REVENUE AUDIT MEMORANDUM ORDER

NO. 1-98
Subject : Audit Guidelines and Procedures in the
Examination of Interrelated Groups of Companies
To : All Revenue Officers Concerned.
This RAMO is issued as a basis guideline for the
joint and coordinated examination of
interrelated groups of companies under Revenue
Memorandum Order No. 61-98.
1. BACKGROUND
1.1 The remarkable decrease in collection from
interrelated group of companies has
seriously affected the collection efforts, of the
Bureau. Statistics showed that while interrelated
transaction accounts for a big percentage of the
transfer of goods and services in the
country , the revenue collection from related-party
groups continue to go on a downtrend.
1.2 The magnitude of revenue lost has become so
alarming that there is a need to
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immediately address this problem. It is a fact that

because these companies are more
interested in their net income as a whole (rather than
as individual corporations) there is
desire to minimize tax payments by taking
advantage of the loopholes in our tax system and
by making use of schemes that allow them to move
around the law in order to reduce their
tax obligations.
1.3 It is therefore necessary to conduct a joint and
coordinated examination of interrelated
group of companies in order to identify the tax
avoidance schemes and be able to prescribed
the necessary measures in order to avoid the erosion
of revenues
2. GENERAL GUIDELINES
2.1 General Procedures. The provision laid down in
Volume 1 of the Handbook on Audit
Procedures and Techniques must be followed with
respect to:
a. Basic reportorial requirements; and
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b. general audit procedures and techniques.

2.2 Special Audit Procedures. In addition, focus
must be made on the following audit issues
(detailed audit procedures are laid down in section 3
of this RAMO);
2.2.1 Use of tax shelters (such as a foundation or
tax-exempt company) in order to
avail of tax exemptions or of lower tax rates;
2.2.2 Shifting income and/or expenses in favor of a
related company with special tax
privileges (e.g BOI Incentives, Tax Holidays, and
etc.);
2.2.3 Transfer pricing in inter-company supply of
goods (Tangible and intangible) and
services;
2.2.4 Inter-company loans and advances, and
financing and arrangements where the
interest charged for the use of money is not at arms
length;
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2.2.5 Arbitrary cost sharing arrangements for

common expenses ;
2.2.6 Tax avoidance through resale and agency
arrangements; and
2.2.7 thin capitalization and earning stripping.
2.3 Use of Section 50 of the NIRC, as amended
The authority for allocating income and expenses
between or among related parties
is laid down in Section 50 of the NIRC, as amended.
This Section gives the Commissioner of Internal
Revenue the authority to make allocation of income
and expenses between or among controlled group of
companies, if a related taxpayer has not
reported its true taxable income.
2.2.3 The purpose of Section 50 is to ensure that
taxpayers clearly reflect income
attributable to controlled transaction and to prevent
the avoidance of taxes with respect to
such transactions. It places a controlled taxpayer in
tax parity with an uncontrolled
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taxpayer by determining the arms-length price intercompany transactions.

Arms Length Price
a. The method to be used in determining the armslength price depends on the type of
transaction ---whether the transactions involves a
transfer of property, services, loans,
advances, rentals or other arrangements.
Accordingly, proper judgment must be used
taking into consideration the peculiarity of the
transaction and the presence of available
information that would reliably determine the correct
income of a controlled taxpayer.
b. The different methods of determining the arms
length price of a controlled transaction
under the OECD Rules on transfer pricing may be
used as a reference. This includes the
used of Comparable Uncontrolled Price Method,
Resale Method, Cost-plus Method and
Gross Profit Margin Method ( there are discussed in
detail in the next section).
c. In addition, the following must be considered
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Data and assumptions consider the completeness

and accuracy of available data and
information and the reliability of assumptions that
are to be made.
Comparability consider similar transactions
between unrelated parties. Factors of
comparability to be considered in the examination
include:
a. Functional analysis factors such as product
design and engineering,
manufacturing, production and process marketing
and distribution, advertising
and etc.
b. Contractual terms This include sales and
purchase agreements, volume,
nature of warranties, credit and payment terms and
other commercial
arrangements.
c. Risks- market risk including fluctuations in
demand, financial risk and
commercial risks.
d. Economic conditions refers to the prevailing
condition in the market.

