In the Strategic Plan of the Bureau of Internal Revenue (BIR) for 2019-2023, one of its priority programs is to implement Advance Pricing Arrangements (APAs) to address the country’s growing transfer pricing concerns, especially in relation to base erosion and profit shifting schemes.
It was 1987 when the Japanese tax authority pioneered the concept of APAs, a year ahead of the US tax authority’s implementation of its APA program. In Southeast Asia, Singapore was the first country to introduce APA guidelines in 2006. Meanwhile, in the Philippines, the issuance of BIR Revenue Regulations (RR) No. 2-2013, or the Transfer Pricing (TP) Guidelines, officially recognized the concept of APAs. The BIR immediately started drafting the implementing regulations for APAs the following year. However, with little luck on the drawing board, the Philippines today remains one of the few Southeast Asian nations that do not have APA guidelines and procedures in place.
Nevertheless, recent developments have demonstrated the BIR’s drive to fortify TP regulation. In 2019, the BIR issued Revenue Audit Memorandum Order No. 1-2019 (TP Audit Guidelines), which provides standardized audit procedures and techniques that revenue officers will follow in the audit of taxpayers with related party transactions. Most recently, the BIR issued RR No. 19-2020, which reinforces the TP rules by requiring affected taxpayers to submit the new BIR Form No. 1709 or Information Return on Related Party Transactions. Along with the BIR’s current momentum in the field of transfer pricing, the APA regulations could likely soon be issued as it would help deal with the increasing complexities in transfer pricing.
A taxpayer may ask, “What is an APA?” and “How will it help my business?” An APA would be relevant to companies that have related party transactions, which under current TP regulations, should comply with the arm’s length principle. At present, TP issues besetting a company would generally arise at the time the BIR conducts an audit. Even though a company may have prepared proper documentation to support its TP policy, the BIR is free to challenge the company’s chosen TP method and TP analysis in determining arm’s length prices during an audit. In such a case, the taxpayer would still need to defend the soundness of its TP method and analysis; failing this could potentially lead to deficiency tax assessments that can have a devastating impact on the business.
That is where APAs would come in handy. APAs present an alternative to being subjected to traditional audit techniques, which typically check for whether past transactions of the taxpayer reflect arm’s length prices. Akin to securing a tax ruling from the BIR, an APA would significantly diminish the uncertainty of the taxpayer, as it could forestall TP disputes from arising. As the name implies, the process involves determining the criteria for applying the arm’s length principle in advance of those transactions taking place. In other words, an APA serves as a dispute avoidance mechanism where the tax authority and the taxpayer would agree on the most appropriate TP method in advance of the occurrence of the related party transactions. While this does not necessarily mean that a taxpayer who voluntarily submits an APA application is no longer subject to audit, the risk of scrutiny by the BIR for covered related party transactions is substantially reduced.
The taxpayer typically goes through five phases in an APA application, which include: (1) Consultation upon submission of a written request to the tax authorities on the scope of the APA; (2) Submission of the official APA file; (3) Assessment of the adequacy and objectiveness of the information provided by the taxpayer to evaluate the pricing method; (4) Discussion and negotiation of the APA file; and (5) Conclusion and circulation of the APA after the tax authorities and the taxpayer have agreed on all matters in the draft APA.
An APA may either be unilateral — one involving the taxpayer and the BIR only — or bilateral/multilateral — involving the taxpayer, the BIR, and one or more foreign tax treaty partners.
Notably, one of the main concerns that taxpayers may have as regards APAs is the time and cost of lodging a successful application, which is determined by factors such as the type of APA requested, the complexity of the transactions involved, the quality of the documents submitted by the taxpayer, and so on. These concerns make it imperative for the taxpayer to check that his efforts in applying for an APA will be rewarded commensurately by the expected benefits to be derived from it. Only then would it make good business sense to go through the unarguably long process, which as experienced by other countries, could take as long as five years in the case of multilateral APAs.
Another point of concern for taxpayers is that even after the time-consuming process of application, tax authorities would typically still require the preparation of an annual report. While the purpose of this is to establish compliance with the terms, conditions, and critical assumptions of the APA throughout its effective period, the same ought to be kept at a minimum to lessen the burden on the worn-out taxpayer.
Applying for and maintaining an APA requires substantial effort and cost on the part of the taxpayer. Hence, pursuing it should be carefully weighed against the time and budget expended if the taxpayer just opts for the traditional TP documentation and audits.
Nevertheless, there is no doubt that having APA regulations is a step in the right direction. Not only does it allow the taxpayer to gain more stability in the treatment of its related party transactions, on the flip side, the BIR can also encourage upfront tax compliance. With the completion of the BIR’s APA regulations within reach, we hope to see this “win-win” scenario finally realized soon.
The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.
Karen S. Pascual is a Senior Associate at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.
+63 (2) 8845-2728