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Understanding Transfer Pricing Adjustments Limitations

It is crucial for taxpayers to be aware that certain transfer pricing adjustments are not eligible for tax deductions under specific circumstances for the company.

Background

It has been a common practice for companies to make transfer pricing (“TP”) adjustments at year end or thereafter.  TP adjustments can result in either an increase (more income or fewer expenses) or decrease (less income or more expenses). While upward adjustments are typically taxed, it is important to highlight that certain downward adjustments may not be eligible for tax deductions for the company.

The Inland Revenue Authority of Singapore (IRAS) has issued detailed guidelines regarding the tax treatment of TP adjustment in different situations. For a detailed understanding, you can refer to the e-Tax Guide: Transfer Pricing Guidelines (Sixth Edition), where the information is summarized in the table below.

ItemAdjustment typeThe IRAS’ position
Taxable?Deductible?
1Year-end adjustments made at the close of the financial year or in the subsequent accounting period.YesYes, but only if certain conditions are met. Refer explanation below.
2Compensating adjustments in accordance with advance pricing arrangements (“APAs”) with the IRASYesYes
3Corresponding adjustments arise from TP adjustments made by foreign tax authorities when the taxpayer has initiated the mutual agreement procedure (“MAP”) under applicable treaties.YesYes
4Self-initiated retrospective adjustmentsYesYes

1. Year-end adjustments made at the close of the financial year or in the subsequent accounting period.

Deductions will be permitted for downward transfer pricing adjustments made by a company during or after the financial year-end, provided that the following conditions are satisfied:

  • The company has conducted transfer pricing analysis and maintains up-to-date documentation to substantiate the determination of arm’s length prices.
  • It is essential that the year-end adjustment is consistently applied across the accounts of all related parties involved. This measure is essential to avoid instances of either double taxation or double non-taxation.
  • The adjustment must be made before filing of the income tax return for the relevant financial year.

2. Compensating adjustments in accordance with APAs with the IRAS

Compensating adjustments pertain to those made based on the terms outlined in unilateral, bilateral, or multilateral APAs agreed upon by a company with the IRAS.  It is important to note that these adjustments do not cover adjustments arising from APAs made by a company with foreign tax authorities.

3. Corresponding adjustments arise from TP adjustments made by foreign tax authorities when the taxpayer has initiated the MAP under applicable treaties.

Companies facing double taxation due to transfer pricing adjustments by foreign tax authorities can seek relief through the MAP under relevant tax treaties. If accepted by the IRAS, the foreign tax authority, and the company, corresponding adjustments will be made to eliminate double taxation.

4. Self-initiated retrospective adjustments

For all other retrospective adjustments initiated by a company that do not fall under the above categories, the IRAS will not allow a deduction on downward adjustments unless they are due to an error or mistake under Section 93(A)(1A) of the Income Tax Act 1947 (“ITA”) and supported by contemporaneous TP documentation. Moreover, the IRAS retains the authority to impose taxes on upward adjustments if they align with arm’s length prices.

Differentiating between year-end adjustments and self-initiated retrospective adjustments.

The difference between year-end adjustments and self-initiated retrospective adjustments is that year-end adjustments occur before the relevant tax filing due date, while self-initiated retrospective adjustments occur after the tax filing deadline.

Example:

  1. Company XYZ’s financial year-end is 31 December 2022 and its Singapore tax return filing deadline is by 30 November 2023. Any TP adjustments made for the financial year 2022 will be considered year- end adjustments if these are made before 30 November 2023.
  2. In some circumstances, companies may opt for retrospective TP adjustments (from IRAS’s perspective) rather than year-end adjustments. For instance, the introduction or modification of a global TP policy might necessitate time for local adaptation and execution. During the policy implementation phase, the company might unintentionally overlook certain related party transactions or uncover misapplications that only become apparent in subsequent years.
  3. Adjustments may also arise from interactions with foreign tax authorities, such as transfer pricing audits resulting in modifications to transfer prices in another jurisdiction, or the finalization of an APA with another tax authority.

Self-initiated retrospective adjustments which involve corrections made by a company due to errors or mistakes under the ITA

In order to support a claim for deduction for retrospective adjustments on past tax returns, companies must apply to the IRAS for relief for the error or mistakes. The IRAS will grant deduction if the relief sought is deemed reasonable and just.

In the landmark Singapore High Court case of AQP vs. Comptroller of Income Tax, the presiding judge delivered a pivotal ruling regarding the scope of errors or mistakes warranting relief. The judge emphasized that such errors should not be limited to mere oversights or unintentional actions. Rather, the provision extends to encompass both mistakes of law and mistakes of fact. This groundbreaking interpretation broadened the horizon of eligibility for relief, acknowledging the complexity of errors that could impact tax assessments. It underscored the court’s commitment to fairness and equity in administering tax laws, ensuring that relief provisions cater to a diverse range of circumstances encompassing both legal and factual inaccuracies.

The guidance from established case law suggests that inadvertent errors or mistakes occurring in the execution of TP policies, such as miscalculations resulting from the application of chosen TP methodologies, should be considered eligible for relief under the ITA.

However, when it comes to self-initiated retrospective TP adjustments involving a change in the interpretation of the law, i.e., what constitutes the arm’s length principle, these are unlikely to be viewed by the IRAS as an error or mistake. Such adjustments would include, for instance, retrospective adjustments due to a change in the TP policy applied, which may or may not arise from TP adjustments made by foreign tax authorities resulting from an audit or APA.

As of now, the interpretation of “error” or “mistake” concerning TP adjustments remains unchallenged in the Singapore courts. Until clarified, the eligibility for tax deductions on self-initiated retrospective TP adjustments is uncertain, posing a possible point of contention with the IRAS.

Ensure timely TP adjustments to mitigate controversy

In view that the IRAS will not allow a deduction on self-initiated retrospective downward adjustments unless they arise from an error or mistake under the ITA, companies are strongly advised to prioritize timely year-end TP adjustments.

Unless these adjustments originate from APAs or MAPs agreed with the IRAS, the most effective strategy to eliminate double taxation and mitigate disputes is to ensure prompt TP adjustments before filing the tax return for the relevant financial period.

In addition to putting through TP adjustments on a timely basis, maintaining contemporaneous TP documentation and ensuring symmetrical adjustments across the accounts of related parties are crucial steps to secure deductions for income tax purposes.

How we can help

We offer a dedicated team of experienced Transfer Pricing professionals with in-depth knowledge of various industries and regional legal frameworks.

Their expertise can assist in navigating Transfer Pricing provisions outlined in the IRAS and OECD Guidelines.

For personalized support, please contact the specified tax professionals mentioned below.

 

  Gina Soh  

     Transfer Pricing Partner

suanlin.soh@swgroup.sg

panda7402

  Yong Xiu Wei

     Transfer Pricing Director

xiuwei.yong@swgroup.sg

 lxl15092022