RR No. 2013

January 23, 2013
REVENUE REGULATIONS NO. 02-13
SUBJECT : Transfer Pricing Guidelines
TO : All Internal Revenue Officers and Others Concerned
Background. — The dramatic increase in globalization of trade has also led to

harmful tax practices that have resulted in tremendous losses of tax revenues for
governments. The most significant international tax issue emerging from
globalization confronting tax administrations worldwide is transfer pricing.
Transfer pricing is generally defined as the pricing of cross-border, intra-firm

transactions between related parties or associated enterprises. 1(1) Typically, a transfer
price occurs between a taxpayer of a country with high income taxes and a related or
associated enterprise of a country with low income taxes. In the Philippines,
"intra-firm/inter-related" transactions account for a substantial portion of the transfer
of goods and services, however, the revenue collection from related-party groups
continue to go on a downtrend.
The revenues lost from intra-related transactions can be attributed to the fact
that related companies are more interested in their net income as a whole (rather than
as individual corporations), as such there is a desire to minimize tax payments by
taking advantage of the loopholes in our tax system.
While transfer pricing issue typically occurs in cross-border transactions, it can

also occur in domestic transactions. One context where transfer pricing issue occurs
domestically is where one associated enterprise, entitled to income tax exemptions, is
being used to allocate income away from a company subject to regular income taxes.
In the Philippines, there is a domestic transfer pricing issue when income are shifted
in favor of a related company with special tax privileges such as Board of
Investments (BOI) Incentives and Philippine Economic Zone Authority (PEZA) fiscal
incentives or when expenses of a related company with special tax privileges are
shifted to a related company subject to regular income taxes or in other
Copyright 2019 CD Technologies Asia, Inc. and Accesslaw, Inc. Philippine Taxation Encyclopedia First Release 2019 1
circumstances, when income and/or expenses are shifted to a related party in order to
minimize tax liabilities. AETcSa
SECTION 1. Objective and Scope. — Pursuant to the provision of

Section 244 in relation to Section 50 of the National Internal Revenue Code
of 1997, as amended ("Tax Code") these regulations are hereby promulgated to:
a. implement the authority of the Commissioner of Internal Revenue

("Commissioner") to review controlled transactions among associated
enterprises and to allocate or distribute their income and deductions in
order to determine the appropriate revenues and taxable income of the
associated enterprises involved in controlled transactions;
b. prescribe guidelines in determining the appropriate revenues and

taxable income of the parties in the controlled transaction by providing
for the methods of establishing an arm's length price; and
c. require the maintenance or safekeeping of the documents necessary for

the taxpayer to prove that efforts were exerted to determine the arm's
length price or standard in measuring transactions among associated
enterprises.
These Regulations apply to:
(1) cross-border transactions between associated enterprises; and
(2) domestic transactions between associated enterprises.
SECTION 2. Purpose of the Regulations. — These Regulations seek to

provide guidelines in applying the arm's length principle for cross-border and
domestic transactions between associated enterprises.
These guidelines are largely based on the arm's length methodologies as set out
under the Organisation for Economic Cooperation and Development (OECD)
Transfer Pricing Guidelines.
SECTION 3. Authority of the Commissioner to Allocate Income and

Deductions. — Pursuant to Section 50 of the Tax Code, the Commissioner is
authorized to distribute, apportion or allocate gross income or deductions between or
among two or more organizations, trades or businesses (whether or not incorporated
and whether or not organized in the Philippines) owned or controlled directly or
indirectly by the same interests, if he determines that such distribution, apportionment
or allocation is necessary in order to clearly reflect the income of any such
organization, trade or business.
Thus, the Commissioner is authorized to make transfer pricing adjustments, in

line with the purpose of Section 50 to ensure that taxpayers clearly reflect income
attributable to controlled transactions and to prevent the avoidance of taxes with
respect to such transactions.
SECTION 4. Definition of Terms. — As used in these Regulations, the

following terms shall have the following meaning:
Comparable transaction. A transaction that is comparable to the controlled

transaction under examination taking into consideration factors such as the nature of
the property or services provided between the parties, functional analysis of the
transactions and parties, contractual terms, and economic conditions. DHEcCT
Comparable uncontrolled transaction. A comparable uncontrolled transaction

is a transaction between two independent parties that is comparable to the controlled
transactions under examination. It can be either a comparable transaction between one
party to the controlled transaction and an independent party ("internal comparable")
or between two independent parties, neither of which is a party to the controlled
transaction ("external comparable").
Associated enterprises. 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 directly or indirectly in the management, control, or
capital of the enterprises. These are also referred to as related parties.
Control refers to any kind of control, direct or indirect, whether or not legally
enforceable, and however exercisable or exercised. Moreover, control shall be
deemed present if income or deductions have been arbitrarily shifted between two or
more enterprises.
Controlled transaction means any transaction between two or more associated

