BIR moves to plug tax leaks from related-party transactions

To plug hefty tax leakages from local and foreign deals involving related parties, the Bureau of Internal Revenue (BIR) on Friday mandated reporting of these types of transactions.

The country’s biggest tax-collection agency published Revenue Regulations (RR) No. 19-2020 signed by Finance Secretary Carlos G. Dominguez III and Internal Revenue Commissioner Caesar R. Dulay, which prescribed the submission of the new BIR Form No. 1709.

Form No. 1709 is information return on related-party transactions (domestic or foreign) and its supporting documents.

Investopedia defined related-party transaction as “a deal or arrangement between two parties who are joined by a pre-existing business relationship or common interest.”

The new BIR form replaced the older BIR Form 1702H (information return on transactions with related foreign persons), which was being used since 1992.

Internal Revenue Deputy Commissioner Arnel S.D. Guballa told the Inquirer that the BIR believed tax leaks from related-party transactions were “substantial,” although he did not have estimates.

RR 19-2020 identified “related parties” to include “close” family members in the case of persons, as well as parent-firms, subsidiaries, associates, joint ventures or employers who wield control or influence during decision-making in the case of entities.

The BIR said related-party transactions included:

• Purchases or sales of goods (finished or unfinished)
• Purchases or sales of property and other assets
• Rendering or receiving of services
• Leases
• Transfers of research and development
• Transfers under license agreements
• Transfers under finance arrangements (including loans and equity contributions in cash or in kind)
• Provision of guarantees or collateral
• Commitments to do something if a particular event occurs or does not occur in the future, including executory contracts
• Settlement of liabilities on behalf of the entity or by the entity on behalf of that related party.

For either reporting entities or related parties, the BIR said “the required disclosures on transactions and outstanding balances shall be made separately for each of the following categories”

• Parent—entities with joint control or significant influence over the entity
• Subsidiaries
• Associates
• Joint ventures in which the entity is a joint venturer
• Key management personnel of the entity or its parent
• Other “related parties”

According to the BIR, “for each of said category, the following information shall be provided:”

• Amount of the transactions
• Amount of outstanding balances
• Provisions for doubtful debts related to the amount of outstanding balances
• Expense recognized during the period in respect of bad or doubtful debts due from related parties.

On top of completely filling-up BIR Form 1709, the following documents must be attached upon submission:

• Certified true copy of the relevant contracts or proof of transaction
• Withholding tax returns and the corresponding 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 parly is a resident
• Certified true copy of advance pricing agreement (if any)
• Transfer pricing documentation

The BIR warned that those who will violate RR 19-2020 will be slapped with penalties of P1,000-25,000 under Section 250 of the Tax Code.

“Through the years, transactions around the world have become more complex and have been subject to abuse by taxpayers with intent to evade taxes by concluding transactions between them at unreasonable prices, thus eroding the tax base,” the BIR said.

“Undeniably, this usually happens between related parties,” the BIR said.

“While majority of related-party transactions are not detrimental, there is a pressing worldwide concern that they can be easily abused in the absence of a relevant framework and effective enforcement,” it said.

“Significant risks arise when related-party transactions are not conducted at arm’s length and are used as a conduit to channel funds out of the company into another related party,” the BIR said.

“Therefore, in order to ensure that proper disclosures of related-party transactions are made and that these transactions have been conducted at arm’s length so as to protect the tax base, there should be an effective implementation of Philippine accounting standards (PAS) 24, related-party disclosures, for tax purposes,” the collecting agency said.

“Under this PAS, an entity’s financial statements shall contain the disclosures necessary to draw attention to the possibility that its financial position and profit or loss may have been affected by the existence of related parties and by transactions and outstanding balances, including commitments, with such parties,” RR 19-2020 read.

“Tax examiners are hereby enjoined to conduct a thorough examination of the related-party transactions and see to it that revenues are not understated and expenses are not overstated in the financial statements as a result of these transactions,” according to the BIR.

TSB