by Eugene Lim, Providence Law Asia LLC
The Inland Revenue Authority of Singapore (IRAS) issued the 5th edition of its Transfer Pricing Guidelines on 23 February, setting out enhancements to the arm’s length principle, adding new transfer pricing documentation requirements, and granting new powers of the Comptroller of Income Tax (Comptroller) to make transfer pricing adjustments and impose surcharges and penalties for non-compliance.
The guidelines update guidance on Singapore’s transfer pricing regime and incorporate the new Income Tax (Transfer Pricing Documentation) Rules 2018, which came into effect on 23 February and transfer pricing related amendments to the Income Tax Act (Cap. 34) (ITA).
The guidelines, recent ITA amendments, and the transfer pricing documentation rules are in line with IRAS’s objective to increase transfer pricing compliance by taxpayers.
Arm’s length principle
The newly revised guidelines reiterate IRAS’s endorsement that the arm’s length principle is to be used for transfer pricing purposes to determine the appropriate pricing between related parties.
The guidelines refer to Section 34D of the ITA as one of the bases for using the arm’s length principle for related party transactions. Section 34D was amended in October 2017 to clarify:
- the types of benefits that could arise when two related parties deal with each other on conditions that are not arm’s length;
- that arm’s length conditions are to be identified on the basis of actual commercial or financial relationships between the parties and how non-related parties will have transacted in comparable circumstances; and
- the types of actions that the Comptroller may take to counteract the benefits resulting from non-arm’s length basis transactions.
Singapore’s transfer pricing approach
The guidelines recommend the use of the following 3-step approach to applying the arm’s length principle to related party transactions: (a) step 1 – comparability analysis; (b) step 2 – identify the most appropriate transfer pricing method and tested party; and (c) step 3 – determine the arm’s length results.
We set out below some of the key enhancements to this approach in the newly revised guidelines.
The guidelines provide enhanced guidance on the comparability analysis in the following ways:
- it sets out the methodology to perform a comparability analysis – which requires taxpayers to (i) examine the economic or financial relations between the related parties and accurately delineate the related party transaction, and (ii) compare this with independent party transactions with similar economically relevant characteristics.
- economically relevant characteristics of related party transactions include: (i) contractual terms of the transaction; (ii) characteristics of goods sold or purchased, services received or provided, or intangible properties used or transferred; (iii) the functions, assets used and risks assumed by the parties; and (iv) the commercial and economic circumstances of the parties.
The guidelines further provide detailed guidance on analysing the contractual terms of related party transactions. Key guidance states:
- written contractual agreements alone may not provide sufficient information to perform a transfer pricing analysis;
- further information including a review of economically relevant characteristics will be required to identify the nature of the actual transaction;
- where there are material differences between the contractual terms and the actual conduct of the related parties, the actual transaction should be based on the actual conduct.
The guidelines expand on the scenarios where the transactional profit split method is particularly useful, such as where:
- the parties’ contributions to the transactions and their interactions are highly inter-related and integrated – i.e., the way in which one party to the transaction performs functions, uses assets and assumes risks is interlinked with, and cannot be reliably evaluated in isolation from the way in which another party to the transaction performs functions, uses assets and assumes risks;
- parties make “unique and valuable” contributions to the transaction, which is defined as where they are not comparable to contributions made by independent parties in comparable circumstances, and they represent a key source of actual or potential economic benefits in the business operations;
- the existence of unique intangible assets makes it difficult to find reliable comparables;
- each party shares the assumption of one or more of the economically significant risks in relation to that transaction or the parties assume the economically significant risks separately but those risks are so closely inter-related or correlated that the playing out of the risks of each party cannot reliably be evaluated separately.
The guidelines clarify that a lack of comparables alone is insufficient to warrant the use of a transactional profit split method as the application of this method in some situations would likely bring about a non-arm’s length outcome for the functions performed.
Refinancing
The guidelines provide guidance on the application of the arm’s length principle for obtaining a loan from a related party to repay an existing loan (i.e., re-financing) or extending the tenure of an existing related party loan.
The taxpayer is required to establish arm’s length terms and interest rates for the new loan in accordance with the framework for determining arm’s length interest rate for related party loans as set out in the guidelines.
Routine support services
The definition of routine support services in the guidelines has been amended to be consistent with the First Schedule of Singapore’s transfer pricing documentation rules.
As an administrative practice, IRAS will allow taxpayers to apply a 5% cost mark-up on routine support services as a reasonable arm’s length charge when certain conditions are satisfied.
Transfer pricing documentation
The guidelines provide guidance on transfer pricing documentation pursuant to Section 34F of the ITA and the transfer pricing documentation rules, which take effect from the year of assessment 2019.
The approach, as set out in the guidelines, is to enable taxpayers to describe their compliance with the arm’s length principle for their related party transactions and provide IRAS with relevant and reliable information to perform an efficient and robust transfer pricing risk assessment analysis.
