A year ago, the Bureau of Internal Revenue (BIR) issued Revenue Regulations (RR) No. 19-2020, prescribing the use of BIR Form No. 1709 (Related Party Transactions Form). The RR requires all taxpayers with related party transactions to submit the form and other supporting documents as an attachment to their annual income tax return (AITR) for the taxable year (TY) 2020 and subsequent TYs.
Following this initiative, the BIR received a lot of clamor from taxpayers, particularly on incurring additional costs just to comply with the new RR. In response, the BIR issued RR 34-2020 in December 2020 to streamline the guidelines by providing safe harbors and materiality thresholds for this transfer pricing (TP) requirement. Based on this RR, the TP Documentation (TPD) and other supporting documents no longer needs to be attached to the form but must be submitted within 30 days upon request during an audit. Revenue Memorandum Circulars (RMC) were also released to address frequently asked questions on the Form and TPD submission — the most recent one being RMC 54-2021.
To clarify the criteria set under Section 2 of RR 34-2020, RMC 54-2021 requires a taxpayer to file the form if: it is required to file an AITR, it has transactions with a domestic or foreign related party during the concerned TY, and it falls under any of the following categories: (a) large taxpayers; (b) taxpayers enjoying tax incentives; (c) taxpayers reporting net operating losses for the current TY and immediately preceding two consecutive TYs; or (d) a related party that has transactions with either (a), (b) or (c).
Those required to file the Form are required to prepare a TPD should they breach any of the following materiality thresholds under Section 3 of the RR, namely: (a) annual gross revenue for the TY exceeding P150 million and the total amount of related party transactions exceeds P90 million, (b) sale of tangible goods involving the same related party exceeding P60 million within the TY, (c) service transaction, interest payments, utilization of intangible goods or other related party transactions, involving the same related party, exceeding P15 million within the TY; and (d) if TPD was required to be prepared during the immediately preceding TY for exceeding (a), (b) or (c). Specifically, for the last criterion, a taxpayer required to prepare TPD for breaching any of the materiality thresholds during TY 2020 must also prepare an updated TPD for TY 2021 if it is still required to file the form.
All related party transactions must be disclosed in the form; estimated amounts are not acceptable. Since the BIR primarily refers to the audited financial statements (AFS) and the TPD during audits, it is likewise prudent that the related party transactions as disclosed in the AFS and TPD match those in the form for consistency.
Further, the conditions under Sections 2 and 3 of the RR are interrelated. Thus, a taxpayer may be obliged to submit the form but may not be required to prepare a TPD. Nevertheless, the form alone is a risk assessment tool for the BIR to conduct an initial assessment to identify high-risk taxpayers for TP audits and potential issues on tax and TP compliance.
For instance, questions on whether the taxpayer, who has claimed treaty benefits, has filed or has pending tax treaty relief applications (TTRA), are tip-offs on whether there was compliance with TTRA administrative guidelines for availing of treaty benefits.
Questions covering changes in functional profile and business restructuring are also red flags for TP audits. According to the BIR, business restructuring resulting in a change in the characterization and reduction of profitability is acceptable only with reduced functions, assets, and risks. In case the taxpayer continues to perform/bear the same functions and risks, the assumption is that it should still derive the same level of profitability prior to the restructuring, otherwise, it may entail adjustments during an audit.
Another concern is whether the taxpayer has prepared a TPD for its related party transactions in compliance with RR 2-2013. A “no” answer would give the BIR a hint that the taxpayer’s TP arrangements may be risky or vulnerable to challenges.
Since the materiality thresholds are only relevant in determining who is required to prepare a TPD, the BIR may still challenge taxpayers with related party transactions even if not required to prepare TPDs under the RR. Thus, during an audit, taxpayers should still present sufficient proof that their related party transactions were conducted at arm’s length. Based on experience, the most reliable evidence is a TPD.
After all, the BIR clarified that nothing prevents any taxpayer from preparing and presenting a TPD during an audit to prove that it reasonably assessed its related party transactions to comply with the arm’s length principle. Thus, regardless of the safe harbors and thresholds provided under the RR, it is still advisable to maintain a TPD, not just for reporting and compliance purposes but also for managing any potential TP audit risks in the future.
The first year of implementation may be challenging for some taxpayers as these regulations were issued during the pandemic. However, with a year gone by, taxpayers should already be mindful of the guidelines and risks associated with non-compliance. Now that rules have been streamlined and well-laid, the duty is upon taxpayers to earnestly disclose and ensure that related party transactions are conducted fairly.
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.
Crystabelle Cruz Lucas is a senior manager at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.
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