Businesses nowadays are known to be competitive and are focused on quality and growth. It is very usual for companies to transact with third parties such as investors, suppliers and customers that some transactions with related parties are more probable to be overlooked. Related party transactions usually involve a huge sum of money which may also cause an immense impact on reportorial requirements because of a mere oversight.
Who are related parties? Individuals, associates, or companies that control or are controlled by, whether directly or indirectly, or are under a common control with another entity are considered related parties. There is a significant influence or control underlying between related parties that can possibly be used for mismanagement of information, especially if the transactions occurring are complex.
To ensure that related party transactions are properly reported and related taxes are paid accordingly, the Bureau of Internal Revenue (BIR) recently issued Revenue Regulation (RR) No. 19-2020 to prescribe the use of the new BIR Form 1709, Information Return on Transactions with Related Party (International and/or Domestic), replacing Form 1702H, series of 1992. The completely accomplished Form 1709, including its supporting documents listed below, shall be a required attachment to the Annual Income Tax Returns:
- certified true copy of the relevant contracts or proof of transaction;
- withholding tax returns and proof of payment of taxes withheld and remitted to the BIR;
- proof of payment of foreign taxes or ruling duly issued by the foreign tax authority where the other party is a resident;
- certified true copy of Advance Pricing Agreement (APA), if any; and
- any transfer pricing documentation.
To avoid possible oversight and payment of tax penalties, below are some usual transactions between related parties and the corresponding tax implications.
- Allocated costs and expenses
This is common for group of companies. For instance, the ultimate parent company pays for the utilities in behalf of all the affiliates and thereafter allocates the cost to the group. In general, no withholding of taxes is required since this is a mere reimbursement of an expense. However, if one of the companies is formed to perform services for the group, the allocated cost billed to the group shall now be subject to Income tax and Value-added tax (VAT) as it will now be considered as an income of the affiliate. Accordingly, the corresponding expense may be subjected to withholding tax.
- Loans and advances
Loans and advances are commonly used for various business purposes such as funding a purchase of an asset or as an assistance to an affiliate for working capital. It shall be noted that such loans and advances are subject to Documentary stamp tax (DST).
- Intercompany sales and purchases
Intercompany sales are subject to Income tax and VAT. Offsetting of intercompany sales and purchases to intercompany payables and receivables, respectively, is very common for this type of transaction. Upon offsetting, the seller company constructively received payment from the buyer company. However, since there is no actual receipt of payment, there are instances that the offsetting amount was overlooked and was no longer subjected to VAT.
Moreover, intercompany sales and purchases shall be conducted at arm’s length. It should be priced within market rates and properly supported by an APA, a transfer pricing agreement documentation. Guidelines for transfer pricing was previously released by the BIR through RR No. 2-2013.
M.P. Camaso and Associates highly suggests taxpayers to proactively monitor its transactions with related parties to prevent paying penalties and surcharges because of failure to pay proper taxes in relation to the above-mentioned transactions.