enterprises.
Independent enterprises or parties. Two enterprises are independent

enterprises with respect to each other if they are not associated enterprises.
Advance Pricing Arrangement ("APA") is an arrangement that determines, in

advance of controlled transactions, an appropriate set of criteria (e.g., method,
comparables and appropriate adjustments thereto, critical assumptions as to future
events) for the determination of the transfer pricing for those transactions over a fixed
period of time.
Mutual Agreement Procedure (MAP) is a means through which tax

administrations consult to resolve disputes regarding the application of double tax
conventions. This procedure, described in Article 25 of the OECD Model Tax
Convention, can be used to eliminate double taxation that could arise from a transfer
pricing adjustment.
SECTION 5. Arm's Length Principle. — The Bureau of Internal Revenue

(the "Bureau") hereby adopts and the use of arm's length principle as the most
appropriate standard to determine transfer prices of related parties.
a. Background and Concept:
The arm's length principle is the internationally recognized standard for

transfer pricing between associated enterprises. Paragraph 1 of Article 9 of Philippine
tax treaties is virtually identical to paragraph 1 of Article 9 of the OECD Model Tax
Convention on Income and Capital, which is considered, in the international arena, as
the authoritative statement of the arm's length principle.
Paragraph 2 of Article 7 (Business Profits) of the OECD Model Tax

Convention on Income and on Capital specifies that, when attributing the profits to a
permanent establishment, the permanent establishment should be considered as 'a
distinct and separate enterprise engaged in the same or similar activities and under the
same or similar conditions'. This corresponds with the application of the arm's length
principle specified in paragraph 1 of Article 9 (Associated Enterprises) of the OECD
Model Tax Convention on Income and on Capital. HTIEaS
The arm's length principle requires the transaction with a related party to be
made under comparable conditions and circumstances as a transaction with an
independent party. It is founded on the premise that where market forces drive the
terms and conditions agreed in an independent party transaction, the pricing of the
transaction would reflect the true economic value of the contributions made by each
entity in that transaction. Essentially, this means that if two associated enterprises
derive profits at levels above or below the comparable market level solely by reason
of the special relationship between them, the profits will be deemed as non-arm's
length. In such a case, tax authorities that adopt the arm's length principle can make
the necessary adjustments to the taxable profits of the related parties in their
jurisdictions so as to reflect the true value that would otherwise be derived on an
arm's length basis.
b. Guidance on the Application of the Arm's Length Principle:
The application of arm's length principle would, first and foremost, involve the
identification of comparable situation(s) or transaction(s) undertaken by independent
parties against which the associated enterprise transaction or margin is to be
benchmarked. This step is commonly known as "comparability analysis". It entails an
analysis of the similarities and differences in the conditions and characteristics that
are found in the associated enterprise transaction with those in an independent party
transaction. Once the impact of these similarities or differences have on the transfer
price have been determined, the arm's length price/margin (or a range) can then be
established using an appropriate transfer pricing method.
In the application of the arm's length principle the following 3-step approach,
discussed in detail in Sections 6, 7, and 8 of these Regulations, may be observed.
Step 1: Conduct a comparability analysis.
Step 2: Identify the tested party and the appropriate transfer pricing method.
Step 3: Determine the arm's length results.
These steps should be applied in line with the key objective of transfer pricing
analysis to present a logical and persuasive basis to demonstrate that transfer prices
set between associated enterprises conform to the arm's length principle.
SECTION 6. Comparability Analysis. —
a. The Concept of Comparability
The arm's length principle is based on a comparison of the prices or margins

adopted or obtained by related parties with those adopted or obtained by independent
parties engaged in similar transactions. For such price or margin comparisons to be
meaningful, all economically relevant characteristics of the situations being compared
should be sufficiently similar so that:
(1) none of the differences (if any) between the situations being compared
can materially affect the price or margin being compared, or
(2) reasonably accurate adjustments can be made to eliminate the effect of

any such differences.
b. Factors Affecting Comparability
A comparability analysis should examine the comparability of the transactions
in 3 aspects: TSIaAc
(1) Characteristics of Goods, Services or Intangible Properties
(i) The specific characteristics of goods, services or intangible

properties play a significant part in determining their values in
the open market. For instance, a product with better quality and
more features would, ceteris paribus, fetch a higher selling price.
Such product or service differentiation affects the price or value
of the product or service. Hence, the nature and features of the
goods, intangible properties or services transacted between
related parties and those between independent parties must be
examined carefully. The similarities and differences (which
would influence the value of the goods, services or intangible
properties) should be identified.
(ii) Characteristics to be examined include, but are not limited to, the
following:
— in the case of transfer of goods: the physical features, the

quality and reliability, and the availability and volume of
supply of the goods;
— in the case of provision of services: the nature and extent

of the services; and
— in the case of intangible property: the form of transaction,

