If your Philippine entity buys from, sells to, or lends to a foreign parent or affiliate, the prices you set between them are transfer prices. The BIR expects those prices to match what independent parties would have agreed under comparable conditions, a standard referred to as the arm's length principle.
Where your pricing falls short of it, Section 50 of the National Internal Revenue Code allows the Commissioner to reallocate income, deductions, or credits between the entities involved. The cost of that adjustment is a 25% surcharge, rising to 50% in cases of fraud, together with 12% annual interest on the deficiency.
This guide walks you through how the arm's length principle is applied in practice, what you have to file, and what happens if you are audited.
Who is Classified as a Related Party?
RR No. 19-2020 defines related-party relationships broadly. It covers any setup where one entity exercises direct or indirect control (or significant influence) over another.
Under RAMO No. 1-2019 (Transfer Pricing Audit Guidelines), the BIR focuses its audit scrutiny on common operational setups such as:
- BPO Subsidiaries & Shared Service Centers: A Philippine entity billing a foreign parent or affiliate on a cost-plus basis for IT, back-office, or customer support.
- Multinational Enterprise (MNE) Manufacturing: A local manufacturing unit selling finished goods to regional distribution entities.
- Cross-Border Holding Operations: Local entities receiving or extending intercompany loans, management fees, or licensing IP to regional sister companies.
- Incentivized Affiliates: Intercompany transactions between PEZA/BOI-registered units (enjoying tax incentives under the CREATE Act or CREATE MORE) and taxable domestic entities.
- Branch Offices: A Philippine branch is treated as a separate enterprise from its head office, so transactions between the branch and its head office, and between the branch and other branches or subsidiaries in the group, all fall within the transfer pricing rules.
Because these parties share a level of common interest, there's a real risk that pricing gets set to shift profits toward a lower-tax jurisdiction. The BIR addresses this through the Arm's Length Principle, which requires that related party prices match what unrelated parties would agree to under comparable conditions.
We break this down further in the sections below.
A note on domestic arrangements: RR No. 2-2013 addresses misallocation where one entity within a group operates under an income tax holiday or the 5% gross income tax while another pays regular corporate income tax. Shifting revenue or costs between them attracts the same scrutiny as a cross-border transaction, which is why incentivised structures draw attention even where no profit leaves the country.
Understanding the Arm’s Length Standard
RR No. 2-2013 (Transfer Pricing Guidelines) formally adopts the OECD Transfer Pricing Guidelines. It establishes the Arm’s Length Principle across all related-party dealings. To prove your intercompany prices reflect market conditions, your entity must conduct a three-step benchmarking exercise:
1. Conduct a Functional Analysis (FAR)
A functional analysis examines the functions each party performs, the assets each employs, and the risks each bears in a controlled transaction. It provides the factual basis for choosing a pricing method, and RR No. 2-2013 treats it as the foundation of the exercise.
The BIR uses this analysis to verify whether profit margins reflect true local value creation. Subsidiaries managing high-value assets or key operational risks require higher profit allocations. By contrast, routine service providers operate on narrower, standardized margins.
For example, a Philippine entity that manages key suppliers and oversees quality control likely deserves a higher margin than an overseas affiliate. That affiliate, by contrast, only performs basic assembly. Your functional analysis is what proves that difference to an examiner.