2.5.2 The term controlled for purposes of this

RAMO shall mean any kind of control
direct or indirect, whether legally enforceable and
however exerciseable or exercised. It is
the reality of the control which is decisive, not is
form of the mode of its exercise or
ownership. A presumption of control arises if income
and expenses have been arbitrarily
shifted.
2.5.3 The term controlled taxpayer means any one
or two or more organizations or
trade, or business owned or controlled directly or
indirectly by the same interest;
2.5.4 The term true taxable income means the
taxable income which would have been
reported by the controlled taxpayer, had it in the
conduct of its affairs dealt with
the other member or members of the groups at
arms-length.
3. AUDIT PROCEDURES
3.1 Transfer Pricing in interrelated supply of goods
or services. This is relevant if one
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of the related party enjoys certain privileges such as

tax exemption, lower tax rates,
incentives , or is a losing company.
3.1.1 In General The method to be used in
determining the arms-length price of a
controlled transaction shall rely primarily on the best
judgment of the examiner
after taking into consideration the prevailing
circumstances as well as the
availability of information at the time transaction.
3.1.2 As a guide, the methods under the OECD
Guidelines on Transfer Pricing may be
used as follows:
a. The comparable uncontrolled price method
(CUP)- this evaluates the arms
length by reference to the amount charged in a
comparable uncontrolled
transaction. In evaluating comparability, consider the
following:
Trademark
Product difference
Geographical differences, and
Extraordinary market conditions;
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b. The Resale Price Method (RPM)-it evaluates

arms length by reference to the gross profit margin
realized in comparable transactions.
c. The Cost Plus Method (CPM)- it evaluates armslength by adding the gross profit to the controlled
taxpayers cost of producing the property involved
in the controlled transaction and then impose the
applicable profit rate.
d. The Profit Split Method- this is done simply by
dividing the profit between the members involved in
the transaction taking into consideration the extent
of their participation in the realization of the
transaction.
3.2 Loans and Advances, and financing
arrangements between or among related parties2.2.1 In General. When one member of a group
makes a loan or advance directly to, or
otherwise becomes a creditor of another member and
either party charges an interest which is not at arms
length, there may be a tax advantage to either the
lender or borrower.
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3.2.2 Loans and Advances may be in the form of:

a. Bona fide indebtedness such as loans or advances
of money or other considerations;
b. Indebtedness arising in the ordinary course of
business from sales leases, or
rendition of services by and between members of the
group, or any other
similar extension of credits;
c. Alleged indebtedness
For purposes of this Section, an arms length rate of
interest is the rate of
interest which would have been charged in
independent transaction between
unrelated parties under similar circumstances.
3.2.2 Financing Arrangements.
3.2.2.1 A common element in related party groups is
the presence of a finance company
(usually a holding company) to provide financial
services for the members of the
group.
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Financial services by a holding company mid range

from serving as a central
lender for the group, in which capacity, it may
borrow funds from unrelated financial institutions
and on loan such amounts on its subsidiaries. It may
also perform financial intermediary services for the
group including factoring and hedging
3.2.2.2 Where one member of a group controlled
entities makes a loan or advance
directly or indirectly, or otherwise becomes t he
creditor of another member of
such group, an arms length price for the use of
money should be charged. The
same is true in the case of indebtedness arising in the
ordinary course of business
such as sales, leases , provision of services and other
similar extension of credits
3.3 Performance of Service for Another
3.3.1 In general under this scheme, one member of
the groups performs marketing
managerial , administrative technical or other
services for the benefit of, or on
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behalf of another member of the group without

charge or at a charge which is not arms-length.
3.3.2 to determine the arms length price for the
service, the Benefits test may be considered.
Under this test , the direct benefits to the member
which received the service must be considered . it is
necessary to take into account on some
reasonable basis all the costs or deductions which
are directly or indirectly related to the service
performed .
3.3.3 Where tangible and intangible property is
transferred, sold, assigned, loaned, leased or
otherwise made available in any manner by one
member of a group to member of the group and
services are rendered by the transferor in
connection with such transfer , the services rendered
in such transaction, provided it is not ancillary, must
be valued.
3.4 Sharing of Cost
3.4.1 In general. A cost sharing arrangement is an
agreement under which the parties
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agree to share the cost of proportion to their

respective share of the anticipated
benefits. This is very common joint undertaking and
in expenses such as research
and development , office and factory spaces, legal
and consultancy services and etc.
3.4.2 In determining the appropriateness of the
sharing arrangement, factors such as
benefit-received , size of the company , participation
in the venture , and etc. should be considered .
3.5 Thin Capitalization and Earning Stripping
3.5.1 In General The most common form of tax
avoidance scheme using corporate structure is highdebt financing of thinly capitalized controlled
company. This scheme favors debt over equity as a
form of financing mainly because of tax favored
treatment of interest payments compared to
dividends.
3.5.2 Under presence laws, interest payments are
fully deductible against taxable
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income while dividends are not. The Tax Advantages

