Risk factors that could trigger a transfer-pricing audit

SOON, THAILAND will no longer have mere transfer-pricing guidelines in the form of Departmental Instruction Paw 113/2545, but will instead put into effect a transfer-pricing law, the draft of which was approved by the Cabinet in May. Taxpayers will of course be required to abide by the new law.

There seems to be no doubt that transfer pricing will be the subject of the Revenue Department’s concerted focus in the coming year. By recently increasing the allocation of resources to perform transfer-pricing audits, the agency has been conducting these audits more aggressively and expanding its targets to taxpayers outside the responsibility of the Large Taxation Office (LTO).

In days past, transfer-pricing audits would only be carried out by the transfer-pricing team, a specialised team at the LTO focused specifically on such audits.

But now, increasingly more transfer-pricing audit cases come from the general tax audit teams either at the LTO or from local tax offices as part of their general or routine tax audits.

These tax audit teams have been equipped with transfer-pricing knowledge through regular training sessions from the specialised transfer-pricing team at the LTO. In this regard, it is now common for local tax authorities to raise transfer-pricing issues during a general tax audit, thus increasing the risk of a transfer-pricing tax assessment.

Below are the key risk areas that can trigger transfer-pricing issues and are commonly raised during general tax audits:

l Intra-group royalties and service fees: A challenge would be whether the royalty/services are beneficial to the taxpayer’s business in Thailand, and whether the fee is commensurate with the benefits received.

l Intra-group funding management: A cash-pooling arrangement is a cash-management tool frequently adopted within groups of companies. The tax authorities like to focus on whether the arrangement results in under-recognised interest income from cash settlements.

l Year-end adjustments: Multinational companies may manage the bottom line of their Thai subsidiaries. If the profit of the subsidiaries is below or over the targeted margin, debit notes or credit notes may be issued to increase or reduce the related party’s revenue or expenses at the end of the year. A reduction in profit margin as a result of this year-end adjustment will draw the attention of the tax authorities.

l Persistent losses: A taxpayer who consistently reports losses is at a high risk for a transfer-pricing audit. The case may end up with the taxpayer not being able to utilise losses carried forward and may also be liable to additional tax, plus surcharge and penalty.

l An inconsistent profit/loss pattern: A comparative analysis of revenue and expenses in each year may be required, including a substantiation of any unusual transactions in any year.

l A profit margin lower than the industry average: The tax authorities generally compare a company’s profitability with companies in the same industry based on their on-hand information. This comparable may not be a true comparable under transfer-pricing guidelines, but the information is used as an initial spot.

l A sudden drop in profit after the expiration of a tax holiday: The authorities could suspect that a sudden drop of profits resulted from transfer-pricing planning after a tax holiday; for example, reducing the selling price to related parties so as to reduce profits which previously were exempted from income tax under the Board of Investment’s promotion.

l Different prices/mark-ups for similar transactions: This is an issue of pricing which would require the taxpayer to substantiate the rationale for different pricing.

Although it is expected that the new transfer-pricing law will provide more clarity on the determination of the appropriate transfer price and clearly indicate the documentation requirements, it is anticipated that the Revenue Department’s scrutiny of related-party transactions will be more stringent.

With this trend, taxpayers with related-party transactions should assess their possible transfer-pricing risks, as well as begin their preparation of transfer-pricing documentation.

Benjamas Kullakattimas is head of tax, KPMG in Thailand