2. Select the Appropriate Transfer Pricing Method
Aligned with RR No. 2-2013 and OECD Guidelines, the BIR recognizes five core methodologies without a strict hierarchy:
| Method | Best Applied To | Practical Example |
|---|---|---|
| Comparable Uncontrolled Price (CUP) | Identical products or services sold in comparable open markets. | Selling raw materials to a foreign affiliate at the same price quoted to an unrelated market buyer. |
| Resale Price Method (RPM) | Distributors reselling goods without adding significant value. | Buying equipment from a foreign parent and establishing local pricing based on standard independent gross margins. |
| Cost Plus Method (CPM) | Routine service providers or contract manufacturers. | Applying an arm’s length service markup (e.g., 10%) on allowable operating expenses incurred by a Manila service unit. |
| Transactional Net Margin Method (TNMM) | Service or distribution transactions lacking direct price comparables. | Comparing net profit margins (e.g., operating margin) of a Philippine IT unit against independent peer companies. |
| Profit Split Method (PSM) | Complex, highly integrated operations sharing unique IP or development risks. | Allocating total profits from a joint technology venture based on each party’s relative contribution. |
TNMM carries most Philippine service and BPO arrangements, since genuine price comparables are rare and the tested party is usually the local entity performing routine work.
If you are unsure about which transfer pricing method is applicable, contact Emerhub’s local compliance experts.
3. Establish the Arm’s Length Range
With your chosen method, you calculate what's known as the arm's length range. This is a range of prices or profit margins that comparable independent companies would earn under similar conditions. If your results fall within that range, your pricing is generally defensible. If they don't, you'll need to adjust your pricing or explain the gap with supporting evidence.
Your TPD should clearly connect your chosen method, the data you used, and the pricing outcome you arrived at. This way, an examiner can follow your reasoning from start to finish.
Filing BIR Form 1709 & Mandatory TPD Thresholds
BIR Form 1709 (Information Return on Related-Party Transactions) acts as the BIR's primary risk-assessment filter. It is an annual disclosure form used by the BIR to identify and assess the transfer-pricing risks of transactions between related parties. Introduced under RR No. 19-2020, its submission scope was later updated by RR No. 34-2020 and RMC No. 76-2020.
Who Must File BIR Form 1709?
Together with your Annual Income Tax Return (AITR), you need to file Form 1709 if you fall under one of these categories:
- Large taxpayers, as classified by the BIR's Large Taxpayers Service.
- Taxpayers enjoying tax incentives, including:
- PEZA and BOI registered enterprises,
- Anyone availing of an Income Tax Holiday (ITH) or a preferential income tax rate, including incentives granted under the CREATE Act (RA 11534) and its amendments under CREATE MORE (RA 12066).
- Taxpayers reporting net operating losses for the current taxable year and the two immediately preceding taxable years.
- Any related party transacting with a taxpayer in one of the three categories above, even if that related party itself doesn't meet any of those criteria on its own.
A small domestic subsidiary with no incentives and no losses can still be pulled into the filing requirement. That happens simply because its foreign parent or sister company is PEZA registered.
If you don't meet the three conditions, you still need to disclose that fact in the Notes to your Audited Financial Statements. Your pricing still has to hold up to the arm's length principle if the BIR ever reviews it.
Late or non-filing of Form 1709 carries a compromise penalty ranging from PHP1,000 to PHP25,000 per taxable year under BIR penalty schedules. Repeated non-compliance may subject the taxpayer to criminal prosecution under Section 275 of the Tax Code.
When is a Full TPD Required?
Under RR No. 34-2020 and RMC No. 54-2021, entities filing Form 1709 must also retain a full Transfer Pricing Documentation (TPD) package if they cross any of these limits:
| Trigger Condition | Materiality Threshold |
|---|---|
| Combined Revenue & Transactions | Gross annual revenue exceeds PHP 150,000,000 AND total related-party transactions exceed PHP 90,000,000. |
| Tangible Goods | Annual sale/purchase of tangible goods to a single related party exceeds PHP 60,000,000. |
| Services, Interest, or Intangibles | Service fees, interest payments, or IP transactions with a single related party exceed PHP 15,000,000. |
| Prior Year Requirement | TPD was required in the immediately preceding taxable year. |
Note: The BIR does not issue a standalone Letter of Authority (LOA) for transfer pricing. Upon receiving a general tax audit LOA under RAMO No. 1-2019, taxpayers have 30 calendar days to submit their completed TPD. A single non-extendible 30-day extension may be requested under RR No. 34-2020 with substantiated grounds.
