In an effort to clarify and provide guidance on how to understand the value chain of commodity marketing and trading activities, The Inland Revenue Authority of Singapore (‘IRAS’) released the Transfer Pricing Guidelines in Commodity Trading in May 2019 (‘e-tax guide’).

The growth of trade and wealth in surrounding areas in Asia has increased the importance of Singapore as a central trading hub for many suppliers, producers, and traders in the global supply chain.

Given the fact that Singapore is literally and physically in the middle of this booming market, these new guidelines come as welcome directions in creating uniform understanding in such a fast-growing, and complex market.

The Current Complexity of the Economics of Commodity Trading

One of the more complicated aspects of commodity trading is the complexity of the value chain itself. There is no uniformity in the value created at each stage of the value chain — value is not created based on the functions performed, but rather the economic significance of the functions themselves, based on their frequency, type, and value creation for the parties involved.

The Broader Activities of Commodity Marketing and Trading

Beyond this distinction in the value chain model, commodity marketing and trading (CMT) does not only include selling and buying commodities, but rather it represents a more sophisticated value chain involving many aspects:

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

From here it is clear why each function within the CMT value chain can vary so much in value. With so much variability, arm’s length pricing requires intensive evaluation of the functions performed, assets involved, as well as the risk involved in each function.

Related read: What is Transfer Pricing in Singapore? »

With an aim to simplify this complex value chain, the IRAS e-tax guide has segmented the various functions of the value chain into four basic areas:

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

Beyond this, IRAS e-tax guide goes to great length to provide in-depth guidance of the application of Transfer Pricing Methods, to benchmark each transaction within its context to the overall value chain. The e-tax guide also includes considering examples of possible risks involved:

• price risk
• inventory risk
• supply risk
• excess/shortfall production risk
• volume risk
• contractual risk
• demurrage risk

Thankfully the e-tax guide also provides examples of risk mitigation strategies within the supply chain, such as:

• Credit checks of trading partners prior to sales
• Diversification of customer base
• Improved receivables management
• Managing a global supply book
• Maintaining a portfolio of varied supply sources
• Spot trading
• Hedging

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What Are the Accepted Transfer Pricing Methods?

IRAS has made it clear that while it has no specific preference, there are five transfer methods that it deems acceptable, and taxpayers may choose their preferred method based on data available to them, and the general practices of their industry.

1. Comparable Uncontrolled Price (CUP) Method

Generally considered the most straightforward method, the CUP method is also usually the preferred method for most taxpayers. It takes a simpler and perhaps more elegant approach to reviewing the rates and conditions to make sure they are at arm’s length between any two parties. The CUP methods can also be used for quoted prices and comparable independent party transactions.

2. Transactional Net Margin Method (TNMM)

In the TNMM, the net profit needs to be determined within any controlled transaction. This net profit is then checked against net profits of other comparable uncontrolled transactions within the market. To adhere to the TNMM, these comparable transactions must share obvious similarities.

3. Profit Split Method (PSM)

The PSM will usually come into play when the parties involved cannot examine their transactions separately, due to other associated common transactions. In order to determine the profit split in the PSM, the parties must explore the terms and conditions of each controlled transaction. The resulting distribution of profits should be based on what would have been gained by independent businesses in a similar transaction.

4. Resale Price Method (RPM)

The RPM method takes the price a commodity is sold at, and then has its resale price lowered with a gross margin. This gross margin is determined by comparing it to other gross margins incomparable, uncontrolled transactions. Subsequent related expenses of the commodity’s purchase (e.g. duties and tariffs) are then deducted.

5. Cost Plus Method (CPM)

In order to compare gross profits to the sales costs of the commodity, the CPM uses the following criteria:

Step One: Establish any and all expenses incurred by the seller in a controlled transaction in order to sell the commodity to the buyer.

Step Two: Add an acceptable mark-up to these expenses to make a reasonable profit on those functions.

Step Three: The expenses plus mark-up give both parties the arm’s length price.

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Requirements for Transfer Pricing Documentation in Commodity Marketing

Finally, the IRAS e-tax guide states that when a commodity trading entity meets the established criteria, it will be required to prepare their own Transfer Pricing Documentation (TPD) associated party transactions.

Even if a commodity trading entity does not meet these criteria, IRAS recommends it to still document it’s TPD in an effort to explain their activity if needed in the future.

If a commodity trading entity does not prepare a TPD, they can be fined up to SGD10,000.

Must Read: FAQ – Singapore Transfer Pricing-Documentation »

A Wrap-Up for Transfer Pricing Guidelines in Singapore

In essence, the IRAS e-tax guide makes large strides in an effort to characterize and classify each of the components in the complex value chain of commodity trading. In practice, it should very much help Singapore taxpayers to determine their contribution to the value chain, and therefore account for their returns on trading.