These misconceptions may seem harmless at first, but they can lead to inappropriate pricing policies, inadequate documentation and increased tax risk during a tax review or audit.
We outline eight of the most common TP myths we have observed, and why businesses should think twice before relying on them.
Myth #1: If I am exempt from TP documentation, I do not need to worry about TP
Singapore’s transfer pricing documentation (TPD) rules provide exemptions from preparing contemporaneous documentation in certain circumstances, such as where transactions fall below the prescribed thresholds.
However, these exemptions relate only to the documentation requirement. They do not exempt taxpayers from complying with the arm’s length principle.
IRAS may still review related party transactions and request evidence demonstrating that the pricing is consistent with what independent parties would have agreed under comparable circumstances. Where the pricing cannot be substantiated, TP adjustments may still arise, accompanied by a surcharge of 5% on the adjustments regardless of whether additional income tax is payable, increasing the overall tax cost.
Businesses should, therefore, distinguish between an exemption from documentation and an exemption from the TP rules because they are not the same.
Myth #2: Intercompany services should always be charged using the Cost Plus Method
The Cost Plus Method is one of the most commonly applied TP methods for intra-group services. However, in practice, we often see businesses defaulting to this method without first considering whether it is the most appropriate approach.
TP is not about selecting the most commonly used method. Instead, it is about selecting the most appropriate method based on the facts and circumstances of the transaction.
For example, where reliable comparable market prices are available, the Comparable Uncontrolled Price (CUP) Method may provide a more direct measure of an arm’s length outcome. In other cases, particularly where services form part of a broader operating model, the Transactional Net Margin Method (TNMM) may be more appropriate. Certain shareholder activities may not warrant a charge to other group entities at all.
Rather than assuming that all intercompany services should be charged on a cost-plus basis, businesses should first understand the nature of the services, the value they create, the functions performed by each party and the availability of reliable comparables. Only then can the most appropriate TP method be determined.
Myth #3: If an agreement says an entity provides “routine support services”, it is automatically a limited-risk service provider
The wording of an intercompany agreement is only one part of the analysis.
Whether an entity is regarded as a limited-risk service provider depends on what it actually does in practice. This requires an assessment of the functions performed, assets employed and risks assumed.
For example, if an entity manages key customer relationships, makes strategic decisions, owns or develops valuable intangibles, or assumes significant commercial risks, it may not be appropriate to characterise it as a limited-risk service provider, regardless of how the agreement is drafted. In TP, substance generally carries more weight than labels.
Myth #4: All routine support services should be charged with a 5% markup
Routine support services automatically qualify for a 5% markup. This often stems from references to the OECD simplified approach for low value-adding intra-group services or Singapore’s administrative practice for qualifying routine support services.
However, not every support service qualifies for these simplified approaches. Before applying a 5% markup, businesses should first consider questions such as:
- What services are actually being provided?
- Do the services meet the relevant qualifying conditions?
- Does the recipient receive an economic or commercial benefit?
- What actual functions are performed, assets are employed and risks are assumed by the service provider?
- Are there any value-creating activities or unique contributions that fall outside the simplified framework?
Applying a standard markup without first understanding the substance or nature of the services may create unnecessary TP risk.
Myth #5: If both related parties are profitable, there is no TP risk
Profitability alone does not determine whether TP outcomes are arm’s length.
A related party may earn profits that are inconsistent with the value it creates, while another entity may earn returns that are lower than expected based on its functions and risks.
TP focuses on whether profits are allocated consistently with the economic activities performed by each entity, not simply whether each company reports a profit.
Myth #6: Limited-risk entities should never incur losses
Limited-risk entities are generally expected to earn relatively stable returns because they assume fewer business risks than entrepreneurial entities.
However, this does not mean they can never make losses. The key question is whether the loss is consistent with the functions performed and the risks actually assumed and controlled by the entity under the relevant arrangement.
Independent parties may also experience temporary losses due to exceptional economic conditions, start-up activities, business restructuring or other commercial factors.
A loss should therefore be considered in the context of the overall facts and circumstances rather than viewed as automatic evidence of non-arm’s length pricing.
Myth #7: External benchmarking is required for every related party transaction
Benchmarking studies are an important component of many TP analyses, but they are not mandatory in every case.
Some transactions may be supported by internal comparable transactions, published market prices or other reliable evidence. In other situations, qualitative analysis may be sufficient where appropriate.
The objective is not to produce benchmarking for its own sake, but to demonstrate that the TP outcome is consistent with the arm’s length principle.
Myth #8: TP is simply a compliance exercise
Many businesses continue to view TP as an annual documentation requirement.
In reality, TP should form part of broader tax governance and business decision-making.
Business restructurings, changes to operating models, new financing arrangements, centralisation of functions and the development of intangible assets may all have TP implications. Considering these issues early often helps businesses avoid costly disputes, double taxation and unexpected adjustments.
Key takeaway
As TP rules continue to evolve, businesses should be cautious of relying on common assumptions or applying simplified approaches without first understanding the underlying facts.
Ultimately, TP is not about applying a standard markup or preparing documentation for compliance purposes. It is about ensuring that related party transactions reflect the value created by each party and are consistent with what independent parties would have agreed under comparable circumstances.
By challenging these common myths and reviewing existing TP policies periodically, businesses can strengthen their TP positions and reduce potential tax risk.
