Transfer Pricing Benchmarking Study in the Philippines: A Practical Guide

A transfer pricing benchmarking study is the documentation exercise by which a Philippine taxpayer proves that its transactions with related parties were priced at arm's length. Under Revenue Regulations No. 2-2013, the Bureau of Internal Revenue adopts the arm's length principle and prescribes a three-step approach: (1) conduct a comparability analysis; (2) identify the tested party and the appropriate transfer pricing method; and (3) determine the arm's length results. The study searches for comparable transactions between independent parties, adjusts for differences, applies a transfer pricing method, and tests whether the taxpayer's price or margin falls within an arm's length range.

What the arm's length principle requires

The arm's length principle requires that a transaction with a related party be made under comparable conditions and circumstances as a transaction with an independent party. Where associated enterprises derive profits above or below comparable market levels solely because of their special relationship, those profits are deemed non-arm's length, and the BIR may adjust taxable profits.

Two or more enterprises are associated if one participates directly or indirectly in the management, control, or capital of the other, or if the same persons participate in both. A controlled transaction is any transaction between associated enterprises. RR No. 2-2013 applies to both cross-border and domestic transactions between associated enterprises.

Step 1: Conducting the comparability analysis

Comparability analysis identifies comparable situations or transactions undertaken by independent parties against which the related-party transaction or margin is benchmarked. A comparable uncontrolled transaction may be an internal comparable (between one party to the controlled transaction and an independent party) or an external comparable (between two independent parties, neither of which is a party to the controlled transaction).

The analysis examines three aspects:

• Characteristics of goods, services, or intangible property — physical features, quality and reliability, volume of supply, nature and extent of services, and the type and duration of intangible property.
• Functions, risks, and assets — a functional analysis comparing economically significant functions (design, manufacturing, distribution, sales, marketing, logistics, financing), assets employed, and risks assumed such as market, financial, credit, and research and development risks.
• Commercial and economic circumstances — geographic location, market size, extent of competition, consumer purchasing power, government regulation, and business strategies.

Step 2: Identifying the tested party and the method

The tested party is the entity to which a transfer pricing method can be most reliably applied and from which the most reliable comparables can be found. The BIR requires sufficient and verifiable information on that entity.

The BIR does not prefer any single method. The method that provides the most reliable measure of an arm's length result should be used, considering the strengths and weaknesses of each method, the nature of the controlled transaction, the availability of reliable information, and the degree of comparability. The methods under Section 10 of RR No. 2-2013 include:

• Comparable Uncontrolled Price (CUP) Method — compares the price charged in a controlled transaction against the price in a comparable uncontrolled transaction.
• Resale Price Method (RPM) — starts from the resale price to an independent party and deducts an appropriate gross margin.

The selection of a Profit Level Indicator (PLI) — such as return on costs, return on sales, or return on capital employed — depends on the characterization of the business, availability of comparable data, and the reliability of the measure.

Step 3: Determining the arm's length result

Once the method is selected, it is applied to independent-party data to arrive at the arm's length result. Because a single figure is often difficult to establish, the analysis generally produces a range of ratios. If the taxpayer's price or margin falls within the arm's length range, no adjustment is made. If it falls outside, the taxpayer must present proof that its result satisfies the arm's length principle; otherwise, the BIR determines the point within the range to which the transaction will be adjusted, sometimes using measures of central tendency such as the median or weighted average.

Comparability adjustments

Differences between the comparables and the tested party must be identified and adjusted for. Adjustments include accounting adjustments and function or risk adjustments. Adjustments should be avoided where the basis for comparability is only broadly satisfied, where they are excessive, where the difference does not materially affect comparability, or where they are highly subjective.

Who must prepare transfer pricing documentation

Under Revenue Regulations No. 34-2020, preparation of Transfer Pricing Documentation (TPD) is mandatory if the taxpayer meets any of these conditions: annual gross sales or revenue exceeding P150,000,000 and total related party transactions exceeding P90,000,000; sale of tangible goods to the same related party exceeding P60,000,000; service, interest, intangible, or other related party transactions with the same related party exceeding P15,000,000; or a TPD was required in the immediately preceding taxable period for exceeding these thresholds. The TPD is not attached to the RPT Form but must be made available during audit. Even taxpayers not required to prepare a TPD must still prove that their related party transactions were conducted at arm's length, since the burden of proof rests on the taxpayer.

Frequently asked questions

Is a benchmarking study the same as transfer pricing documentation? The benchmarking study is the core analytical component of the TPD. It contains the comparability analysis, the selection of the tested party and method, and the arm's length result.

What is the materiality threshold for preparing a TPD? The thresholds are set out in RR No. 34-2020, including the P150,000,000 gross revenue and P90,000,000 related party transaction thresholds.

Can the BIR still audit a taxpayer that is not required to prepare a TPD? Yes. The BIR retains the right to conduct a transfer pricing audit against taxpayers with related party transactions, regardless of whether they are required to file the RPT Form or prepare a TPD.

Practical takeaways

• The arm's length principle is the standard, and the BIR applies a three-step approach: comparability analysis, identification of the tested party and method, and determination of the arm's length result.
• Comparability analysis must cover product characteristics, functions, risks and assets, and commercial and economic circumstances.
• No single transfer pricing method is preferred; choose the method that produces the most reliable result.
• Comparability adjustments should be made only where they demonstrably improve comparability.
• The burden of proving arm's length pricing rests on the taxpayer, even where a TPD is not mandatory.

Primary sources

The rules discussed above are drawn from the following issuances, embedded here in full for your reference.

RR No. 2-2013 — Prescribes the transfer pricing guidelines (Published in Manila Bulletin on January 25, 2013) Digest | Full TextOpen in Law LibraryDownload PDF

RMO No. 26-2020 — Prescribes the use of the revised Exchange of Information Manual, amending for this purpose Revenue Memorandum Order Nos. 2-2013 and 3-2013Open in Law LibraryDownload PDF

RMC No. 54-2021 — Clarifies certain provisions of Revenue Regulations No. 34-2020 Digest | Full TextOpen in Law LibraryDownload PDF

This article is general information and not legal advice. For your specific situation, consult a lawyer or ask ASG Legal AI.