The current Section 50 of the Tax Code (copied from the US Tax Code) is the source of the Bureau of Internal Revenue’s (BIR) authority to reallocate income and expenses between related parties, effectively disregarding contracts and agreements in what is called “sweetheart deals” or “transfer pricing schemes.” Section 50 meant to give full powers to the Commissioner of Internal Revenue to prevent erosion of revenues.
But Section 50 seems weak, from a legal
standpoint, as it is too much of a motherhood statement not strong enough to
call a spade a spade. Not a single case of transfer pricing has been won in
Court by the BIR, perhaps due to the difficulty in proving that prices are not
at arm’s-length, or that legally, there is no sufficient legal basis to impugn
valid agreements between related parties, even in agreements involving
In the case of Filinvest v.
Commissioner of Internal Revenue (GR 163653 and 167689, July 19, 2011), a
transfer pricing test case, the BIR imputed interest income to a holding company
which re-lent the proceeds of a loan taken from a bank to its operating
subsidiary. The BIR won in the tax court but upon appeal, the Supreme Court
canceled the assessment stating that the BIR has no power to impugn valid
contracts and arrangements unless it is against public order or policy.
According to the Court, the BIR’s broad powers of distribution, apportionment,
allocation of gross income and deductions, does not include the power to impute
“theoretical interests” to the controlled taxpayer’s transactions. In other
words, the BIR has no power to impute income where no income was agreed upon by
the related parties. In this case, between a holding company and a subsidiary.
Such power is not covered under Section 50.
Now, here comes Corporate Income Tax and
Incentives Rationalization Act (Citira) wanting to strengthen that power. The
government fears that our country has become a target of transfer pricing
schemes by multinational enterprises and there is a need to arrest this
situation. This fear is well-founded and could be true. The Philippines is a
high-tax jurisdiction, our tax laws against transfer pricing and profit
shifting is not rock-solid, audit enforcement to capture transfer pricing
schemes is weak. All the ingredients for a likely target of profit shifting are
present. In short, the country is exposed to transfer pricing practices without
Domestic transfer pricing practices by
conglomerates and related-parties are also being eyed by the government to be
tightened. The wide array of tax incentives gave a wider opportunity to save on
taxes through shifting of income and deductions between one subject to regular
taxes vis-à-vis one with incentives. Such shifting is done with the overall
objective of having a bigger income for the group net of tax.
Under Citira, Section 50 was amended to give
clear, specific powers to the Commissioner of Internal Revenue that includes
not only the power to allocate, apportion or distribute income and deductions
between related parties, but also the power to impute income. The inclusion of
“authority to impute” now corrects the loophole in the Filinvest case where the
Supreme Court said that Section 50 did not include the power to impute income.
Likewise, Citira clarified that the same
power can be exercised by the Commissioner where a transaction or arrangement
is motivated by obtaining a tax benefit or advantage with no commercial reality
or economic effect. Examples of obtaining benefit are: altering the incidence
of a tax, relieving a person from a tax liability, avoiding or postponing a tax
The phrase “no commercial reality or economic
effect” is a question of fact which the taxpayer being assessed has the burden
to dispute. Another difficult hurdle with the BIR.
The old school of thought that tax avoidance
is legal and allowed, in contrast to tax evasion which is illegal, will
eventually be discarded by Section 50 once amended. Any transaction where the
motive is to obtain a tax benefit, regardless if through tax avoidance or tax evasion,
can be voided by the Commissioner under the proposed amendment of Section 50.
The only difference, perhaps, is the criminal liability that is attached to tax
evasion, but not on avoidance. The dividing line between evasion and avoidance
has become thinner with Citira’s proposed amendment to Section 50. Thus, a more
careful and prudent tax planning is necessary.
The intent of the government to plug
loopholes that lead to erosion of revenues through transfer pricing schemes is
very clear. Aside from amendments introduced in Citira, the BIR also issued
Revenue Audit Memorandum Order (Ramo) 1-19 on August 20, 2019. This BIR
issuance was meant to complement Citira through stricter enforcement of
transfer pricing audits and requirement for transfer pricing documentation.
I heard that the BIR is continuously
undertaking training of its examiners on transfer pricing audits. But I have
yet to hear if the necessary databases for the benchmarking have already been
secured. Upon Citira becoming a law, we expect a vigorous enforcement of
Ramo 1-19 basically follows the
internationally accepted OECD transfer pricing rules and principles. My take is
that, as long as the BIR sticks with these principles, there is no cause to
worry. On the part of businesses with related-party transactions, preparedness
is the key.
The author is the Founding Partner, Chair and
CEO of Du-Baladad and Associates Law Offices (BDB Law), a member-firm of WTS
The article is for general information only
and is not intended, nor should be construed as a substitute for tax, legal or
financial advice on any specific matter. Applicability of this article to any
actual or particular tax or legal issue should be supported therefore by a
professional study or advice. If you have any comments or questions concerning
the article, you may e-mail the author at [email protected]
or call 8403-2001 local 300.