Transfer pricing refers to the determination of prices at which goods, services and intangible properties are transacted between related parties. The arm’s length principle is the internationally endorsed standard for transfer pricing between related parties. It requires the transaction with a related party to be made under comparable conditions and circumstances as a transaction with an independent party. Essentially, this means that if two related parties derive profit levels above or below the comparable market level solely by reason of the special relationship between them, the profits will be deemed as non-arm’s length. In such a case, tax authorities can make the necessary adjustments to the taxable profits of the related parties so as to reflect the true value if based on an arm’s length basis.

It its circular published on 23 February 2006, IRAS recommends that taxpayers adopt the following 3-step approach to apply the arm’s length principle in their related party transactions:

Step 1: conduct a comparability analysis

Step 2: identify the appropriate transfer pricing method and tested party

Step 3: Determine the arm’s length results

A comparability analysis should examine the comparability of the transactions in 3 aspects: characteristics of goods, services or intangible properties; analysis of functions, risks and assets; and commercial and economic circumstances. The ultimate aim of the analysis is a comprehensive assessment and identification of the areas and extent of significant similarities and differences between the transactions/entities in question and those to be benchmarked against. Such thorough understanding of the level of comparability is necessary in deciding the choice of transfer pricing method and tested party.

There are 3 traditional transaction methods and 2 transactional profit methods, which have been developed in the international arena for evaluating a taxpayer’s transfer prices/margins against a benchmark.

Once the appropriate transfer pricing method has been identified, the method is applied on the data of independent party transactions to arrive at the arm’s length result. As transfer pricing is not an exact science, IRAS is prepared to accept the use of ranges to determine an arm’s length range.

Since keeping adequate documentation may result in compliance and administrative costs for taxpayers, IRAS adopts the following principles with regard to documentation:

-   taxpayers are only required to prepare or obtain documents necessary to allow a reasonable assessment of whether they have complied with the arm’s length principle.

-   Unlike many other tax jurisdiction, Singapore currently does not impose a penalty specifically for the lack or insufficiency of documentation.

-   IRAS does not require documentation to be submitted when the tax returns are filed. The documentation should be kept by the taxpayers and submitted to IRAS only when requested to do so.  

For more details http://www.iras.gov.sg/ESVPortal/resources/transferpricingcircular.pdf

Updated July 2006