As tax practice evolves, corporate practices and arrangements, especially those of multinational companies, face challenge from tax authorities. Particular scrutiny has been devoted to transactions that result in minimized tax liability or shifting of profits between related companies.
One of the most common transactions among members of multinational groups is the provision of services. In 2015, Base Erosion and Profit Shifting (BEPS) final reports were released tackling transfer pricing (TP) issues categorized into 15 Action Plans. The BEPS Project aims to address and prevent tax planning strategies that exploit gaps and mismatches in tax rules to make profits somehow “disappear” for tax purposes, or to shift profits to low-tax locations even when there is minimal or no economic activity, resulting in little or no corporate tax being paid.
Action Plans 8-10 on Aligning Transfer Pricing Outcomes with Value Creation specifically covers intra-group services. The Bureau of Internal Revenue (BIR) issued Revenue Audit Memorandum Order No. 1-2019 or the Philippine TP Audit Guidelines which provide the framework and guidance for TP examinations, anchored on the provisions of Action Plans 8-10 and existing Organisation for Economic Co-operation and Development (OECD) TP Guidelines. The Philippine TP Audit Guidelines apply to several controlled transactions including intra-group services.
There are two main issues in analyzing intra-group services from a TP perspective. First, whether the intra-group services have been provided (benefit test). Second, whether the charge for such services is at arm’s length.
For the first point, the determination of whether services have been rendered depends on whether the activity performed by one enterprise in favor of another has economic or commercial value to enhance the latter’s commercial position. A service can be considered as having economic value if it would have been willingly paid for had it been performed by an independent party, or performed in-house for itself.
An example of intra-group services is centralized services or those services centralized in the parent company of a group, or in one or more group service centers, and made available to the group. These services generally include administrative services such as accounting, auditing, legal, computer services, as well as customer-related service and call centers, among others.
In applying the benefit test, the Philippine TP Audit Guidelines and the OECD Guidelines provided several services which would not be considered valid services and thus, should not be remunerated. These services include shareholder and duplicative services. Shareholder services are normally performed by the parent company or regional office solely because of its ownership interest in one or more group members. These services generally cover functions related to reporting requirements of the parent company and consolidation of reports, the juridical structure of the parent company (e.g., shareholder meetings and issuance of shares), among others. On the other hand, duplicative services, as the term itself denotes, refers to activities undertaken by a group member that merely duplicates a service that another group member is already performing for itself, or that is being performed for such entity by a third-party service provider.
Anchoring on the logic of the benefit test where an economic value must be established, taxpayers must answer the question — are these the types of activities that independent enterprises would be willing to pay for or to perform for themselves?
Once it has been established that services are rendered intra-group, it is necessary to determine whether the remuneration is in accordance with the arm’s length principle. This means that the charge for intra-group services should be that which would have been made and accepted between independent parties in comparable circumstances. In determining the arm’s length price, the perspective of both the service provider and service recipient must be considered, especially the value of the service to the recipient and how much an independent party would be willing to pay for the same services in comparable circumstances, as well as the costs incurred by the service provider.
On the cost allocation aspect, the existing guidelines provided two methods to determine the arm’s length charge: (1) direct charge method and (2) indirect charge method. The direct method can be used when the service arrangements on which the charges are based can be clearly identified. Otherwise, an indirect charge method can be used, as in cases where it would be difficult to apply the direct charge method.
In either case, the next question would be whether the charge should have a mark-up. To answer this, one may put himself in the shoes of an independent party and consider that independent parties would normally seek to charge for such services to generate profit rather than provide the services at cost, especially if the rendered services involve high-level or technical services.
Further, the functions performed and benefits associated with the provision of the services should also be considered in determining the arm’s length charge. It is worth noting that in pricing the services between members of a group, it would not be appropriate to increase the charge solely for the purpose of making sure that the associated enterprise makes a profit, especially if a market price is available.
Currently, TP audits in the Philippines are embedded in the regular tax audit. Considering this, it is important for taxpayers to keep the documentation and supporting analysis for service arrangements with related parties to defend the reasonableness and rationale of entering into service transactions with affiliates. Particularly, taxpayers must ensure that the basis for their TP policy is well-documented, including the relevant agreements, amount of cost actually spent, and supporting analysis for the mark-up or charge applied.
Given that intra-group service is one of the main transactions covered by the Philippine TP Audit Guidelines, taxpayers must address any potential issues on its TP arrangements as early as possible. As the saying goes, “Solve the problem or leave the problem. Do not live with the problem.”
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.
Joyce Anne Boaloy is a manager at the Tax Services department of Isla Lipana & Co., the Philippine member firm of the PwC network.
joyce.b.boaloy@pwc.com