The Transfer Pricing Methodology, as outlined in Clause 5 of the Director-General’s Notification No. 400, refers to the approach used to consider whether the compensation set by a company for controlled transactions (i.e., transactions between related parties as defined under Section 71 bis, paragraph 2 of the Revenue Code) is consistent with the compensation that would be agreed upon by independent parties in comparable transactions.
There are five legally recognized transfer pricing methodologies:
1. Comparable Uncontrolled Price (CUP) Method,
2. Resale Price Method (RPM),
3. Cost Plus Method (CPM),
4. Transactional Net Margin Method (TNMM), and
5. Transactional Profit Split Method (TPSM).
A company may opt to use an alternative pricing method other than the five recognized methods, but only if it can demonstrate that none of the five methods are applicable and that the alternative method is appropriate to use with the circumstance. In such cases, the company must notify the Director General in writing within the relevant accounting period in which the alternative method is applied. The notification must include a preliminary explanation of the method used and a detailed justification for why the recognized methods could not be applied.
One commonly seen alternative method, especially in the financial advisory circle, is the Discounted Cash Flow (DCF) method. Fundamentally, DCF is a valuation technique, often used to assess the value of a business. Once the valuation is determined, it can be used to set the offering price of shares in a public offering, for example.
Let us consider the Revenue Department’s perspective about the use of valuation methods for determining transfer prices before the specific transfer pricing regulations are enacted. In Tax Ruling No. Kor. Khor. 0706/2549 dated 2 August 2006, Company P, which operated fuel stations and convenience stores, intended to transfer leasehold rights over land (which lacked an official information on assessment value from the Lands Department or other government agencies) to an affiliated company. The company engaged independent appraisers certified by the Securities and Exchange Commission (SEC) to conduct the valuation. The company then asked the Revenue Department: How many independent appraisers should be used for the Revenue Department to accept the valuation as a “fair market price” for both buyer and seller? If multiple appraisers are used and their valuations differ, can the average be considered the market price?”
The Revenue Department responded if the use of independent appraisers certified by the SEC to value the asset—regardless of the number of appraisers—resulted in the appraised value that fall lower than the net book value, it could not be confirmed whether this was the market price. (The interpretation of this opinion would be: “A valuation is not a realized price and, therefore, cannot be considered a market price, which is the prices +that are agreed upon in actual transactions between independent parties for similar assets.”)
Moreover, the Department emphasized that if the compensation for the asset transfer falls below the market value, the Revenue officers are empowered to adjust the compensation to reflect the market price.
Today, under Notification No. 400, Company P will no longer need to request a formal ruling. Instead, the company would simply notify the Director-General of the necessity and explain why the five recognized methods could not be applied. It would also need to justify the appropriateness of the alternative method, such as DCF, and provide a brief explanation of how the method works.
In such cases, the risk lies in the Revenue Department’s role as a competent authority, which allows access to non-public information. This includes the use of sets of secret comparable companies to assess tax liabilities. For instance, although unlikely, the officer may access data on leasehold transfers between independent companies in similar businesses and use the CUP method for comparison. This raises the question: Is the use of confidential data in tax assessments transparent and fair to taxpayers?
We will revisit the application of the five recognized transfer pricing methods to ensure that controlled transactions comply with the arm’s length principle (Section 71 bis of the Revenue Code) in future discussions.
[Contact Person: Mr. Phongnarin Ratarangsikul | Partner]