the type of intangible, the duration and degree of
protection, and the anticipated benefits from the use of the
property.
(iii) Similarities in the actual characteristics of the product, intangible

or service, are most critical when one needs to compare prices of
related party transactions against independent ones, such as when
the Comparable Uncontrolled Pricing (CUP) method is adopted
as the transfer pricing method. On the other hand, comparisons
of profit margins (used in methods other than CUP) may be less
sensitive to the features and characteristics of the product or
service in question, as the margins generally correlate more
significantly with the functions performed, risks borne and assets
used by the entity.
(2) Analysis of Functions, Risks and Assets
(i) Economic theory purports that the level of return derived by an

entity should be directly correlated to the functions performed,
the assets used and risks assumed. For instance, an entity selling
a product with warranty should earn a higher return compared to
another entity selling the same product without the provision of
warranty. The difference in margin is due to the additional
function performed and risk borne by the first entity. Likewise, a
product with a reputable branding is expected to fetch a higher
return compared to that of a similar product without the
branding, due to the additional asset (in this case, trademark)
employed in enhancing the value of the product. ETAICc
(ii) Hence, a crucial step in comparability analysis must entail a

comparison of the economically significant functions performed,
risks assumed and assets employed by the related party with
those by the independent party (which has been selected as the
party against which the associated enterprise's margin or
transactions are to be benchmarked). This is typically known as
conducting a "functional analysis".
(iii) The functions that should be compared include (but are not
limited to) design, research and development, manufacturing,
distribution, sales, marketing, logistics, advertising, financing,
etc.
(iv) It is also relevant and useful, when identifying and comparing

the functions performed, to consider the assets that are employed
or to be employed. This analysis should consider the type of
assets used, such as plant and equipment, valuable intangibles,
etc. and the nature of the assets used (i.e., the age, market value,
location, availability of intellectual property protections), etc.
(v) An appraisal of risks is also important in determining arm's

length prices/margins. The possible risks assumed that should be
considered in the functional analysis include market risks, risks
of change in cost, price or stock, risks relating to the success or
failure of R&D, financial risks such as changes in the foreign
exchange and interest rates, credit risks, etc.
(vi) In practice, one cannot be expected to compare all functions,

risks and assets employed. Hence, it must be emphasized that
only functions, risk and assets that are economically significant
in determining the value of transactions or margins of entities
should be identified and compared.
(3) Commercial and Economic Circumstances
(i) Prices may vary across different markets even for transactions
involving the same property or services. In order to make
meaningful comparisons of prices or margins between
entities/transactions, the markets and economic conditions in
which the entities operate or where the transactions are
undertaken should be comparable. The economic circumstances
that may be relevant in determining market comparability
include the availability of substitute goods or services,
geographic location, the market size, the extent of competition in
the markets, consumer purchasing power, the level of the market
at which the enterprises operate (i.e., wholesale or retail), etc.
(ii) Government policies and regulations (such as price controls,

national insurance, etc.) may have an impact on prices and
margins. Hence, the effects of these regulations should also be
examined as part of the examination for comparability of the
market and economic conditions.
(iii) Business strategies should also be examined in determining

comparability for transfer pricing purposes. Business strategies
would take into account many aspects of an enterprise, such as
innovation and new product development, degree of
diversification, risk aversion, assessment of political changes and
other factors bearing upon the daily conduct of business.
(iv) An entity may embark on business strategies of temporarily

charging a lower price for its product compared to similar
products in the market or incurring higher expenses in the short
run (hence resulting in lower profit levels). Such strategies are
commonly used for market penetration and market share
expansion or defense. The key issue with respect to business
strategies that temporarily reduce profits in anticipation of higher
long-term profit is whether the adoption and outcome of such
strategies produce an arm's length result. Hence, a claim that
such strategies have been adopted ought to be demonstrated with
evidence that that an independent party would have been
prepared to sacrifice profitability for a similar period under
similar economic circumstances and competitive conditions, so
that a higher long-term profit can be realized. caHASI
SECTION 7. Identification of the Tested Party and the Appropriate

Transfer Pricing Method. —
a. Determination of the Tested Party
The tested party is the entity to which a transfer pricing method can be most
reliably applied to and from which the most reliable comparables can be found. For
an entity to become a tested party, the Bureau requires sufficient and verifiable
information on such entity.
b. Selection and application of Transfer Pricing Methodologies (TPM)
(1) The specific methods to be used in determining the arm's length price
are discussed in Section 10 of these Regulations.
(2) The selection of a transfer pricing method is aimed at finding the most
appropriate method for a particular case. Accordingly, the method that
provides the most reliable measure of an arm's length result shall be
used. For this purpose, the selection process should take into account
the following:
(i) the respective strengths and weaknesses of each of the transfer

pricing methods;
(ii) the appropriateness of the method considered in view of the

nature of the controlled transaction, determined in particular
through a functional analysis;
(iii) the availability of reliable information (in particular on

