Transfer pricing guidelines updated to incorporate new content
On 10 August 2021, the Inland Revenue Authority of Singapore (IRAS) released the long- awaited 6th Edition of the Transfer Pricing Guidelines (“6th Ed TPG”), three years after the release of the 5th edition. Key highlights of the 6th Ed TPG include new guidance on the conditions for obtaining a remission of a surcharge, guidance on related party financial transactions, shareholder activities and low value-adding intragroup services and cost contribution arrangements (CCAs). The 6th Ed TPG provides significant updates and amendments to the 5th edition, signaling that the government is adopting a more serious stance in transfer pricing enforcement and is a step closer to aligning Singapore’s rules with the broader global transfer pricing practices.
This article summarises the main changes made in the 6th Ed TPG.
Transfer pricing audits
IRAS has officially renamed “Transfer Pricing Consultation,” an initiative launched in 2008, to Transfer Pricing Audit (TPA). The 6th Ed TPG clearly states that a possible outcome of the TPA is an adjustment to taxable income under Section 34D of the Singapore Income Tax Act (SITA) if related party transactions are found to be concluded under non-arm’s length conditions. The new chapter consolidates earlier guidance on the topic and IRAS further clarifies that it would not accept a taxpayer’s request for an advance pricing arrangement (APA) for a related party transaction that is under audit or investigation.
The renaming of the Transfer Pricing Consultation is consistent with IRAS’ increasingly firm hand and proactive efforts to enforce Singapore’s transfer pricing legislation. There already has been an increase in transfer pricing audit activity.
It is important to note that enforcement does not stop at compliance with the transfer pricing documentation requirement. Whilst most taxpayers have complied with and prepared the requisite transfer pricing documentation per the statutory requirements over the past six years (since the introduction of the 2nd TPG in 2015), it appears that IRAS is now gearing up to review and challenge the robustness of such documentation.
Remission of surcharge
A 5% surcharge on transfer pricing adjustments made by IRAS was introduced in 2018. The surcharge applies regardless of whether any tax is payable as a result of the adjustment, as well as where taxpayers voluntarily make self-initiated upward adjustments on their related party transactions for previous financial years.
The new guidance provides for partial or full remission of the surcharge if certain conditions are fulfilled. Specifically, IRAS will consider remission of the surcharge only for taxpayers that are cooperative during the transfer pricing audit or review and have solid compliance records.
The following conditions must be met in a TPA scenario for a taxpayer to obtain a remission of the surcharge:
- The taxpayer has been cooperative and has provided required responses and documentation within the timeline set by IRAS;
- The taxpayer has maintained proper transfer pricing documentation in accordance with Section 34F of the SITA and the transfer pricing documentation rules; and
- The taxpayer has a good compliance record with respect to the submission of its tax returns and payment of tax by the due dates for the current Year of Assessment (YA) and the two immediately preceding YAs.
Two additional conditions apply to obtain a remission where a taxpayer makes a voluntary self-initiated upward adjustment:
- The adjustment is made within two years from the tax return filing due date; and
- The taxpayer has not received any queries from IRAS relating to related party transactions for the relevant YA or has not received a notification of the commencement of an audit or investigation.
Taxpayers that historically have not been remunerated or have been remunerated in an amount below an arm’s length amount may wish to consider a self-initiated retroactive upward adjustment. This may apply to:
- Ongoing loss-making companies that are captive service providers to a multinational group or that are characterised as low or routine risk service providers/distributors/ manufacturers;
- Singapore-headquartered holding companies that have not been charging arm’s length fees for management and support services rendered to their related parties; and
- Taxpayers that in prior years may have taken aggressive or incorrect transfer pricing positions and now wish to bring themselves into compliance by adjusting profits upwards without incurring a surcharge.
Granting a penalty remission for good behaviour is not novel, although only a handful of tax administrations have adopted this approach in the context of transfer pricing enforcement. Perhaps recognising the dilemma of taxpayers that wish to bring themselves into compliance but do not want to incur the surcharge, IRAS seems to be progressive in empowering taxpayers to actively manage their transfer pricing risks. Thailand is the only other Asian country affording such relief.
For many taxpayers, transfer pricing documentation is often prepared on an ex-post basis (i.e., after the event) and it then may be too late for taxpayers to put through book entries to correct any inaccurate transfer pricing positions taken in the relevant year. Thus, we expect the remission to be welcomed by many taxpayers. To maximize the benefits of the remission, affected taxpayers may wish to consider making their retroactive upward adjustments for prior years by the time their YA 2021 tax return is filed (since YA 2019 was the first year the surcharge was introduced).
Related party financial transactions
The 6th Ed TPG dedicates 18 pages to the chapter on “related party financial transactions,” as compared to the nine pages in the 5th Ed TPG on “related party loans.” As the change in the title of the chapter suggests, the 6th Ed TPG covers guidance on the broader gamut of financial transactions such as cash pools, financial guarantees, hedging and captive insurance instead on only focusing on “loans,” and it confirms that such transactions must be in line with the arm’s length principle.
