Southeast Asia is a diverse region with a global merchandise share of US$2.2t1, of which the largest contributor is intra-Southeast Asia trade, at around 24%.
The establishing of the ASEAN Economic Community (AEC) on 31 December 2015 after years in the making was a significant milestone for the regional economic integration agenda. The AEC, by design, seeks to create a single regional market and production base amongst member nations.
The foreign direct investments (FDI) from and into ASEAN have been ever increasing and multinational enterprises (MNE) have been expanding their operational base across Southeast Asia. Similarly, Southeast Asia- headquartered companies have also been acquiring assets overseas and are expanding to capture the market potential.
Increasing merchandise trade and FDIs have collectively propelled greater internationalisation and intra-MNE dealings. There is also greater cross-border flow of talent across jurisdictions in the region.
More recently, several MNEs are being disrupted in several areas and innovation has been the key to sustainability and expansion. The fourth industrial revolution and rapid adoption of technology have brought new areas of focus for several MNEs and provided opportunities for them to rethink their existing business and operational models.
Furthermore, tax authorities are increasingly focused on what their fair share of tax is. Amidst all these, transfer pricing (TP) emerges as a common and important theme.
Most of the Southeast Asia countries have been early adopters of TP rules except a few that recently came onboard. With increasing internationalisation and new business models, several Southeast Asia countries have started building their transfer pricing audit capabilities by hiring more tax officers and training them at international bodies such as the Organisation of Economic Co-operation and Development (OECD). Amongst the jurisdictions in Southeast Asia, Indonesia, as a G20 member, has participated in the OECD's Base Erosion and Profit Shifting (BEPS) project since its inception.
Brunei, Malaysia, Singapore, Thailand and Vietnam have also become members of the inclusive framework of BEPS project. These countries have either implemented or are in the process of implementing changes in their respective domestic legislations in relation to Actions 5 on countering harmful tax practices, Action 6 on preventing treaty abuse, Action 13 on transfer pricing documentation and Action 14 on enhancing dispute resolution.
Recent regulatory changes
Subsequent to the release of Action 13 final report in October 2015, several jurisdictions in Southeast Asia have adopted the framework. Singapore first released an e-tax guide on Country-by-Country Reporting (CbCR) framework for Singapore-headquartered multinationals in October 2016. Indonesia released the Ministry of Finance regulation PMK 213 in December 2016, giving an extremely tight deadline for taxpayers to comply with such new regulations. Malaysia and Vietnam soon released their own guidelines in the first half of 2017. Cambodia introduced its TP rules in October 2017. More recently in January 2018, the Thai Cabinet approved the draft transfer pricing act that will add specific TP provisions to the Revenue Code, which will become effective for accounting years beginning on or after 1 January 2017. With some legislative changes enacted in February 2018, Singapore is now fully subscribed to Action 13 and has issued updated TP guidelines, fully adopting Actions 8 to 10 on aligning TP outcomes with value creation.
The other jurisdictions in Southeast Asia are expected to come fully onboard sooner or later.
Transfer pricing audits
The extent and intensity of TP audits vary across the region. Indonesia, Vietnam, Malaysia and Thailand are some of the jurisdictions that are known for their intense TP audit regimes. Suffice to say, TP is not an exact science and there is always room for interpretations and differences in opinion amongst parties.
The tax authorities across Southeast Asia are reviewing their current rules and audit frameworks to consider and implement concepts around "substance" and "value creation", in line with the guidance contained in Actions 8 to 10 of the BEPS project. What this means for taxpayers is that they need to assess and evaluate whether their current structures and TP policies are able to withstand scrutiny in the future.
The diversity of the region brings together an array of TP issues into perspective. Some countries are resource-rich and others are manufacturing hubs whilst a location like Singapore predominantly acts as a regional headquarters or principal location.
With the increased focus on BEPS, many companies today face TP disputes in more countries than one. With the outcome of Actions 8 to 10 and Action 13, some tax authorities are using the BEPS guidance on a selective basis to support their TP adjustments in the TP audits.
Arguments around "attributing residual profits to mine owners or plantation companies as they perform the most important aspect in a value chain" and "marketing intangibles" are quite common in Indonesian and Malaysian TP audits. Inbound service charges and royalty payments are almost always questioned and often involves justification with time-consuming evidentiary information around the benefits received by the taxpayers by making such payments. Most of the disputes in the region typically involve these types of transactions.
The post-BEPS era has seen a lot of scrutiny around the Intangible Property (IP) arrangements given that there is enhanced guidance. Singapore has seen much audit activities around substance of intra-group service charges, commercial rationale of certain arrangements and intra-group financing transactions. Taxpayers have been responding to multiple audits across several jurisdictions and in countries like Indonesia have disputed audit outcomes. The treaty-based exchange of information has also increased among the Southeast Asian countries.
The first exchange of CbCR reports is due this year for FY 2016 filings. What this means is that the governments will have a big-picture view around an MNE's global and local footprint and potentially use it as a tool to design their audit processes. Taxpayers are facing an ever-increasing compliance burden and encouraged to evaluate how technology could be used as an enabler to help them in complying with requirements in multiple countries.
Southeast Asia has been one of the active digital economy participants. With access to key markets, MNEs operating in this space will have more income expected to be generated through e-commerce. There is a pressing need for tax authorities in the region to establish a common set of TP rules and provide more guidance for taxpayers operating in this space.
On 7 June 2017, over 70 ministers and other high-level representatives participated in the signing ceremony of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI). MLI will enter into force from July 2018. Being a BEPS associate, Singapore, Indonesia and Malaysia have signed the MLI. Amongst others, Singapore has opted for mandatory binding arbitration. It remains to be seen whether Singapore could potentially emerge as Southeast Asia's arbitration hub for TP disputes.
Whilst several jurisdictions within Southeast Asia have adopted the BEPS measures on a unilateral basis, enhanced coordination amongst tax authorities is not seen despite the AEC being already set up. Having a uniform set of TP rules, such as a wider recognition of the OECD's safe harbour mark-up for routine services, approaches or methodologies to determine arm's length pricing, TP documentation requirements and timelines to submit master or local files and CbCRs, will be useful in future.
Mutual Agreement Procedures (MAP) statistics published by the OECD reveal that countries like Indonesia and Singapore have seen increasing numbers of TP cases. With the increase in audit activities, these are only bound to increase.
As such, a system that truly adopts Advance Pricing Agreements (APA) as an alternative to protracted audit discussions will be welcomed. Even the adoption of a mechanism that allows for simultaneous or joint audits will be seen as a means to share technical knowledge and bring audit processes to a coordinated timeline as opposed to the natural delay caused by a one-sided audit whereby the double tax result is brought for MAP and one government needs to play catch up.
With regards to MAP, which will continue to prevail, it would be beneficial for countries to adhere to the timelines as provided by the BEPS-related commitments (minimum standards) at least with participating countries of the OECD Inclusive Framework and in absence of an amicable resolution, adopt the binding arbitration alternative. A recent EY global survey had 82% respondents stating that TP will be the leading issue driving demand for MAP cases in the coming three years.
As the regional economy develops in response to wider economic influences and disruptions, the landscape for tax policies including TP invariably becomes more complex. It is therefore imperative that businesses proactively build, manage, document, review and defend their transfer pricing policies and processes, and align them with their business strategy so as to mitigate any potential tax risks.
The author is Luis Coronado, Partner and ASEAN International Tax Leader, Ernst & Young Solutions LLP.
The views in this article are those of the author and do not necessarily reflect the views of the global EY organization or its member firms.