uncontrolled comparables) in order to apply the selected method
and/or other methods; and
(iv) the degree of comparability between controlled and uncontrolled

transactions, including the reliability of comparability
adjustments that may be needed to eliminate material differences
between them.
(3) The Bureau does not have a specific preference for any one method.
Instead, the TPM that produce the most reliable results, taking into
account the quality of available data and the degree of accuracy of
adjustments, should be utilized.
(4) In exceptional circumstances where there may not be comparable

transactions or sufficient data to apply the above-described methods the
Bureau may use the following approaches to verify whether the
controlled transactions comply with the arm's length principle:
(i) Extension of the transfer pricing methods. The comparable may

be with enterprises in another industry segment or group of
segments; and
(ii) Use of a combination or mixture of the transfer pricing methods

or other methods or approaches.
(5) In all cases, taxpayers should be able to explain why a specific TPM is
selected or used in recording controlled transactions through proper
documentation. HDTcEI
c. Selection of Profit Level Indicator (PLI)
(1) In applying the TPM, due consideration must given to the choice of PLI
which measures the relationship between profits and sales, costs
incurred or assets employed. The use of an appropriate PLI ensures
better accuracy in the determination of the arm's length price of a
controlled transaction. PLI is presented in the form of a generally
recognized or utilized financial ratio. The selection of an appropriate
PLI depends on several factors, including:
(i) characterization of the business;
(ii) availability of comparable data; and
(iii) the extent to which the PLI is likely to produce a reliable

measure of arm's length profit.
(2) Commonly used PLI include:
(i) Return on costs: cost plus margin and net cost plus margin.
(ii) Return on sales: gross margin and operating margin.
(iii) Return on capital employed: return on operating assets.
SECTION 8. Determination of the Arm's Length Results. — Once the

appropriate transfer pricing method has been identified, such is applied on the data of
independent party transactions to arrive at the arm's length result.
In some cases, it will be possible to apply the arm's length principle to arrive at
a single figure or specific ratio (e.g., price or margin) that is the most reliable to
establish whether the conditions of a transaction are arm's length. However, it is
generally difficult to arrive at a specific ratio or range of deviation that may be
considered as arm's length. More likely, the transfer pricing analysis would lead to a
range of ratios. Hence, the use of ranges to determine an arm's length range shall be
applied, provided that the comparables are reliable.
a. If the relevant condition of the controlled transaction (i.e., price or

margin) is within the arm's length range, no adjustment should be
made. If the relevant condition of the controlled transaction (e.g.,
price or margin) falls outside the arm's length range asserted by the
Bureau, the taxpayer should present proof or substantiation that the
conditions of the controlled transaction satisfy the arm's length
principle, and that the result falls within the arm's length range
(i.e., that the arm's length range is different from the one asserted
by the tax administration). If the taxpayer is unable to establish this
fact, the Bureau must determine the point within the arm's length
range to which it will adjust the condition of the controlled
transaction.
b. In determining this point, where the range comprises results of

relatively equal and high reliability, it could be argued that any
point in the range satisfies the arm's length principle. Where
comparability defects remain, it may be appropriate to use
measures of central tendency to determine this point (for instance
the median, the mean or weighted averages, etc., depending on the
specific characteristics of the data set), in order to minimise the
risk of error due to unknown or unquantifiable remaining
comparability defects.
SECTION 9. Comparability Adjustment. — Differences between the

transaction of the comparables and that of the tested party must be identified and
adjusted for, in order for the comparables to be useful as basis for determining the
arm's length price. Comparability adjustments include accounting adjustments and
function/risk adjustments. EDCTIa
a. Comparability adjustments are intended to eliminate the effects of

differences that may exist between situations being compared and
that which could materially affect the condition being examined in
the methodology (e.g., price or margin). These should not be
performed to correct differences that have no material effect on the
comparison, as these adjustments are neither routine nor
mandatory in a comparability analysis. When proposing a
comparability adjustment, a resultant improvement or increase in
the accuracy in the comparability should be demonstrated.
b. The following adjustments should be avoided as they do not

improve comparability:
(1) adjustments that are questionable when the basis for

comparability criteria is only broadly satisfied;
(2) excessive adjustments or adjustments that too greatly affect

the comparable as such indicates that the third party being
adjusted is in actually not sufficiently comparable;
(3) adjustments on differences that do not materially affect the

comparability;
(4) highly subjective adjustments, such as on the difference in

product quality.
SECTION 10. Arm's Length Pricing Methodologies. 2(2) — In determining

the arm's length result, the most appropriate of the following methods may be used.
a. Comparable Uncontrolled Price (CUP) Method — The CUP

