Domestic-level profit-shifting: How it’s done and why it should be avoided

When we hear the term “profit shifting,” we often associate it with cross-border transactions between and among members of multinational companies (MNCs) aimed at reallocating profits across different countries or tax jurisdictions to minimize tax liabilities.

- AARON PAUL A. SANTOS

Profit shifting enables businesses to move profits from high-tax jurisdictions to low-tax or no-tax areas to reduce the total tax liabilities of a conglomerate or a corporate group. While this strategy may be used to somehow avoid tax, it raises concerns about the fairness of tax computations and the revenue foregone by governments, resulting in the need for stricter regulations to ensure proper payment of taxes.

Although profit shifting often involves intercompany transactions among MNCs, it is not solely an international practice, as it can also occur within a single country. In some cases, businesses take advantage of tax incentives granted to certain industries or areas or engage in intercompany transactions among parent/holding companies, subsidiaries, and affiliates or entities under common ownership to unduly improve their tax positions.

The Bureau of Internal Revenue (BIR) acknowledged this risk and acknowledged that while transfer pricing issues typically occur in cross-border transactions, they can also occur in domestic transactions. The BIR illustrated how domestic transfer pricing issues may arise when income is shifted from a company subject to regular income tax to a related company enjoying special tax privileges from the Board of Investments (Bol) or the Philippine Economic Zone Authority (PEZA). Similarly, expenses from a tax-incentivized entity maybe transferred to a related company subject to regular income taxes, or income and expenses may be strategically allocated among related parties to reduce a group’s tax liabilities.