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What are the Transfer Pricing Guidelines in Commodity Trading?

What are the Transfer Pricing Guidelines in Commodity Trading?

Transfer Pricing Guidelines in Commodity Trading by IRAS

The Inland Revenue Authority of Singapore (‘IRAS’) released the first edition of the Transfer Pricing Guidelines Special Topic—Commodity Marketing and Trading Activities in May 2019 (‘e-tax guide’). The e-Tax guide is the first special topic guide and provides guidance on how to analyze the value chain of commodity marketing/ trading activities in Singapore.

Singapore is a leading hub for international commodity trade as it is at the crossroads of major shipping and communication routes, has one of the world’s major oil refining and distribution centres, and is in close proximity to producers, suppliers, global trading entities and fast-growing markets. Therefore, due to locational advantages, a number of multinational enterprises have set up operations in Singapore to conduct commodity marketing and trading activities.

Commodity Trading Economic Significance

Commodity trading involves a complex value chain and the level of contribution at each stage differs. The value created at various stages would determine the arm’s length allocation of trading profits. Contribution to value creation is not based on the number of functions performed, but the economic significance of the functions in terms of their frequency, nature, and value created by the respective parties to the transaction is important.

What are the Commodity Marketing and Trading activities?

Commodity marketing and trading (CMT) activities involve not just buying and selling commodities, but a complex value chain involving, for example,

  • Sourcing
  • Refining
  • Inventory management
  • Strategic pricing decisions
  • Managing portfolio mix and ensure diversification
  • Collecting real-time market intelligence
  • Logistics
  • Determine and implement a risk management strategy, etc.

The exact nature of functions undertaken and their contribution to the value chain can vary widely. Where such activities are conducted between related parties, a thorough examination of the actual functions performed, assets used and risks assumed in each specific related party commodity transaction is important in determining the arm’s length pricing.

Keeping in view the various activities undertaken in the value-chain, the e-tax guide carves out four broad categories of functional characterization:

  • Service Provider: Market research services
  • Agency function: Marketing functions
  • Distributor: Purchase or sale of certain commodity
  • Full-risk entrepreneur: Trading certain commodity on an aggregated regional or global trading book basis

The e-tax guide provides elaborate guidance on the application of Transfer Pricing Methods to benchmark the related party transactions keeping in view the characterization and also provides examples of risks assumed by commodity marketing/ trading entities and strategy to control risks.

Examples of risk: excess/ shortfall production risk, inventory risk, supply risk, contractual risk, demurrage risk, price risk, volume risk, etc.

Examples of ways to control risks: Diversification of customer base, managing a global supply book, maintaining a portfolio of varied supply sources, spot trading, hedging, credit checks prior to sales, enhanced receivables management, etc.

What are the Transfer Pricing Methods?

While IRAS has no preference, there are five Transfer Pricing Methods that are accepted. Taxpayers may select the Transfer Pricing Method keeping in view the availability of comparability data and common industry practices.

Let’s take a brief look at these 5 common methods:

  1. Comparable Uncontrolled Price (CUP) Method

    Being the most preferred and traditional choice, the CUP Method is considered the most straightforward way of assessing whether rates and conditions are at arm’s length between the related entities. It can be applied to either a quoted price or comparable independent party transaction.

  2. Resale Price Method (RPM)

    Known as “resale price”, the RPM takes the price at which an associated business sells a commodity to a third party.  The resale price is subsequently lowered with a gross margin, which is calculated by comparing gross margins in comparable uncontrolled transactions. The expenses associated with the product’s purchase such as custom duties are then deducted.

  3. Cost Plus Method (CPM)

    Comparing gross profits to the sales costs, the CPM is used in the following steps:

    Step 1: Determine the expenses incurred by the seller in a controlled transaction for the goods sold to the associated buyer.

    Step 2: This expense must be followed by an acceptable mark-up to make a reasonable profit in view of the performed functions.

    Step 3: Upon adding the mark-up to the expenses, a price can now be determined at arm’s length.

  4. Transactional Net Margin Method (TNMM)

    The net profit of a controlled transaction of an associate business needs to be determined in the TNMM. The net profit is then compared to net profits obtained by comparable uncontrolled transactions of independent businesses. In order for transactions to be comparable, the TNMM requires these transactions to have some distinct similarities.

  5. Profit Split Method (PSM)

    In a situation where associated businesses participate in interrelated transactions and are unable to examine these transactions separately, the PSM comes into use and the profits are usually agreed to be split. The PSM explores the terms and conditions of these forms of controlled transactions by defining the distribution of profits that would have been gained by independent businesses through participating in such transactions.

Transfer Pricing Documentation for Commodity Marketing

Lastly, the IRAS e-tax guide emphasizes that when a commodity marketing/trading entity meets certain criteria, it is required to prepare Transfer Pricing Documentation(TPD) for the related party transactions. Where a commodity marketing/trading entity is not required to prepare Transfer Pricing Documentation, IRAS encourages it to document and explain its Transfer Pricing arrangement. In the event the entity fails to prepare a TPD, they can be liable to a fine not exceeding SGD10,000.

Related Read: Importance of Transfer Pricing Documentation »

In a Nutshell

To conclude, the IRAS e-tax guide provides valuable guidance for the commodity trading/ marketing entities to assist the Singapore taxpayers in the determination of appropriate characterization keeping in view the contribution to the overall value chain and accordingly, justify the return attributable from Singapore Transfer Pricing perspective. Therefore, the multinational groups involved in commodity trading across various jurisdictions should evaluate their related party pricing models and document the basis of such pricing.


FAQs

  • Transfer pricing relates to pricing between related parties of goods, services and intangibles. To assess the price of transactions between related parties, the arm’s length principle has to be embraced. Taxpayers will plan and retain contemporary Transfer Pricing Documents to show that their related party transactions are conducted at arm’s length.
  • Commodity marketing and trading activities are not just buying and selling commodities, but a complex value chain involving:
    • Sourcing
    • Refining
    • Inventory management
    • Strategic pricing decisions
    • Managing portfolio mix
    • Collecting real-time market intelligence
    • Logistics
    • Determine and implement a risk management strategy, etc.
  • Commodity Trading is the investment into physical products such as oil, agriculture, and gold. Many businesses worldwide are commonly involved in commodity trading.
  • Here are 4Transfer Pricing Methods that are commonly used:
    • Profit Split Method
    • Cost Plus Method
    • Comparable Uncontrolled Price (CUP) Method
    • Resale Price Method
  • Strategically located at the crossroads of major shipping and communication routes, Singapore has one of the world’s major oil refining and distribution centres, and is in close proximity to producers, suppliers, global trading entities, and fast-growing markets. Therefore, due to locational advantages, a number of multinational enterprises have set up operations in Singapore to conduct commodity marketing and trading activities.
  • Commodity trading involves a complex value chain and the level of contribution at each stage differs. The value created at various stages would determine the arm’s length allocation of trading profits. Contribution to value creation is not based on the number of functions performed, but the economic significance of the functions in terms of their frequency, nature, and value created by the respective parties to the transaction is important.

Contact Our Singapore Team

Nipun Arora

Nipun Arora

Director

Transfer Pricing & Data Protection-as-a-Service

We are here to help you navigate and understand the Transfer Pricing guidelines.

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