Method evaluates whether the amount charged in a controlled
transaction is at arm's length by reference to the amount charged in
a comparable uncontrolled transaction in comparable
circumstances. Any difference between the two prices may
indicate that the conditions of the commercial and financial
relations of the associated enterprises are not arm's length, and that
the price in the uncontrolled transaction may need to be substituted
for the price in the controlled transaction.
The use of the CUP Method to determine transfer price entails

identification of all the differences between the product or service
of the associated enterprise and that of the independent party. If
these differences have a material effect on the price, adjustment of
the price of products sold/services rendered by the independent
party to reflect these differences shall be made to arrive at the
arm's length price. A comparability analysis under the CUP
Method shall take into account the following:
(1) Product characteristics such as physical features and

quality;
(2) If the product is in the form of services, the nature and

extent of such services provided;
(3) Whether the goods sold are compared at the same points in
the supply or production chain;
(4) Product differentiation in the form of patented features such

as trademarks, design, etc.;
(5) Volume of sales if it has an effect on price;
(6) Timing of sale if it is affected by seasonal fluctuations or

other changes in market conditions;
(7) Whether cost of transport, packaging, marketing,

advertising, and warranty are included in the deal;
(8) Whether the products are sold in places where the economic
conditions are the same; and
(9) Whether a business strategy is adopted in the controlled

transaction that would produce material difference on the
price of the controlled transaction as against the price in an
uncontrolled transaction.
b. Resale Price Method (RPM) — RPM is applied where a product
that has been purchased from a related party is resold to an
independent party. Essentially, it seeks to value the functions
performed by the reseller of a product. The resale price method
evaluates whether the amount charged in a controlled transaction is
at arm's length by reference to the gross profit margin realized in
comparable uncontrolled transactions. This method is generally
appropriate where the final transaction is made with an
independent party. The usefulness of the method largely depends
on how much added value or alteration the reseller has done on the
product before it is resold, or the time lapse between purchase and
onward sale. Thus, RPM is most appropriate in a situation where
the reseller adds relatively little value to the properties. The greater
the value added to the properties by the reseller, for example,
through complicated processing or assembly with other products
or, the longer the time lapse — to the extent that market conditions
might have changed — before it is resold or, when the reseller
contributes substantially to the creation or maintenance of an
intangible property that is attached to the product, such as
trademarks or tradenames, the more difficult it is to use RPM to
arrive at the arm's length price. IcDHaT
The starting point in RPM is the price (the resale price) at which a
product that has been purchased in a controlled sale is then resold
to an independent third party (uncontrolled resale). This price (the
resale price) is then reduced by an appropriate gross margin (the
resale price margin) representing the amount out of which the
reseller would seek to cover its selling and other operating
expenses and, in the light of functions performed (taking into
account assets used and risks assumed), make an appropriate
profit. An arm's length price for the original transfer of property
between the associated enterprises (controlled transaction) is
obtained after subtracting the gross margin (resale price margin)
from the resale price, and adjusting for other costs associated with
the purchase of the product, such as customs duties.
The following are factors which may influence the resale price
margin and other considerations when performing a comparability
analysis for purposes of the resale price method:
(1) Functions or level of activities performed by the reseller and
the risks undertaken (e.g., whether the reseller is merely a
forwarding agent or, a distributor who assumes full
responsibility for marketing and advertising the product by
risking its own resources in these activities);
(2) Whether similar assets are employed in the controlled and

uncontrolled transactions, (e.g., a developed distribution
network);
(3) Although broader product differences are allowed as

compared to the CUP method, product similarities are still
significant to some extent particularly when there is a high
value or unique intangible attached to the product;
(4) If the resale price margin used is that of an independent

enterprise in a comparable transaction, differences in the
way business is managed may have an impact on
profitability;
(5) The time lapse between original purchase and resale of the
product as a longer time lapse may give rise to changes in
the market, exchange rates, costs, etc.;
(6) Whether the reseller is given exclusive rights to resell the

products;
(7) Differences in accounting practices where adjustments must

be made to ensure that the components of costs in arriving
at gross margins in the controlled and uncontrolled
transactions are the same;


resale gross margin of the controlled transaction as against
the resale gross margin in an uncontrolled transaction. CaDSHE
As gross profit margins represent the gross compensation (after

cost of sales) for specific functions performed, assets used and
risks assumed, product differences are less critical than under the
CUP Method. Therefore, where the related and independent party
transactions are comparable in all aspects except for the product
itself, RPM might produce a more reliable measure of arm's length
conditions than the CUP Method. Nonetheless, it can be expected
that the more comparable the products, the more likely it is that the
RPM will produce better results.
c. Cost Plus Method (CPM) — CPM focuses on the gross mark-up

obtained by a supplier who transfers property or provides services
to a related purchaser. Essentially, the method attempts to value
the functions performed by the supplier of the property or services.
CPM is most useful where semi-finished goods are sold between
associated enterprises or where the controlled transaction involves
the provision of services.
CPM indirectly measures whether the price for the property or

