IRAS Transfer Pricing Guidelines on Commodity Marketing and Trading Activities

Singapore is one of the world’s top shipping and commodity hub. Hence, transfer pricing (TP) is becoming increasingly important as most global commodity firms have set up operations in Singapore. In response to this issue, the Inland Revenue Authority of Singapore (IRAS) released the transfer pricing guidelines for commodity marketing and trading activities (e-Tax guide) on 24 May 2019.

Largely adopted from the OECD Transfer Pricing Guidelines 2017, the e-Tax guide analyses the economic value of taxpayers’ commodity marketing/trading (CMT) activities in Singapore and aims to assist taxpayers to comply with the arm’s length principle and TP documentation requirements.

Commercial Considerations and Objectives

The e-Tax guide recognises that a CMT entity may act at different levels of the market across a range of customers, suppliers and commodities, or transact with the same party at different times or under different circumstances for different commercial objectives. The CMT entity may take different forms such as a support service provider, marketing agent, distributor or full-fledged trader.

IRAS recognises that a CMT entity and its related parties may have the ability to enter into more varied arrangements than independent parties. Therefore, IRAS would not disregard a related party commodity transaction or replace it with an alternative transaction provided that it is commercially rational.

Functional Analysis

Function

The e-Tax guide recognises that CMT activities involve not just buying and selling commodities, but a wide spectrum of activities, such as sourcing, collecting real time market intelligence, managing logistics, optimising physical movement and delivery of cargoes, determining commodity placement strategy, sales and marketing, blending, storage, building and maintaining customer relationships, managing risks and cash flows, and financial management.

The intensity of functions performed by a CMT entity can vary based on the nature of the related party commodity transaction which in turn defines its contribution to value. Therefore, accurate delineation of the actual related party commodity transaction is imperative in determining the arm’s length price. In addition, the decision-making capacity and capacity to exercise authority of the CMT entity should be considered when identifying the functions performed. 

Asset

Given the complexity of the commodity market and the characteristics of commodities, specialised expertise is necessary to conduct CMT activities and manage risks. The e-Tax guide has noted that valuable intangibles may be developed and utilised by CMT entities such as trading and logistical know-how, customer and supplier relationships and other software or tools used in performing CMT activities. Consequently, the use of these assets must be considered when determining the transfer price.

Risk

To assume a risk for transfer pricing purpose, the party must be able to control the risk and has the financial capacity to assume the risk. The e-Tax guide provided an extensive list of examples of risks relevant to CMT activities and the ways to control these risks. These risks are summarised as follows:

  • Excess production risk
  • Credit risk
  • Shortfall production risk
  • Contract risk
  • Customer non-performance risk
  • Logistics risk
  • Supply risk
  • Demurrage risk
  • Inventory risk
  • Quality risk
  • Price risk
  • Foreign exchange risk
  • Market risk
  • External risks

 

Economic Value and Taking Title to Commodity

Taxpayers must consider the contribution made by CMT entity to the overall value creation in the group supply chain. Value creation is not based on number of functions performed, but rather the economic significance of the functions in terms of frequency, nature and value.

In addition, the e-Tax guide has stated that taking title to commodity alone is not sufficient to determine the overall functional profile of the taxpayer. The taxpayer may assume limited inventory risk but may still contribute significant economic value to its related party.

Transfer Pricing Methods

IRAS accepts the use of the five internationally accepted methods as set out in the IRAS Transfer Pricing Guidelines to price related party commodity transactions. Other methods may also be used provided that the outcome of that method satisfies the arm’s length principle and the CMT entity would need to explain and maintain proper transfer pricing documentation on reasons for choosing the other method. 

When selecting the most appropriate method, taxpayers should consider the following:

  • Availability of reliable independent comparable data
  • Industry practices

A CMT entity should not always be assumed as the tested party. If the functional analysis of the related party commodity transaction indicates that the related party of the CMT entity has less complex functional profile, the related party could be the tested party. This is because it would be easier to find more comparable data and the choice of such a party as the tested party would also likely result in the need for fewer comparability adjustments and hence, greater accuracy in the adjustments made.

Comparable Uncontrolled Price (CUP) Method

  • Can be applied by reference to either comparable independent party transactions or quoted price.
  • Quoted price refers to the commodity price obtained from commodity exchange market, price reporting/statistical agencies, independent brokers or governmental price-setting agencies, where such indexes are commonly used by independent parties to determine prices.
  • Comparable independent party transaction: For example, comparable independent commission rates may be used to price CMT activities involving an agent or marketing services.
  • Quoted price: Taxpayers should consider if quoted price is being widely and routinely used by other independent industry players. For example, jet fuel, gasoline and diesel can be priced based on the relevant Means of Platts Singapore (MOPS) indices.
  • To reliably apply the CUP Method, taxpayers should ensure the economically relevant characteristics of the related party commodity transaction and independent party transactions/quoted price are comparable and make reasonably accurate adjustments when there are material differences which can affect the arm’s length price and if they are expected to increase the reliability of the results. 
  • In relation to quoted price CUP, another particularly relevant factor is the pricing date. Taxpayers must have reliable evidence of the pricing date and ensure that it is consistent with the actual conduct of the related party transaction. Otherwise, IRAS may deem the pricing date based on the evidence available (e.g. shipment date as evidenced by bill of lading) which could result in double taxation arising for the CMT entities and their related parties.

