Nowadays, numerous companies are related to one another — transacting with each other every day, sharing in management costs, engaging in lending or financing activities, providing services, licensing intellectual property, and other means to help each other in their business operations. However, if such intercompany agreements in the Philippines were simply downloaded from whatever source on the internet and left unreviewed, you may already be in a position of a ticking compliance bomb.
The Bureau of Internal Revenue (BIR), along with the Securities and Exchange Commission (SEC), and other relevant authority bodies has increasingly intensified the framework for intercompany transactions between related parties, such as with the provisions of Revenue Regulations No. 19-2020, SEC Memorandum Circular 10-2019, and the Organization for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines — and it is known that the number one red flag for auditors is something called Boilerplate Contracts.
But First, What are Intercompany Agreements?
Intercompany Agreements (ICAs) are legally binding contracts intended to govern transactions between two or more companies within the same corporate group. Some of these transactions can include:
- Purchasing goods or services at transfer prices
- Granting intercompany loans and making interest payments
- Licensing Intellectual Properties and gaining royalties
- Arrangements of Sharing Costs
- Sharing technical or professional services rendered among affiliates
In the Philippines, there are several regulatory provisions specifically tailored for intercompany agreements, such as:
- BIR Revenue Regulations No. 19-2020 and No. 34-2020
- SEC Memorandum Circular No. 10, Series of 2019 on Disclosure of Related Party Transactions (RPTs)
- Philippine Financial Reporting Standards (PFRS), particularly PFRS 9 and PAS 24 on related party disclosures
- OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2022 Edition)
The Arm’s Length Principle
Hence, as intercompany agreements, it is expected that these are framed at “friendly” pricing — highlighting the risks of manipulation between transacting parties. Thus, the Transfer Pricing Rules come into play.
Under the Philippine Transfer Pricing Rules, all intercompany transactions must be priced as if they were conducted between unrelated parties, at “arm’s length”. It is important to note that this principle must be well documented, substantiated, and, crucially, integrated into the intercompany agreements of the entities.
Therefore, a generic contract that fails to include the rationale and pricing methodology will not survive scrutiny by authorities, such as the BIR Audit.
What are Boilerplate Contracts and Why Are They Dangerous in the Philippine Context?
Simply put, “boilerplate” refers to standardized contract language that is “copy-pasted” without much review or customization, in accordance with the tax regulations and relevant provisions governing intercompany transactions in a specific state. Indeed, efficiency is admirable; however, boilerplate intercompany agreements foster vulnerabilities that are more exposed to the Philippine regulatory frameworks.
Ignorance of Local Regulatory Specifications
As widely understood, the Philippine Tax Law is not a one-size-fits-all system, especially given its progressive nature. The BIR’s Revenue Regulation 19-2020 requirement for intercompany agreements is to align with the company’s functional analysis, including the functions performed, assets employed, and risks assumed by each party. Thus, a boilerplate cannot possibly reflect such company-specific details.
Lack of Proper Transfer Pricing Documentation
Additionally, the BIR requires that large taxpayers with annual gross sales or revenue exceeding P150 million and a total amount of P90 million in related party transactions submit Transfer Pricing Documentation under Revenue Regulations 34-2020. Therefore, intercompany agreements must serve as the primary documentation. As such, generic agreements that lack the specifics required for transfer pricing documentation will be invalidated and may subject the entities to penalties under Sections 250 and 266, and other related provisions of the National Internal Revenue Code (NIRC).
Failure to Disclose as Prescribed by the SEC
Furthermore, it is mandated for publicly listed companies and large corporations in the Philippines to disclose their material related-party transactions under the provisions of SEC MC 10-2019. Since boilerplate agreements lack specifications regarding the nature, value, and commercial terms of a transaction — it exposes the companies involved to deficiencies and may lead to potential SEC sanctions.