service in the controlled transaction is an arm's length price by
assessing whether the mark-up on the costs incurred by the
supplier of the property or service in the controlled transaction
meets the arm's length standard. This method is often useful in
cases involving the manufacture, assembly, or other production of
goods that are sold to related parties or where controlled
transaction involves the provision of intra-group services.
The starting point in CPM is the cost incurred by the supplier of

property or services in a controlled transaction for property
transferred or services provided to a related purchaser. An
appropriate mark-up is added to this cost to find the price that the
supplier should be charging the buyer.
The cost base used in determining costs and the accounting

policies should be consistent and comparable between the
controlled and uncontrolled transaction, and over time in relation
to the particular enterprise. The costs referred to in CPM are the
aggregation of direct and indirect costs of production.
Comparability, when applying CPM, should take into account the
similarity of functions performed, assets used and risks assumed,
contractual terms, market conditions and business strategies as
well as any adjustments made to account for the effects of any
differences in the aforementioned factors between the controlled
and uncontrolled transactions.
A comparability analysis under CPM shall take into account the

following:
(1) Functions or level of activities performed by the seller and

the risks undertaken;
(2) Whether similar assets are employed in the controlled and

uncontrolled transactions;
(3) Although broader product differences are allowed as

compared to the CUP method, product similarities are still
significant to some extent; DTSIEc
(4) If the gross margin used is that of an independent enterprise

in a comparable transaction, differences in the way business
is managed may have an impact on profitability;
(5) Differences in accounting practices where adjustments must

be made to ensure that the components of costs in arriving
at gross margins in the controlled and uncontrolled
transactions are the same;


cost plus mark-up of the controlled transaction as against
the cost plus mark-up in an uncontrolled transaction.
As in RPM, fewer adjustments may be necessary to account for

product differences under CPM than the CUP Method, and it may
be appropriate to focus on other factors of comparability (such as
the functions performed and economic circumstances). Where the
associated enterprise and independent party transactions are not
comparable in all aspects and the differences have a material effect
on the margin, taxpayers are expected to make appropriate
adjustments to eliminate the effects of these differences.
d. Profit Split Method (PSM) — PSM seeks to eliminate the effect on

profits of special conditions made or imposed in a controlled
transaction (or in controlled transactions that are appropriate to
aggregate) by determining the division of profits (or losses) that
independent enterprises would have expected to realize from
engaging in the transaction or transactions.
This method provides an alternative in cases where no comparable

transactions between independent parties can be identified. This is
true normally in a situation where transactions are very interrelated
that they cannot be evaluated separately, or in situations involving
a unique intangible. The method is based on the concept that
profits earned in a controlled transaction should be equitably
allocated among associated enterprises involved in the
transaction(s) on an economically valid basis that approximates the
allocation of profits that would have been anticipated and reflected
in an agreement made at arm's length.
Generally, the profit to be split is the operating profit, but it may be

appropriate to carry out a split of the gross profit and then deduct
the expenses incurred by or attributable to each relevant party.
The allocation of profit or loss under the profit split method shall
be made in accordance with the following approaches:
(1) Residual Profit Split Approach. — The combined profits

from the controlled transactions under examination are split
in two stages.
(i) In the first stage, each participant is allocated

sufficient profit to provide it with a basic return
appropriate for the type of transactions in which it is
engaged. Ordinarily, this basic return would be
determined by reference to the market return
achieved for similar types of transactions by
independent parties. Thus, the basic return would
generally account for the value, with reference to
comparable independent market data, of the
contribution or functions performed by each party
and not account for the return that would be
generated by any unique and valuable assets
possessed by the participants.
(ii) In the second stage, any residual profit (or loss)

remaining after the first stage division would be
allocated among the parties based on an analysis of
the facts and circumstances that might indicate how
this residual would have been divided between
independent parties (i.e., taking into consideration
the value of unique assets used by the parties, usually
intangible assets). The remaining profit which is
attributable to such unique assets is allocated
between the parties based on the relative
contributions of the parties to the creation of such
assets, taking into consideration how independent
parties would have divided such residual profits in
similar circumstances.
(2) Contribution Profit Split Approach. — The combined

profits, which are the total profits from the controlled
transactions under examination, are divided between the
associated enterprises in a single stage based upon the
parties' relative contribution to the profit or the relative
value of the functions performed by each of the associated
enterprises participating in the controlled transactions,
supplemented as much as possible by external market data
that indicate how independent enterprises would have
divided profits in similar circumstances. STHDAc
e. Transactional Net Margin Method (TNMM) — TNMM operates in

a manner similar to the cost plus and resale price methods in the
sense that it uses the margin approach. This method examines the
net profit margin relative to an appropriate base such as costs, sales
or assets attained by the member of a group of controlled taxpayers
from a controlled transaction.
TNMM compares the net profit margins attained by an entity from

