Singapore: IRAS’s transfer pricing guidance for headquarters in Singapore

Key takeaways

• Taxpayers should ensure that the remuneration for the HQs is consistent with the arm’s length principle. To determine this remuneration, taxpayers should analyze the functions performed, the assets used, and the risks borne by the HQs and their related parties to delineate the intercompany transactions, characterize the entities and apply the most appropriate transfer pricing methodologies.
• Where the HQs assume economically significant risks and can be characterized as entrepreneurs, remuneration via residual profits (typically in the form of a variable return) may be appropriate, with other related parties receiving an arm’s length return for more routine activities.
• For the HQs that do not assume economically significant risks, do not make key business decisions and are better characterized as routine service providers, a fixed return may be more appropriate.
• Given the potential scrutiny to HQ activities in Singapore by IRAS and/or the overseas tax authorities, taxpayers should ensure that robust documentation following the Guide is prepared for these centralized activities to support the transfer pricing policies applied.

In more detail

Rationalizing the centralization of activities within Singapore

The Guide recognizes that there are various reasons for MNE groups to centralize activities and establish HQs. This includes aggregating personnel with specialized knowledge (such as legal and IP management) to oversee business units, achieving economy of scale/efficiency and being closer to target markets, etc.

Furthermore, the Guide acknowledges that MNE groups may select Singapore for the location of their centralized activities after taking into account the following commercial considerations: excellent business connections, sophisticated ecosystems (e.g., supply chain management capabilities, finance and professional services), strong talent base and established infrastructure (e.g., legal, regulatory, tax and digital), etc.

Determining an arm’s length remuneration for centralized activities

The Guide states that analyzing related party transactions and selecting transfer pricing methods precede the determination of arm’s length transfer price for centralized activities. Generally, the Guide is consistent with the IRAS e-tax guide “Transfer Pricing Guidelines (Fifth Edition)” published on 23 February 2018 (“IRAS Transfer Pricing Guidelines“) and the principles established in the OECD’s “Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations” published on 10 July 2017 (“OECD Transfer Pricing Guidelines“).

In the Guide, IRAS observes that related party transactions should be accurately delineated following an analysis of the functions performed, assets used and risks borne by the HQs and the counterparties. Afterward, a suitable transfer pricing methodology is chosen based on the delineation of transactions.

With respect to the possible functional characterizations for entities performing centralized activities, the guidance identifies the following categories (the list is neither prescriptive nor exhaustive).

• Principal in distribution, manufacturing or research and development arrangements — the HQ acts as a principal and undertakes risk-taking and decision-making in these arrangements.
• Activities relating to core business processes — the HQ provides services that are extensive and go beyond the administrative and executory services, and mitigate the key business risks of the MNE group.
• Activities relating to administrative, technical, financial, commercial, management, coordination and control functions — the HQs perform services that are administrative and executory in nature and are generally considered as corporate overheads.
• Shareholder activities — the HQs carry out activities from the perspective of shareholders and they do not benefit the group entities in general.

For the remuneration to the HQs, the Guide notes the following:

• The HQ’s functional and risk profile — not its designation as a “headquarters” in the MNE’s transfer pricing documentation — will determine how it is characterized and what returns it should earn.
• Where the HQs assume economically significant risks and can be characterized as entrepreneurs, retaining residual profit (typically in the form of a variable return) by the HQs may be appropriate, with other related parties receiving an arm’s length return for more routine activities.

• For HQs that do not assume economically significant risks, do not make key business decisions and can be characterized as a more routine service provider, a fixed return may be more appropriate.

Transfer pricing documentation requirements for centralized services

Transfer pricing documentation (TPD) for the HQ’s centralized activities should meet the requirements in Section 6 of the IRAS Transfer Pricing Guidelines, and should include the following information:

• details of the economic circumstances and business strategies for the related party transaction between the HQ and the foreign affiliates
• an explanation of the value-generating process of the MNE group, the interdependent functions performed by the HQ and its foreign affiliates, and the value contributed by the HQ and its foreign affiliates
• a thorough functional analysis that details the assumption, management and control of risks by the HQ
• reliable evidence and documents to support the HQ’s assumption, management and control of risks
• the price-setting policy of the HQ, including details of the selection of the most appropriate transfer pricing method and information/documents to justify the pricing
• where services have been provided or received, explanations of the following:
  • the benefit and necessity of the services to the related parties
  • the choice of charging method, i.e., direct charge and/or indirect charge (including details of the method of allocation)
  • how and where the service-related costs are booked and charged to the service recipients
  • the administrative practices used

Recommendations to MNE taxpayers

The Guide provides important instructions to MNE taxpayers on how to develop the appropriate transfer pricing policies to remunerate a Singapore HQ based on the value it creates to the group. Over-compensation or under-remuneration would lead to transfer pricing risks either in the foreign jurisdictions or in Singapore. MNE taxpayers should monitor any significant changes to their underlying business that may impact the centralized activities in Singapore, as such changes may require amendments to the transfer pricing policies. Contractual arrangements on the related party transactions should also be reviewed periodically to ensure consistency with the functional profile of the HQ and its counterparties.

Given the increasing scrutiny of business structures that involve HQs, MNE taxpayers should prepare robust TPD for the transacting parties to support the transfer pricing policies. For entities claiming routine returns outside Singapore, we have increasingly observed foreign tax authorities requesting details as to whether the Singapore HQ indeed performs key entrepreneurial/principal functions and manages economically significant risks. MNE taxpayers should ensure that the descriptions of the functional and risk profiles for the HQ and the foreign-related counterparties in the TPD are consistent with each other and reflect the facts.

The Guide specifically incorporates “key decision-making” as a hallmark feature of an entrepreneur principal. For a Singapore principal to bear significant entrepreneurial risks and earn residual profits, it is expected to perform key decision-making functions related to the risks and have the financial capacity to bear these risks. MNE taxpayers should review whether their Singapore principals earning residual profits meet these requirements, and consider whether any business restructuring steps are necessary to strengthen their substance in the Singapore HQs following these requirements in the Guide.

In practice, while an MNE taxpayer may follow the Guide in developing its transfer pricing policy for the Singapore HQ, there is still no guarantee that the foreign tax authorities of the counterparties will always agree with it. Should a dispute arise, the MNE taxpayer would have to navigate through the different interpretations of competing tax jurisdictions and defend its transfer pricing policy in relation to the Singapore HQ based on its functional, risk and asset profile. Our Singapore transfer pricing team can assist with developing the appropriate transfer pricing model, documentary support and work with the relevant tax authorities, including using Advance Pricing Arrangement or Mutual Agreement Procedures where relevant, to obtain tax certainty for MNE groups.