by obtaining a tax benefit or advantage with no commercial reality or economic benefit.

CONSIDERING TRANSFER PRICING RISKS
If and when the proposed amendment to Section 50 of the Tax Code passes into law, we can expect the BIR to take an aggressive approach to transfer pricing. Philippine companies with related-party transactions will have to increase vigilance to potential transfer pricing issues that may have a significant impact on reporting its taxable income. Given the current administration’s drive for tax reform, the passage of the CITIRA Bill into law will further intensify the need for taxpayers to include transfer pricing as a significant part of their tax planning and risk management strategies.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.

Ana Katrina C. Celis-De Jesus is a Tax Senior Director of SGV & Co.