Transfer Pricing on Loans
By: Atty. Irwin C. Nidea, Jr.
"If related companies have intercompany advances, which are non-interest-bearing, and there is no written agreement stipulating interest, the CIR cannot impute interest on these transactions, that can result in an assessment of deficiency income tax. The Civil Code is the anchor of this legal principle. Article 1956 of the Civil Code expressly states: “No interest shall be due unless it has been expressly stipulated in writing.”"
Irwin C. Nidea Jr. +632 8403-2001 loc.330 |
In recent years, a significant tax issue has emerged surrounding the taxation of inter-company loans, specifically in relation to imputed interest. This has raised important questions about the power of the Commissioner of Internal Revenue (CIR) to assess tax on transactions that involve loans or advances between related parties. Transfer pricing non-compliance is the new tool being used by the Bureau of Internal Revenue (BIR) in its efforts to impute interest on non-interest-bearing loans and advances between related parties. A close examination of the law, its application, and recent Supreme Court decisions sheds light on the limitations of the CIR’s powers and how these should be applied to ensure fairness and clarity in the taxation process.
Under Revenue Memorandum Order (RMO) No. 63-99, the CIR has specific guidelines for determining taxable income from inter-company loans or advances. This order relies on Section 50 of the 1997 National Internal Revenue Code (NIRC), which governs the allocation of income and deductions between related parties. The RMO outlines that the arm’s length interest rate should serve as the basis for determining the taxable income from such loans.
Section 4.2.1 of RMO No. 63-99 states that the arm’s length interest rate should reflect the rate of interest that would have been charged in an independent transaction between unrelated parties under similar circumstances. Additionally, Section 4.2.2 mandates that for domestic transactions, the interest rate to be applied is the Bank Reference Rate (BRR) prescribed by the Bangko Sentral ng Pilipinas (BSP).
Unlike in other countries, however, this rule can only apply when interest is actually agreed upon and stipulated by the parties involved. It does not give the CIR the authority to arbitrarily impute interest on loans or advances that were made without any formal interest agreement.
Section 50 of the NIRC grants the CIR the power to distribute, apportion, or allocate income and deductions between related parties to prevent tax evasion or ensure that the income of any business is accurately reflected. However, this power is not as broad as some might assume. It is important to note that Section 50 only allows the CIR to allocate actual, existing income or deductions — not theoretical income.
In this regard, the Filinvest case is particularly instructive. In this ruling, the Supreme Court clarified the limits of the CIR’s authority under Section 50. The Court held that the CIR cannot impute “theoretical interest” to controlled taxpayer transactions, meaning that if no interest was actually agreed upon, the CIR cannot arbitrarily assess income based on a presumed interest rate. As the Court emphasized, “there must be proof of the actual or, at the very least, probable receipt or realization by the controlled taxpayer of the item of gross income sought to be distributed, apportioned or allocated by the CIR.”
The CIR also has the authority to make transfer pricing adjustments, which involve adjusting prices for intra-company transactions between related entities. This power is also governed by Section 50 of the NIRC. However, the Supreme Court in the Asia United Bank case made it clear that transfer pricing adjustments under Section 50 are strictly confined to allocating expense deductions, not creating income or expenses that do not exist.
Transfer pricing issues typically arise when transactions between related companies are structured in ways that shift profits or expenses to minimize tax liabilities. While the CIR can make adjustments to these transactions, the Court in the Asia United Bank case emphasized that these adjustments must be based on actual transactions, not hypothetical or imputed amounts. In other words, the CIR cannot use its power to manipulate income by attributing interest charges or other expenses where none were actually incurred.
The CIR’s authority to distribute, apportion, or allocate income and deductions is clearly defined under Section 50 of the NIRC. However, this power does not extend to the creation of income or deductions through imputation, especially when no such income has been realized. As the Supreme Court has consistently ruled, taxes should be based on actual, existing income and transactions. The imposition of taxes based on theoretical or speculative amounts undermines the principles of fairness and legal certainty that are fundamental to the tax system.
So, if related companies have intercompany advances, which are non-interest-bearing, and there is no written agreement stipulating interest, the CIR cannot impute interest on these transactions, that can result in an assessment of deficiency income tax. The Civil Code is the anchor of this legal principle. Article 1956 of the Civil Code expressly states: “No interest shall be due unless it has been expressly stipulated in writing.”
Unless this Civil Code provision is amended, it seems that related parties are protected from imputed interest charges on intercompany advances. This is a limitation that may not be present in other countries. Nevertheless, this is a reminder that the government must exercise its taxing powers within the bounds of the law and its limitations, ensuring that the assessment and collection of taxes are fair, reasonable, and based on transactions that are considered real by local law and jurisprudence.
The author is a senior partner of Du-Baladad and Associates Law Offices, a member-firm of WTS Global.
The article is for general information only and is not intended, nor should be construed as a substitute for tax, legal or financial advice on any specific matter. Applicability of this article to any actual or particular tax or legal issue should be supported therefore by a professional study or advice. If you have any comments or questions concerning the article, you may e-mail the author at This email address is being protected from spambots. You need JavaScript enabled to view it. or call 8403-2001 local 330.