Avoiding Double Taxation via MAP
A transfer pricing adjustment is one of the most common ways to get double-taxed. If the BIR raises your Philippine entity's taxable income following an audit, the related profit is likely already taxed in the other country at the original, unadjusted amount. That's the same income taxed twice.
To address this issue, RR No. 10-2022 governs the Mutual Agreement Procedure (MAP). Under applicable Double Taxation Agreements (DTAs), MAP allows the BIR to negotiate directly with foreign tax authorities. This administrative process helps resolve double-taxation disputes resulting from transfer pricing audits.
For example, say the BIR raises your Philippine subsidiary's taxable income following an audit, and your foreign parent already paid tax on that same income abroad. MAP lets the two tax authorities negotiate a resolution so you're not taxed twice on it.
Ensure BIR Compliance with Emerhub
Navigating BIR transfer pricing audits requires local tax expertise and precise benchmark modeling. Emerhub’s Philippine tax advisors assist multinational operations with:
- Determine whether your entity, and any related party you transact with, triggers the Form 1709 filing requirement.
- Assess your transactions against the TPD materiality thresholds and flag exposure before your AITR deadline.
- Build a functional analysis and select the most defensible arm's length pricing method for your transaction type.
- Prepare a complete, contemporaneous Transfer Pricing Documentation package that can withstand a BIR audit.
Reach out to our Philippines team for a consultation on your transfer pricing exposure and documentation readiness.
Sources:
RAMO No. 1-2019, Transfer Pricing Audit Guidelines
RR No. 34-2020, Amending the Filing and Documentation Requirements
RR No. 2-2013, Transfer Pricing Guidelines
RR No. 19-2020, introducing Form 1709
RMC No. 76-2020, clarifying RR No. 34-2020
RR No. 10-2022, Mutual Agreement Procedure guidelines
OECD Transfer Pricing Guidelines, adopted by reference in RR No. 2-2013
Frequently asked questions
Does transfer pricing only apply to large multinational companies?
The arm's length principle under Section 50 of the NIRC applies to any related party transaction regardless of company size. Smaller entities may fall outside the Form 1709 filing requirement or the TPD materiality thresholds. Even so, they're still expected to price intercompany transactions at arm's length if the BIR ever reviews them.
What's the difference between BIR Form 1709 and Transfer Pricing Documentation?
Form 1709 is a disclosure return filed with your AITR that reports the existence and nature of your related party transactions. TPD is the underlying technical study that justifies why your related party pricing is arm's length. It includes your functional analysis, chosen pricing method, and comparability data. You can be required to file Form 1709 without needing a full TPD if you don't cross the materiality thresholds.
When is BIR Form 1709 due?
Form 1709 is filed together with your Annual Income Tax Return, which falls due on the 15th day of the fourth month following the close of your taxable year. For calendar-year taxpayers, that's April 15 of the following year.
Do PEZA or BOI registered companies need to comply with transfer pricing rules?
Enjoying an Income Tax Holiday or a preferential tax rate under PEZA, BOI, or the CREATE Act specifically places you in one of the four categories required to file Form 1709. Incentives don't exempt you from either the disclosure requirement or the underlying arm's length principle.
Can I be audited for transfer pricing without receiving a dedicated transfer pricing audit notice?
The BIR doesn't issue a separate Letter of Authority for transfer pricing. Once you receive an LOA covering an audit of your internal revenue taxes generally, the BIR can request your TPD as part of that broader examination. You're expected to produce it within 30 days.
What happens if my related party transactions were priced incorrectly but I filed Form 1709 on time?
Filing on time avoids the compromise penalty for late or non-filing. It doesn't protect you from a deficiency assessment if the BIR determines your actual pricing wasn't at arm's length. That assessment can still carry the full 25% (or 50%, in fraud cases) surcharge and 12% annual interest, separate from any filing penalty.