The concept of “quasi-equity” is discussed for the first time, offering guidance on the characterisation of a purported loan between related parties to determine whether it should be considered debt or equity and setting out criteria for delineating the features of the financial transaction. There is more detailed guidance and examples on the application of different methodologies for pricing financial transactions between related parties, including guidance on risk-free rates of return, centralized financial functions, such as administering cash pools, analysis of the borrower’s credit rating and the impact of implicit support on the borrower’s credit rating.
The 6th edition TPG categorically states that the IRAS does not regard interest-free loans to be on arm’s length terms unless it can be established that unrelated parties under similar circumstances would provide loans without charging interest. This makes it critical for taxpayers to undertake an early analysis of their related party financial transactions to determine the characterisation and prepare appropriate documentation to support their positions with an appropriate economic analysis.
Related party services
Related party or intragroup services are activities performed by one or more members of a group for related parties within the same group; examples of such services include administrative, technical, financial, commercial, management, coordination and control functions. Once a related party service has been provided, a taxpayer should ascertain the appropriate charge for the service based on the arm’s length principle.
The IRAS has a long-established administrative practice of accepting a 5% cost mark-up for certain routine support services without the need for taxpayers to prepare benchmarking studies. The 6th Ed TPG provides taxpayers with another option to apply the 5% profit mark-up under the OECD simplified approach for low value-adding intragroup services (i.e., the OECD simplified approach), subject to certain conditions, a main one being that the tax authorities of the related counterparty must have similarly adopted the OECD simplified approach.
The 6th Ed TPG provides new guidance on shareholder activities (including examples and clarifying that these activities would not be regarded as related party services and should not be charged to any group members) and on the use of a value-added cost mark-up as a profit level indicator for analysis under the transactional net margin method (setting out strict criteria for its application, similar to the case of the Berry ratio).
The list of services under IRAS’ administrative concession is restrictive and many related party services would not qualify for the 5% mark-up. The new option to rely on the OECD’s simplified approach is welcome, as it should mitigate some of the compliance burden for taxpayers. That said, where taxpayers engage in services such as services constituting the core business of the multinational group, research and development services, manufacturing and production services, sales, marketing and distribution activities, financial transactions, insurance and reinsurance, and services of corporate senior management (other than management supervision of services that qualify as low value-adding intragroup services), a robust benchmarking study still will be required to determine the arm’s length margin for the services.
Earlier in 2021, IRAS published special topic transfer pricing guidance on centralized service activities of multinational groups in Singapore. The 6th Ed TPG further elaborates guidance on related party services, thereby affirming that related party service transactions remain a key focus area for IRAS.
Cost contribution arrangements
Members of a multinational group may enter into a CCA to share the development of intangible or tangible assets or to obtain services from each other. To further align Singapore’s rules with the OECD’s transfer pricing guidelines, IRAS includes a new section in the 6th Ed TPG on CCAs, which confirms that mutual benefit is a fundamental concept to a CCA, requiring all participants to share in the overall contributions to a CCA, the associated risks and the exploitation of profits.
The 6th Ed TPG contains detailed guidance on applying the arm’s length principle to two types of CCAs: Development CCAs and Services CCAs, specifically with respect to the entry, withdrawal and termination stages of a CCA. A Development CCA is set up for the joint development, production or obtaining of intangible or tangible assets and a Services CCA is set up for the purpose of obtaining services.
IRAS also highlights in the 6th Ed the applicable deductibility and withholding tax treatment for balancing payments, and the requirement for the application of a mutual agreement procedure if the taxpayer requests a transfer pricing adjustment that would result in an increase in its claim for a deduction or a reduction in tax previously withheld.
The introduction of this new section affirms IRAS’ recognition of CCAs as common global commercial arrangements. Notably, the guidance comes on the heels of a decision of the Singapore high court involving CCAs and provides timely clarity on the applicable tax treatment of CCAs from a Singapore tax perspective.
While CCAs are common for U.S. and Europe-headquartered multinational companies, the endorsement of the CCA allows Singapore-headquartered companies to similarly adopt CCA arrangements, which may help to simplify multiple intercompany transactions among group members.
Frequently asked questions (FAQs)
The 6th Ed TPG includes FAQs that provide guidance on the preparation of transfer pricing documentation, including the importance of having comprehensive information as required under the relevant rules and meeting the contemporaneous tax return filing deadline. The IRAS clarifies that while taxpayers can leverage documentation prepared at the group level or prepared for other tax authorities, the documentation must be supplemented by local entity information and analysis to meet Singapore’s transfer pricing requirements.
A key takeaway from the FAQs is IRAS’ underlying expectation for taxpayers to prepare high quality and robust transfer pricing documentation, with sufficient information on the business, supply chain and related party transactions to enable IRAS to assess the arm’s length nature of the taxpayer’s dealings with its related parties. Not all transfer pricing documentation is created equal, so it is important for taxpayers to put in place a solid first line of defense.
Koh Yun Qi