a related party transaction to those attained by the same entity in
uncontrolled transactions or, by comparable independent entities
involved in similar transactions, relative to some appropriate base
such as costs, sales, or assets.
In short, TNMM evaluates whether the amount charged in a

controlled transaction is arm's length by reference to the operating
profit earned in comparable uncontrolled transactions.
Being a transactional profit method that is typically applied to only

one of the parties involved in the transaction, the TNMM is closely
aligned to the resale price and cost plus methods.
This similarity means that this method requires a level of

comparability similar to that required for the application of the two
traditional transaction methods (the resale price method, and the
cost plus method).
The primary difference between TNMM and RPM or CPM is that

the former focuses on the net margin instead of the gross margin of
a transaction. However, one of the weaknesses of using net margin
as the basis for comparison is that it can be influenced by many
factors that either do not have an effect, or have a less substantial
or direct effect, on price or gross margins. Examples of such
factors include the efficiency of plant and machinery used,
management and personnel capabilities, competitive position, etc.
Unless reliable and accurate adjustments can be made to account
for these differences, TNMM may not produce reliable measures
of the arm's length net margins.
TNMM is usually appropriate to use when the gross profit of the

business is not easy to determine such that either CPM, in case of a
manufacturer/service-provider, or RPM, in case of a distributor,
cannot be used. Since the net margin figure is always available,
TNMM may be used instead, applying the same formula as those
for CPM (for manufacturer/service provider) or RPM (for
distributor) but rather using net margin in lieu of the gross
margin/profit.
SECTION 11. Advance Pricing Arrangements and Mutual Agreement
Procedure. — An Advance Pricing Arrangement (APA) is a facility available to
taxpayers who are engaged in cross-border transactions. It is an agreement entered
into between the taxpayer and the Bureau to determine in advance an appropriate set
of criteria (e.g., method, comparables and appropriate adjustments thereto) to
ascertain the transfer prices of controlled transactions over a fixed period of time. The
purpose of an APA is to reduce the risk of transfer pricing examination and double
taxation.
There are two kinds of APA: (i) Unilateral APA; and (ii) Bilateral or
Multilateral APA. A unilateral APA is an agreement involving only the taxpayer and
BIR, while a bilateral/multilateral APA is an agreement involving Philippines and one
or more of its treaty partners. A Bilateral or Multilateral APA is authorized under the
Mutual Agreement Procedure (MAP) Article of the 37 Philippine tax treaties.
It is not a mandatory requirement for taxpayers to avail of an APA for their

controlled transactions. If a taxpayer avails of an APA, it may choose freely between
a unilateral and bilateral/multilateral APA. If a taxpayer does not choose to enter into
an APA and its transactions are subject later on to transfer pricing adjustments, it may
still invoke the MAP Article to resolve double taxation issues. SIHCDA
The Philippine tax treaties' article on MAP provides a mechanism for the
Philippine competent authority to mutually arrive at satisfactory solution with the
competent authority of the treaty partner to eliminate double taxation issues arising
from transfer pricing adjustments.
The Bureau shall issue separate guidelines on the application of APA and
MAP processes.
SECTION 12. Documentation. — Taxpayers must demonstrate that their

transfer prices are consistent with the arm's length principle. The main purpose of
keeping adequate documentation is for taxpayers to be able to (i) defend their transfer
pricing analysis, (ii) prevent transfer pricing adjustments arising from tax
examinations, and (iii) support their applications for MAP. Taxpayers who have not
prepared adequate documentation may find their application for MAP rejected or that
the transfer pricing issue would be much more difficult to resolve.
a. Retention Requirement — The BIR does not require transfer

pricing documents to be submitted when the tax returns are filed.
However, such documents should be retained by the taxpayers and
submitted to BIR when required or requested to do so.
b. Retention Period — In general, transfer pricing documents must be

retained preserved within the period specifically provided in the
Tax Code as the retention period, unless a different period is
otherwise legally provided. However, it is to the best interest of the
taxpayer to maintain documentation for purposes of MAP and
possible transfer pricing examination.
c. Contemporaneousness — The transfer pricing documents must be

contemporaneous. It is contemporaneous if it exists or is brought
into existence at the time the associated enterprises develop or
implement any arrangement that might raise transfer pricing issues
or review these arrangements when preparing tax returns.
d. Documentation Details — the details of transfer pricing documents

include, but are not limited to, the following:
(1) Organizational structure
(2) Nature of the business/industry and market conditions
(3) Controlled transactions
(4) Assumptions, strategies, policies
(5) Cost contribution arrangements (CCA)
(6) Comparability, functional and risk analysis
(7) Selection of the transfer pricing method
(8) Application of the transfer pricing method
(9) Background documents
(10) Index to documents
SECTION 13. Penalties. — The provisions of the Tax Code and other
applicable laws regarding the imposition of penalties and other appropriate sanctions
shall be applied to any person who fails to comply with or violates the provisions and
requirements of these regulations. DCHaTc
SECTION 14. Transitory Provision. — Transactions entered into prior to
the effectivity of these Regulations shall be governed by the laws and other
administrative issuances prevailing at the time the controlled transactions were
entered into.
SECTION 15. Separability Clause. — If any part or provision of these