Resale Price Method (RPM)

  • Appropriate where parties are remunerated by reference to sales values and earn a percentage discount (or gross margin). For example, agent and marketing functions.
  • Commission rates from comparable independent party contracts (as discussed earlier) can be used to determine the percentage discount. Similarly, taxpayers can also apply RPM by determining the gross margin earned by internal or external comparable companies.

Cost Plus Method (CPM) / Transactional Net Margin Method (TNMM) – Full Cost Mark-Up

  • Cost-based transfer pricing methods are appropriate where costs are a relevant indicator of the value of the CMT activities. For example, services related CMT activities (e.g. gathering market intelligence) which do not require significant specialised expertise, risks assumption/control functions.
  • May also be appropriate where the related party commodity transaction involves contract or toll manufacturing (CMT entity would not be the tested party in this scenario).
  • Reliability of these methods may be reduced where the CMT activities involve significant value (e.g. decision-making capacity, capacity to exercise authority, risks assumption/control functions).

Profit Split Method (PSM)

Appropriate where:

  • Interaction between CMT entity and related parties and their contributions are highly inter-related and integrated.
  • Both parties make unique and valuable contributions to the related party transaction.
  • Existence of unique intangible assets makes it difficult to find reliable comparables.
  • Both parties share the assumption of economically significant risks or the parties assume the risks separately but those risks are so closely inter-related that they cannot be reliably evaluated separately.
  • For example, it may be appropriate for global trading of commodities whereby the Singapore-based CMT entity and its overseas related party trade on commodities and arbitrage their positions through an integrated, single, global trading book where they work closely to optimise the global profitability and share the assumption of economically significant risks.

TNMM – Operating Margin

  • Appropriate where sales is a relevant indicator of the value of the functions performed by the CMT entity (e.g. distribution activities with limited buy-sell activities and risks).
  • This method is unlikely to be an appropriate and reliable method if the CMT entity performs valuable contributions and risk-taking entrepreneurial activities in relation to commodity trading. 
  • However, it may afford a practical solution to otherwise insoluble transfer pricing problems when used sensibly with appropriate adjustments to comparable independent party transactions to account for differences.

TNMM – Berry Ratio and Value-Added Cost Mark-up

  • Berry ratio (i.e. the ratio of gross profit to operating expenses) and value-added cost mark-up rely on presumption that the value of the functions performed is proportional to the operating expenses and not to sales.
  • Appropriate where the CMT entity buys commodity from related parties for resale to other related parties under back-to-back arrangements taking ‘flash title’, and it does not bear any risk or perform any value-added functions.

TNMM – Return on Asset

Appropriate where assets (rather than costs or sales) are a better indicator of the value of the CMT activities carried out in a related party transaction. For example, contract manufacturing activities.

Transfer Pricing Documentation

CMT entities are required to prepare transfer pricing documentation if they meet certain conditions as addressed in the IRAS Transfer Pricing Guidelines – Fifth Edition. In failure to do so, CMT entities shall be liable to a fine not exceeding SG$10,000.

In addition, any transfer pricing adjustments made by IRAS are subject to a surcharge of 5% regardless of whether there is tax payable on the adjustments.

Our firm can assist with transfer pricing documentation fully compliant with IRAS’s requirements at affordable price. We can assist with local file and master file for Singapore and other countries.


Contributed by consultant Samuel Tay

Samuel was attached to two international accounting firms prior to joining Transfer Pricing Solutions Asia. He has prepared transfer pricing documentation for clients from the Asia Pacific region (e.g. Malaysia, Singapore and Australia).

His expertise includes handling transfer pricing engagements and conducting benchmarking studies for companies from various industries such as oil and gas, shipping, chemical, wood, jewellery and the electronics industry.

In his spare time, Samuel enjoys reading and playing sports.




Contributed by our Director Adriana Calderon

Adriana is the co-founder of Transfer Pricing Solutions Asia and Transfer Pricing Solutions Malaysia and Lead Partner in Asia.

Adriana has extensive international experience with Big Four and mid-tier firms advising multinational companies in the areas of corporate and international taxation across South America, the US, Australia and the Asia Pacific Region.

As a TP practitioner, Adriana has advised companies in the Asia Pacific Region across various industries and in a wide range of projects associated with planning.

Adriana also enjoys teaching and is a regular speaker and facilitator of Transfer Pricing seminars and workshops in Singapore. She is a transfer pricing trainer for the Institute of Singapore Chartered Accountants and Singapore Institute of Accredited Tax Professionals.

Adriana lives in Singapore with her family and is a mother to two energetic boys.



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