Global oil prices have risen again due to rising fraudFloridaICT in the Middle East, attacks on critical energy infrastructure, and disruption of key shipping routes such as the Strait of Hormuz. Rising costs of fuel and power rapidly translate into higher manufacturing expenses, increased logistics and freight charges, and rising operating costs across supply chains. For Philippine entities that are part of multinational conglomerates, this commercial reality inevitably raises an important tax question: When external shocks fundamentally alter cost structures and profitability, can existing intercompany pricing arrangements still be considered far-fetched?
This question is not unfamiliar to businesses. Just a few years ago, the COVID-19 pandemic forced businesses and tax authorities to confront similar issues. Pricing models designed for stable economic conditions suddenly failed to reflect reality. Lockdowns disrupted supply chains, demand patterns changed overnight, and many institutions, especially those characterized as “regular” or “limited risk,” experienced losses or severe margin erosion. The pandemic served as a stress test for the transfer pricing framework, revealing how vulnerable static policies can be when markets are anything but normal.
During the pandemic, Philippine taxpayers discovered that contractual labels alone provide little protection. Entities described as having limited risk were questioned even when they incurred losses, while benchmarking analyzes based on pre-pandemic data were challenged for lack of relevance. Tax authorities paid less attention to how transactions were described on paper and more to how businesses actually operated during the crisis. Perhaps the most important lesson of that period was the growing importance of narrative. Taxpayers who can clearly explain why their results deviated from historical norms based on commercial reality were in a far better position to defend their results than those who relied solely on the numbers.
Today's oil price shock has revived many of the same issues, although under a different set of circumstances. Unlike the pandemic, which disrupted economic activity, rising oil prices are putting upward pressure on costs for almost every industry. Manufacturing entities will have to pay more for energy, distributors will have to contend with fuel surcharges and transportation instability, and shared service centers will have to absorb increased power consumption expenses. These cost increases are often sudden, while intercompany pricing arrangements are typically set on an annual basis, creating a timing mismatch that puts pressure on existing transfer pricing models.
Therefore, an important question is whether the current environment can be considered an extraordinary market situation. Although the transfer pricing guidelines do not precisely define such circumstances, they recognize that economic conditions affecting comparability should be taken into account. War-induced energy price increases have many characteristics in common with the COVID-19 crisis: they are exogenous, systemic, unpredictable, and largely beyond the control of individual operating entities. Treating these situations as if they are part of normal market fluctuations, divorced from business reality, risks applying the arm's length principle in a purely mechanical manner.
One of the most immediate transfer pricing issues arising from oil price volatility is whether existing intercompany prices remain afloat. Many Philippine subsidiaries operate under cost-plus or fixed markup arrangements that assume a relatively stable cost base. When the costs of fuel, electricity and logistics rise, maintaining the same markup can lead to a sharp decline in margins or even a loss. Although the arm's length principle does not guarantee profitability, persistent deviations from expected returns inevitably warrant scrutiny, especially when comparable companies appear to remain profitable.
This leads to another issue: can institutions with regular or limited exposure absorb oil-related cost increases without adjusting prices? From the tax authority's point of view, there is an inherent tension. On the one hand, absorbing significant cost increases may indicate that the entity is taking risks inconsistent with its characterization. On the other hand, passing through costs without contractual support or functional justification may seem artificial. The issue is not whether costs have increased or not, but who, under foreseeable conditions, should bear the economic burden of that increase.
Benchmarking analysis makes matters more complicated. Oil price volatility increases the dispersion of profits among comparable companies, resulting in wider interquartile ranges and a higher incidence of loss-making comparable companies. Businesses are once again facing difficult decisions: whether to include loss-making companies, whether multi-year averages make sense, and whether the current year's figures better reflect economic reality. These are exactly the same debates that emerged during the COVID-19 audit, underscoring the cyclical nature of transfer pricing challenges during periods of crisis.
At the center of many controversies is the issue of risk allocation. Modern transfer pricing principles emphasize that risks should be allocated to entities that control those risks and have the financial capacity to bear them. In practice, oil price risk is often influenced by strategic decisions related to sourcing, logistics, hedging and pricing, with decisions generally made at the group or regional level rather than at the Philippine subsidiary. When a local entity absorbs losses from oil price shocks despite lacking control over these decisions, the question inevitably arises as to whether the pricing outcome is consistent with economic reality.
From the Bureau of Internal Revenue's perspective, these developments are likely to translate into familiar audit questions. Why did profitability decline despite regular characterization? Why weren't the markups adjusted in response to rising costs? Why do comparable companies remain profitable while taxpayers do not? Experience with COVID-19 audits shows that weak documentation often exacerbates these issues. General references to “high costs”, unsupported claims of extraordinary circumstances, and benchmarking studies carried out unchanged from previous years all weaken the taxpayer's position.
Therefore, practical defense strategies must go beyond numerical adjustments. Pricing results should be aligned with actual conduct, and the transfer pricing document should clearly explain how oil price volatility affected operations, costs and margins. Taxpayers must document not only the existence of high costs, but also their inability to control or reduce those costs and the commercial justification for any temporary deviations from target returns. The experience gained during the pandemic can serve as a useful template, but it should be adapted to reflect the specific nature of energy-driven shocks rather than health-related disruptions.
Ultimately, the current oil price explosion does not suspend the arm's length principle. Instead, it tests how faithfully that principle is applied under pressure. The lessons from COVID-19 remain relevant: arm's-length results are not defined by stable margins or rigid adherence to historical benchmarks, but by economically rational behavior supported by reliable, well-articulated documentation. For Philippine taxpayers, oil price volatility is not just an operational challenge. This is a transfer pricing risk that demands active management, thoughtful analysis and a narrative firmly based on business reality.
Let's Talk TP is a weekly newspaper column from P&A Grant Thornton aimed at keeping the public informed about various developments in taxation. This article is not intended to be a substitute for competent professional advice.
Nikolai F. Canceran is a partner from the tax advisory and compliance division of P&A Grant Thornton, the Philippine member firm of Grant Thornton International Limited.
pagrantthornton@ph.gt.com