Regulations shall be held to be unconstitutional or invalid, other provisions hereof
which are not affected thereby shall continue to be in full force and effect.
SECTION 16. Repealing Clause. — All existing rules, regulations and

other issuances or portions thereof inconsistent with the provisions of these
Regulations are hereby modified, repealed or revoked accordingly.
SECTION 17. Effectivity. — This Regulations shall take effect after fifteen
(15) days following publication in a newspaper of general circulation.
(SGD.) CESAR V. PURISIMA

Secretary
Department of Finance
Recommending Approval:
(SGD.) KIM S. JACINTO-HENARES

Commissioner
Bureau of Internal Revenue
Footnotes
1. UN Practical Manual on Transfer Pricing for Developing Countries.
2. For further guidance and examples, please refer to the Organisation for Economic
Cooperation and Development (OECD) Transfer Pricing Guidelines.
Published in the Manila Bulletin on January 25, 2013.
Endnotes
1 (Popup - Popup)
1. UN Practical Manual on Transfer Pricing for Developing Countries.
2 (Popup - Popup)
2. For further guidance and examples, please refer to the Organisation for Economic
Cooperation and Development (OECD) Transfer Pricing Guidelines.

RR No. 2013

Uploaded by

Copyright:

Available Formats

RR No. 2013

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

RR No. 2013

Uploaded by

Copyright:

Available Formats

January 23, 2013

REVENUE REGULATIONS NO. 02-13

SUBJECT : Transfer Pricing Guidelines

TO : All Internal Revenue Officers and Others Concerned

Background. — The dramatic increase in globalization of trade has also led to

Transfer pricing is generally defined as the pricing of cross-border, intra-firm

While transfer pricing issue typically occurs in cross-border transactions, it can

SECTION 1. Objective and Scope. — Pursuant to the provision of

a. implement the authority of the Commissioner of Internal Revenue

b. prescribe guidelines in determining the appropriate revenues and

c. require the maintenance or safekeeping of the documents necessary for

These Regulations apply to:

(1) cross-border transactions between associated enterprises; and

(2) domestic transactions between associated enterprises.

SECTION 2. Purpose of the Regulations. — These Regulations seek to

SECTION 3. Authority of the Commissioner to Allocate Income and

Thus, the Commissioner is authorized to make transfer pricing adjustments, in

SECTION 4. Definition of Terms. — As used in these Regulations, the

Comparable transaction. A transaction that is comparable to the controlled

Comparable uncontrolled transaction. A comparable uncontrolled transaction

Associated enterprises. Two or more enterprises are associated if one

Controlled transaction means any transaction between two or more associated

Independent enterprises or parties. Two enterprises are independent

Advance Pricing Arrangement ("APA") is an arrangement that determines, in

Mutual Agreement Procedure (MAP) is a means through which tax

SECTION 5. Arm's Length Principle. — The Bureau of Internal Revenue

a. Background and Concept:

The arm's length principle is the internationally recognized standard for

Paragraph 2 of Article 7 (Business Profits) of the OECD Model Tax

Step 1: Conduct a comparability analysis.

Step 3: Determine the arm's length results.

SECTION 6. Comparability Analysis. —

a. The Concept of Comparability

The arm's length principle is based on a comparison of the prices or margins

(2) reasonably accurate adjustments can be made to eliminate the effect of

b. Factors Affecting Comparability

(1) Characteristics of Goods, Services or Intangible Properties

(i) The specific characteristics of goods, services or intangible

— in the case of transfer of goods: the physical features, the

— in the case of provision of services: the nature and extent

— in the case of intangible property: the form of transaction,

(iii) Similarities in the actual characteristics of the product, intangible

(2) Analysis of Functions, Risks and Assets

(i) Economic theory purports that the level of return derived by an

(ii) Hence, a crucial step in comparability analysis must entail a

(iv) It is also relevant and useful, when identifying and comparing

(v) An appraisal of risks is also important in determining arm's

(vi) In practice, one cannot be expected to compare all functions,

(3) Commercial and Economic Circumstances

(ii) Government policies and regulations (such as price controls,

(iii) Business strategies should also be examined in determining

(iv) An entity may embark on business strategies of temporarily

SECTION 7. Identification of the Tested Party and the Appropriate

a. Determination of the Tested Party

b. Selection and application of Transfer Pricing Methodologies (TPM)

(i) the respective strengths and weaknesses of each of the transfer

(ii) the appropriateness of the method considered in view of the

(iii) the availability of reliable information (in particular on

(iv) the degree of comparability between controlled and uncontrolled

(4) In exceptional circumstances where there may not be comparable