of interest payments in
contrast to dividend is an outright savings of 35%
(34%-32% under CTRP) in the form of a deductible
expense against the taxable base. If interest
payments are subjected to 20% Final Tax (while
inter corporate dividends are at 0% tax)
financing through debt rather than equity would still
have an advantage equivalent to 15%.
3.5.3 In the absence of rules prescribing guidelines
and presumptions as to what constitute thin
capitalization (unlike other countries), there is a
necessity to determine the reasonable ratio of debt
over equity considering all factors surrounding the
case.
4. EFFECTIVITY
This RAMO shall take effect immediately.
BEETHOVEN L. RUALO
Commissioner of Internal Revenue

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REVENUE AUDIT MEMORANDUM ORDER

NO. 1 95
SUBJECT : Audit guidelines and procedures on the
proper determination of the liability of
Philippine branches and liaison offices, of Multi
National Enterprises (MNEs) engaged in soliciting
orders, purchases, service contracts, trading,
construction and other activities in the Philippines.
TO : All Internal Revenue Officers, Employees and
Others Concerned
I. RATIONALE
Whereas Revenue Audit Memorandum Order
(RAMO) No. 1 86 dated April
25, 1986 imposes income tax on the gross income
generated from constructive trading
and commission income derived from brokering
activities of Philippine branches of
MNEs engaged in trading activities;
Whereas RAMO No. 1 86 makes no recognition of
such factors as the nature of
item traded, the risk involve and participation of the
local branch;
388
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Whereas the implementation of RAMO No 1 86

makes use of much approximations and estimates;
Therefore, this Order is issued to revise RAMO No.
1 86 and to cover taxation of Philippine branches
and liaison offices of MNEs engaged in soliciting
orders, purchases, service contracts, trading,
construction and other activities.
With this Order, taxation of Philippine branches and
liaison offices of MNEs engaged in soliciting orders,
purchases, service contracts, trading, construction
and other activities becomes more practical, easy
and equitable. At the same time, this Order
addresses taxation of construction and other
activities by the same Philippine branches
and liaison offices of MNEs as separate
undertakings.
II. OBJECTIVES
This Order is issued to :
a) Amend and supersede RAMO No. 1 86
dated April 25, 1986 which provides for the
procedures for tax audit of Philippine branches
of foreign corporations.
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b) Address the issue on the proper determination of

the income tax liability of Philippine
branches and liaison offices of MNEs pursuant to
Section 43 of the National Internal
Revenue Code (NIRC) wherein the Commissioner
of Internal Revenue (CIR) is
authorized to distribute, apportion or allocate gross
income or deduction among
organizations in order to clearly reflect the income
of any such organization.
c) Provide guidelines on implementation of policies
on the proper determination of the
income tax liability of Philippine branches and
liaison offices of MNEs.
d) Prescribe the minimum procedures required in the
audit of the income tax liability of
Philippine branches and liaison offices of MNEs.
III. COVERAGE
a) This Order shall apply only to Philippine branches
and liaison offices of Japanese
trading firms which are members of the Sogo
Shoshas and registered with the Japanese
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Chamber of Commerce and Industry (JCCI), and

also all other foreign trading companies
similarly situated as determined by the
Commissioner of Internal Revenue.
b) Furthermore, the contents of this Order will apply
only to income tax liabilities of
Philippine branches and liaison offices of MNEs and
will not affect the withholding,
including branch profit remittance, and business tax
obligations of the same Philippine
branches and liaison offices of MNEs which shall be
subject to the provisions of the
National Internal Revenue Code (NIRC).
IV. GUIDELINES
1. The Philippine income tax due from soliciting
orders, purchases, service contracts,
trading, construction and other activities of the
Philippine branches and liaison offices
of MNEs will be ascertained using the following
formula:
For solicitation and trading activities:
{(Worldwide Operating Sales to the Philippines
attribution tax )}
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{( Income X Worldwide Sales X rate)}

For construction and other activities:
plus {(Net Income from construction and other
activities X tax rate })
3. In implementing the above formula, the
following terms shall be construed to mean as
follows:
a) Worldwide (W/W) shall include head office
accounts and those of branches located in
different countries but shall exclude subsidiary
accounts.
b) W/W Operating Income shall include the Gross
Income minus Selling, General
& Administrative expenses. Operating Income does
not include non operating
and extraordinary items like interest expense,
exchange profit / loss, capital gains
/ losses or other income / loss not related to
operation.

