Revenue Audit Memorandum 1-98
Revenue Audit Memorandum 1-98
Revenue Audit Memorandum 1-98
This RAMO is issued as a basic guideline for the joint and coordinated examination of interrelated
group of companies under Revenue Memorandum Order No. 61-98.
1. BACKGROUND
1.1 The remarkable decrease in collection from interrelated group of companies has
seriously affected the collection efforts of the Bureau. Statistics showed that while 'inter-
related transaction' accounts for a big percentage of the transfer of goods and services in
the country, the revenue collection from related-party groups continue to go on a
downtrend.
1.2 The magnitude of revenue lost has become so alarming that there is a need to
immediately address this problem. It is a fact that, because these companies are more
interested in their net income as a whole (rather than as individual corporations) there is a
desire to minimize tax payments by taking advantage of the loopholes in our tax system
and by making use of schemes that allow them to move around the law in order to reduce
their tax obligations.
2. GENERAL GUIDELINES
2.1 General Procedures. The provisions laid down in Volume 1 of the Handbook on Audit
Procedures and Techniques must be followed with respect to:
2.2 Special Audit Procedures. In addition, focus must be made on the following audit issues
(detailed audit procedures are laid down in Section 3 of this RAMO ):
2.2.1 Use of tax shelters (such as a foundation or a tax-exempt company) in order
to avail of tax exemptions or of lower tax rates;
2.2.2 Shifting income and/or expenses in favor of a related company with special
tax privileges (e.g. BOI Incentives, Tax Holidays, and etc.);
2.2.4 Inter-company loans and advances, and financing arrangements where the
interest charged for the use of money is not at arm's length;
2.2.5 Arbitrary cost-sharing arrangements for common expenses;
2.3.1 The authority for allocating income and expenses between or among related
parties is laid down in Section 50 of the NIRC, as amended. This Section gives the
Commissioner of Internal Revenue the authority to make allocation of income and
expenses between or among controlled group of companies, if a related taxpayer
has not reported its true taxable income.
2.3.2 The purpose of Section 50 is to ensure that taxpayers clearly reflect income
attributable to controlled transactions and to prevent the avoidance of taxes with
respect to such transactions. It places a controlled taxpayer in tax parity with an
uncontrolled taxpayer by determining the arm's-length price of inter-company
transactions.
2.5.2 The term 'controlled' for purposes of this RAMO shall mean any kind of
control, direct or indirect, whether legally enforceable and however exercisable or
exercised. It is the reality of the control which is decisive, not its form or the mode
of its exercise or ownership. A presumption of control arises if income and
expenses have been arbitrarily shifted.
2.5.3 The term 'controlled taxpayer' means any one or two or more organizations or
trade, or businesses owned or controlled directly or indirectly by the same interests;
2.5.4 The term 'true taxable income' means, the taxable income which would have
been reported by the controlled taxpayer, had it in the conduct of its affairs dealt
with the other member or members of the group at arm's-length.
3. AUDIT PROCEDURES
3.1 Transfer Pricing in interrelated supply of goods or services. This is relevant if one of
the related-party enjoys certain privileges such as tax exemption, lower tax rates,
incentives, or is a losing company.
3.1.1 In General. — The method to be used in determining the arm's-length price
of a controlled transaction shall rely primarily on the best judgment of the examiner
after taking into consideration the prevailing circumstances as well as the
availability of information at the time of transaction.
3.1.2 As a guide, the methods under the OECD Guidelines on transfer Pricing may
be used, as follows:
d. The Profit Split Method — this is done simply by dividing the profit
between the members involved in the transaction taking into
consideration the extent of their participation in the realization of the
transaction.
3.2 Loans and Advances, and financing arrangements between or among related parties
3.2.1. In General. When one member of a group makes a loan or advance directly
or indirectly to, or otherwise becomes a creditor of another member and either party
charges an interest which is not at arm's length, there may be a tax advantage to
either the lender or borrower.
c. Alleged indebtedness
For purposes of this Section, an "arm's length rate of interest" is the rate of
interest which would have been charged in independent transactions
between unrelated parties under similar circumstances.
3.3.2 To determine the arm's length price for the service, the "Benefit Test" may be
considered. Under this test, the direct benefit to the member which received the
service must be considered. It is necessary to take into account on some reasonable
basis all the costs or deductions which are directly or indirectly related to the service
performed.