By Adriana Calderon, Director, Transfer Pricing Solutions Asia Pte Ltd, Singapore
The Inland Revenue Authority of Singapore released on March 19 an e-Tax guide on transfer pricing guidelines for multinational enterprise groups that have centralised activities through a “headquarters” entity in Singapore. The guide focuses on the economic value contributions of centralised activities performed by Singapore taxpayers and their importance for the multinational group. It includes guidance for functional analysis of related party activities in Singapore and on selecting appropriate transfer pricing methods.
The new transfer pricing guidelines identified two roles that a Singaporean headquarter could play within a multinational enterprise. The first role is as an “entrepreneur” that makes key business decisions, performs significant functions to organise and operate the business, controls and assumes significant risks, and has the financial capacity to assume risks. The second role is as a centralised service provider that performs a range of activities for the benefit of the multinational group.
The key to the allocation of profits is conducting a detailed functional analysis with a clear description of the value activities performed by the Singapore taxpayer within the multinational group. Based on a detailed functional analysis, the Singapore taxpayer should decide on the appropriate transfer pricing method that needs to be applied to set the price in controlled transactions that arise from implementing the transfer pricing model.
Functional analysis
The functional profile of a Singapore taxpayer is dependent on the nature of the activities it conducts, which in turn define its contribution to value. Hence, it is crucial to ensure that the contribution made by a Singapore taxpayer to the value creation is taken into consideration when determining the arm’s length transfer price for a related party transaction. Such contribution may vary depending on the intensity of activities undertaken.
There are four types of activities identified in the transfer pricing guidelines that a Singapore-based headquarters can perform.
The first activity is as a principal in distribution, manufacturing, or research and development arrangements, with decision-making and risk-taking attributes. The performance of these activities requires a high level of expertise and skill. Therefore, the expected compensation is high, which can be in the form of residual profit splits between the multinational group companies.
The second activity group relates to core business processes for the supply chain of goods and/or services. The level of expertise and skill is medium, and therefore a service charge will be expected for the provision of these activities as they benefit the group because these activities will improve the overall performance of the multinational group.
The third activity group relates to administrative, technical, financial, commercial, management, and coordination and control functions that are routine or non-core in nature (also known as support functions). The level of expertise and skill is low as the activities are non-core to the business. Nevertheless, a service charge will be expected for the provision of these activities as they benefit the group because these activities support the smooth running of the group entities.
The fourth group of activities is shareholder activities that relate to other group entities that are performed from the perspective of a shareholder. The objective of these activities is compliance with the regulations. As they are shareholder activities, they do not benefit the group entities, so compensation is not expected.
The characterisation of the Singapore taxpayer in these four categories is critical to establish the appropriate allocation of profit or service charge that the Singapore taxpayer should earn.
Transfer pricing method
As the activities performed by the headquarters benefit the multinational group entities, the headquarters should be compensated on an arm’s length basis. The amount of compensation should be determined based on appropriate analysis to ensure the related party transactions are accurately delineated using the five transfer pricing methods.
If the Singapore taxpayer acts as an ”entrepreneur” or “principal,” the Singapore headquarters will assume all/some of the key business risks arising from its activities. Under this scenario, the Singapore headquarters should receive the residual profit via the application of a residual profit split method.
If the Singapore taxpayer conducts core activities, the Singapore headquarters will manage the critical business risks for the multinational group. If the entity is characterised as a service provider, it will need to establish the arm’s length service charge. The amount of the service charge depends on the level of value addition of the service.
Similarly, if the Singapore Taxpayer conducts non-core/support activities, the Singapore headquarters will perform a routine activity and be entitled to an arm’s length service charge.
Transfer pricing documentation
Transfer pricing documentation is mandatory in Singapore for certain taxpayers that meet certain conditions. The transfer pricing documentation is key to show evidence of how the price is in line with the arm’s length principle.
Singapore headquarters performing any of the four activities described in the guidelines are expected to prepare transfer pricing documentation to demonstrate compliance with the arm’s length principle. The transfer pricing documentation should include a robust functional analysis and details on the value contribution activities performed by the Singapore taxpayer. The transfer pricing documentation should also have a clear price-setting policy for the controlled transactions entered by the Singapore taxpayer that includes the appropriate transfer pricing method used to set and test the price of the controlled transaction.
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