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c) Sales to the Philippines shall be defined as the

aggregated amount of exports and
offshore transactions to the Philippines by the Head
Office, all branches and liaison offices and shall
include the amount of indent transactions from
which commissions are generated. These shall also
include imported materials and equipment of
construction projects undertaken in the Philippines,
but shall exclude local service income from
construction projects or onshore income from
local construction.
d) W/W Sales shall consist of domestic, export,
import and offshore transactions
which include not only principal transactions but
also indent transactions from
which commissions are generated.
e) Attribution rate shall mean a rate of 75% to be
applied against the formula.
f) The tax rate to be applied shall be in accordance
with Section 25 (a) of the NIRC
which is 35%.
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g) Net income on construction shall consist of local

service income from construction projects or
onshore income from construction projects less the
costs associated with local construction projects
including the cost of locally purchased
materials and equipment, if any.
h) Net income on all other activities shall consist of
income such as management consultancy services
and other undertakings that Philippine branches and
liaison offices of MNEs are engaged in, net of costs
and expenses associated with such income.
3. In the application of the formula, no offsetting of
losses from one line of business to
the detriment of the other line business shall be
allowed. This would mean that the tax
due from each line of business shall be computed
independently from the other line of business.
V. PROCEDURES
1. Request documents containing information on the
nature of business transactions of
the taxpayer as follows:
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a) The structure of the Philippine branch or liaison

office, the Home Office, other branches or more than
50% owned or controlled subsidiaries located
outside the Philippines dealing with the local branch;
b) The ownership, relationship, extent of control,
directors and officers of the
Philippine branch or liaison office and the Home
Office;
c) The business activity of the MNE and how it
relates to the activity of the local
branch or liaison office and other branches or more
than 50% owned or
controlled subsidiaries dealing with the local
company.
2. Ascertain the mathematical accuracy and
completeness of the income tax return,
financial statement and supporting schedules filed by
the taxpayer.
3. Require the submission of financial statements
exclusive for transactions dealing with
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construction and all other activities and have a

certified public accountant render an
opinion as to its fairness and conformity with
accepted accounting standards.
For solicitation / trading activities
4. Obtain a copy of the Worldwide Financial
Statements duly certified by an
independent public accountant of the country which
issues the financial statements
and authenticated but the Philippine Embassy or
Consulate situated within the
country where the Home Office of the MNE is
located.
5. Verify correctness of Worldwide Operating
Income and the Worldwide Sales figures
against the financial statements obtained in 4 above.
6. Request for a summary of Sales to the Philippines
duly certified by an independent
public accountant and authenticated by the
Philippine Embassy or Consulate situated
within the country where the Home Office of the
MNE is located. The Sales to the
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Philippines shall include the offshore portion of the

local construction projects which
includes the supply of machinery and equipment.
7. Request for presentation of copies of pertinent
sales invoices, bills of lading, freight
and insurance coverages and other documents to
verify Sales to the Philippines, on a
test or sampling basis.
For construction activities:
8. Review all Contracts and analyze the nature of the
Contracts, the parties involved, the
terms and conditions, the total contract price, the
payment and other pertinent information.
9. Determine method of accounting, whether
completed contract or the percentage of
completion, and check the correctness of take up in
the books of accounts.
10. Segregate the income from exempt transactions
from that of taxable transactions, if
applicable.
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11. Determine the total contract price and

composition of the project. The total contract
price includes:
a. Supply of Machinery and Equipment
( sometimes referred to as the
offshore portion) XX
b. Supply of Labor / Civil Works
(sometimes referred to as the
onshore portion) XX
----------Total Contract Price XX
=======
12. Verify that only the supply of local / civil works
(onshore portion) is included in
computation of profit / loss on local construction
project
13. Determine if cost and expenses correspond only
to the service portion of the project
referred to an 11 above.
14. Be aware of charging of income and expenses by
mere book entries using the branch /
home office account.
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For all other activities

15. Verify that all income from other activities are
included as part of the gross income.
16. Ensure that only expenses related to the activities
above are included in the
determination of the net income.
IV. EFFECTIVITY
This Order shall take effect immediately.
LIWAYWAY VINZONS CHATO
Commissioner of Internal Revenue

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