A summary of Singapore’s transfer pricing documentation requirements under Section 34F of the ITA is as follows.
|
Scope |
Transfer pricing documentation requirement |
|
When it takes effect |
From year of assessment 2019 |
|
Who must prepare |
Taxpayers who meet either of the following conditions must prepare transfer pricing documentation for their related party transactions undertaken in a basis period: · Gross revenue derived from their trade or business is more than S$10 million for that basis period; or · Transfer pricing documentation is required to be prepared for the previous basis period. |
|
What to prepare |
Documentation is based on a 3-tiered structure consisting of: (a) documentation at the group level; (b) documentation at the entity level; and (c) Country-by-country report. The guidelines prescribe information to be included in the documentation at the group and entity levels. Details regarding the country-by-country report are set out in Part XXB of the ITA and e-Tax guide on country-by-country reporting. |
|
Exemption from preparing |
The exemptions from preparing transfer pricing documentation as prescribed as follows:
|
|
When to prepare |
Not later than the filing due date of the tax return. |
|
When to submit |
Within 30 days from a request by IRAS to submit the TPD to IRAS. |
|
When to refresh |
As long as the details in the transfer pricing documentation remain accurate, taxpayers may refresh their documentation once every three years. The guidelines provide guidance on conditions that must be satisfied for documentation prepared previously to be used for the current basis period. |
|
How long to retain documentation |
A period of at least 5 years from the end of the basis period in which the transaction took place. |
Adjustments
The guidelines include a new section on the types of actions that IRAS can take to make transfer pricing adjustments when related parties do not transact at arm’s length and understate their profits. This reflects the recent amendments to Section 34D of the ITA in October 2017.
Adjustments now include an ability to increase income by treating income as accruing in or derived from Singapore or received in Singapore from outside Singapore or to reducing a loss by treating the loss as not having been incurred.
The guidelines also state that IRAS is able to disregard actual related party transactions or replace them with an alternative transaction in exceptional circumstances where the arrangements made in relation to the transaction lacks the commercial rationality and the arrangement prevents determination of a price that would be acceptable to both of the parties taking into account their respective perspectives and the options realistically available to them at the time of entering into the transaction.
When the actual related party transaction is being replaced with an alternative transaction, the replacement structure would be guided by the facts of the actual transaction so as to achieve a commercially rational result that is in accordance with the arm’s length principle.
Insufficient transfer pricing documentation
If taxpayers have insufficient transfer pricing documentation or do not have documentation to substantiate their transfer prices, the guidelines provide that the following adverse consequences could apply to the taxpayers:
- IRAS will make an upward transfer pricing if profits have been understated;
- IRAS may not be able to support such taxpayers in mutual assistance procedure (MAP) discussions to resolve double taxation that arises from any transfer pricing audit by IRAS or foreign tax authorities;
- IRAS may not accept advance pricing agreement applications from such taxpayers;
- for transfer pricing adjustments made by IRAS for year of assessment 2019 or later, a surcharge of 5% will be imposed on the adjustments regardless of whether there is tax payable on the adjustments;
- taxpayers that do not comply with the TPD requirements shall be liable to a fine not exceeding S$10,000.
The guidelines also include a new section which elaborates on the surcharge and penalty that the Comptroller will impose from year of assessment 2019 when taxpayers fail to comply with the arm’s length principal or the transfer pricing documentation requirement pursuant to Sections 34E and 34F of the ITA.
The surcharge and penalty imposed by the Comptroller is not deductible for tax purposes. The Comptroller may offer to compound the offence in lieu of prosecution.
Annex A – Specified transactions qualifying for exemption from transfer pricing documentation
Taxpayers are exempt from preparing transfer pricing documentation for transactions undertaken with their related parties in a basis period in any of the following cases:
- Related party domestic transaction subject to the same tax rate
- Related party domestic loan
- Related party loan on which indicative margin is applied
- Routine support services on which 5% cost mark-up is applied
- Related party transaction covered by advance pricing arrangement
- Related party transaction not exceeding the thresholds set out in the table below.
|
Category of transactions |
Value (S$) |
Meaning of value of transaction |
|
Purchase of goods by the taxpayer from a related party |
15 million |
Amount paid or payable by the taxpayer for the goods |
|
Sale of goods by the taxpayer to a related party |
15 million |
Gross revenue derived by the taxpayer from the sale |
|
Loan by the taxpayer to a related party |
15 million |
Principal amount of the loan |
|
Loan to the taxpayer by a related party |
15 million |
Principal amount of the loan
|
|
Provision of service to the taxpayer by a related party |
1 million |
Amount paid or payable by the taxpayer for the provision, i.e. service fee expenses |
|
Provision of service by the taxpayer to a related party |
1 million
|
Gross revenue derived by the taxpayer from the provision, i.e. service fee income |
|
Grant of a right to use movable property to the taxpayer by a related party |
1 million |
Amount paid or payable by the taxpayer for the grant, i.e. royalty expenses |
|
Grant of a right to use movable property by the taxpayer to a related party |
1 million |
Gross revenue derived by the taxpayer from the grant, i.e. royalty income |
|
Lease of any property to the taxpayer by a related party |
1 million |
Amount paid or payable by the taxpayer for the lease, i.e. rental expenses |
|
Lease of any property by the taxpayer to a related party |
1 million |
Gross revenue derived by the taxpayer from the lease, i.e. rental income |
|
Grant of a guarantee to the taxpayer by a related party |
1 million |
Amount paid or payable by the taxpayer for the grant, i.e. guarantee expenses |
|
Grant of a guarantee by the taxpayer to a related party |
1 million |
Gross revenue derived by the taxpayer from the grant, i.e. guarantee income |
|
Any other transaction |
1 million |
Amount paid or payable by the taxpayer to the related party under the transaction, or gross revenue derived by the taxpayer from the related party under the transaction, as the case may be |
— Eugene Lim is an international tax and trade lawyer who works extensively in the Asia Pacific region, having been based in Hong Kong and China for 11 years before moving to Singapore in 2014 to head the Singapore Tax, Wealth Management, and Trade practice in one of the largest international law firms in Singapore. Eugene is currently practicing with Providence Law Asia LLC and can be reached at [email protected].
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