Not Following With PFRS 9 and PAS 24
Also, the Philippine Financial Reporting Standards (PFRS) and Philippine Accounting Standards (PAS) provide guidelines for related-party matters. Specifically, under PFRS 9, intercompany loan agreements must reflect fair value at origination, and this shall be fully disclosed as related-party transactions under PAS 24. Hence, a boilerplate loan agreement that omits such market-based interest rates, repayment terms, and important provisions creates an accounting misstatement — which can be considered as material, leading to an adverse audit opinion.
Cannot Be Used in Disputes
In terms of litigation, BIR assessment proceedings, or other relevant government agencies that have jurisdiction over the entities involved in such intercompany agreements — ambiguous, non-specific, or vague contracts provide little to no legal basis or protection. Philippine Courts and regulatory bodies have consistently held that unclear contractual agreements will be construed against the party who relies upon them.
The Real Cost of Failed Compliance in Intercompany Agreements
The consequences of non-compliance with intercompany agreements in the Philippines are neither theoretical nor minor to be considered. Some of the businesses that failed to meet such requirements face:
- Tax Deficiency Assessments – the BIR may disregard poorly documented intercompany transactions, resulting in several deficiencies such as income tax, value-added tax, and withholding tax assessments, adding up to a 25% surcharge and other penalties or interest provided by the NIRC, as amended. Additionally, disallowed deductions may also result from this, which can run into millions of pesos.
- Sanctions for Officers Involved – Also, when it is proven that tax evasion was the result of the failed compliance, such officers involved can be imprisoned for 1 to 10 years and pay fines of up to P10 million. Corporate officers and Chief Financial Officers can be held personally liable (Sec. 254 & 255 of the NIRC).
- SEC Sanctions for Non-Compliance in Disclosures – Entities that are mandated to disclose RPT, yet failed to do so, expose themselves to administrative sanctions, such as payment of fines and revocation of licenses. It is important to note that this is relevant for companies seeking Bangko Sentral ng Pilipinas (BSP), Insurance Commission (IC), or SEC-regulated entity status.
- Damage in Reputation and Losing Potential Investors – Since the Philippine market has been increasingly demanding Environmental, Social, and Governance (ESG) compliance, and asks for corporate governance transparency, a BIR assessment or SEC disclosure violation related to boilerplate intercompany agreements can lead to permanent damage in the trust of stakeholders, affect the valuation of the entity, and lose opportunities with potential investors.
What Proper Intercompany Agreements Should Include
A legally sound and BIR-defensible intercompany agreement in the Philippines should contain, at a minimum, the following:
- Identifying the contracting parties and the relationship between them within a corporate group
- Specific description of the services, goods, intellectual property, or financial instruments subject to the agreement
- The transfer pricing method used and the reason behind the selection
- Arm’s length pricing implemented, supported by a study or comparability analysis
- Payment terms, invoicing procedures, and the currency used for settlement
- The duration, renewal, and termination clauses
- Profit or loss allocation applicable to cost-sharing arrangements
- Specifying the governing law clause, such as the applicable Philippine laws and the jurisdiction of the agreement
- Anti-avoidance representations that confirm its commercial justification
- Referencing supporting transfer pricing documentation as prescribed by the BIR
In addition, a best practice considered is backdating carefully and documenting contemporaneously. Philippine transfer pricing regulations require that intercompany agreements be executed first before such transactions occur. Further, backdated agreements, regardless of whether commercially justified, are a red flag for BIR auditors. Contemporaneous documentation is a compliance requirement.
Protect Your Business
Overall, intercompany transactions can indeed get complex, especially when it comes to transfer pricing compliance. That’s why it is now the right time to take a closer look at your agreements.
You can start by reviewing what you currently have, ensuring everything is complete, updated, and properly executed in line with local regulations, while making sure your agreements actually reflect your transactions and not just generic templates that could cost you more in the long run.
If you’re unsure where your current setup stands, Babylon2k is here to help. We assist businesses in reviewing and aligning intercompany agreements with BIR, SEC, and PFRS requirements — so you’re not left exposed to unnecessary risks. Send us a message or book a consultation, and let’s make sure your agreements are built to protect your business.
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