TRANSFER Pricing (TP) is a major tax consideration for Multinational Enterprises (MNEs) across the world, and Africa is no different.
Although just a decade ago, only a handful of countries in Sub-Saharan Africa (SSA) had effective TP Regulations (South Africa in 1995 and Kenya in 2006), several SSA countries have published and implemented TP Regulations within the past decade, Tanzania being one of them.
Notably, the recent developments in the international TP space, including the release of the Organisation for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) reports, have significantly increased focus on TP by tax administrators and MNEs in Tanzania and across Africa in general.
Moreover, with the need for African governments to increase tax revenue, tax administrators have identified TP as a source of additional revenue and have begun to aggressively enforce compliance and conduct TP audits.
The Tanzania Revenue Authority is no different, it has now a fully functional International Taxation Unit (ITU) that solely focuses on international taxes overseeing all TP matters.
All the above factors have culminated in making TP a growing concern for many MNEs currently in Tanzania and within Africa and those seeking to expand their operations to/ out of African countries because of the associated risks.
It has therefore become important that MNEs get a proper understanding of the various TP requirements in Tanzania and across Africa and how these can affect their business operations, and how to adequately plan and manage their Related Party Transactions.
Transfer price is not a new terminology for many accountants and those in the business world. But to what extent does each of the practitioners understand transfer pricing and the impact the transfer pricing arrangements may have as far as tax compliance in Tanzania is concerned raises a number of questions.
Let us refresh our minds and in simple words define what transfer pricing and the basic terminologies are all about in order to understand transfer pricing. Transfer pricing is an accounting and taxation practice that allows for pricing transactions internally within businesses and between subsidiaries that operate under common control or ownership.
The transfer pricing practice extends to cross-border transactions as well as domestic ones. In Tanzania, Transfer Pricing is regulated by Section 33 of the Income Tax Act, 2019 and the Tax Administration (transfer Pricing) Regulations, 2018. Section 33 of the Income Tax Act is intended to curb transfer pricing practices which may have adverse implications for the Tanzania’s tax base.
The measures to curb transfer pricing schemes are in essence contained in Section 33(1) which states that “in any arrangement between persons who are associates the persons shall quantify, apportion and allocate amounts to be included or deducted in calculating income between the persons as is necessary to reflect the total income or tax payable that would have arisen for them if the arrangement had been conducted at arm’s length”.
In understanding transfer pricing, the concept of arm length principle is key.
The Transfer Pricing regulations 2018 have defined arm’s length price to mean the principle whereby commercial or financial transactions between associates is taking place on the same terms as if such transactions had taken place between independent persons under comparable conditions and circumstances.
The question is then who is an associate? The Income Tax Act, 2019 has defined an associate as: An associate in relation to a person, means another person where the relationship between the two is – a) that of an individual and a relative of the individual, unless the Commissioner is satisfied that it is not reasonable to expect that either individual will act in accordance with the intentions of the other;
b) that of partners in the same partnership, unless the Commissioner is satisfied that it is not reasonable to expect that either person will act in accordance with the intentions of the other;
c) that of an entity and – • a person who –
(aa) either alone or together with an associate or associates under another application of this definition; and
(bb) whether directly or through one or more interposed entities, controls or may benefit from 50 per cent or more of the rights to income or capital or voting power of the entity; or (ii) under another application of this definition, is an associate of a person to whom subparagraph (i) applies; or d) in any case not covered by paragraphs (a) to (c), such that one may reasonably be expected to act, other than as employee, in accordance with the intentions of the other. In simple terms, a price is at arm’s length if the price is a true reflection of an independent market price under same conditions or in other words the price is not influenced whatsoever by virtue of any relationship coexisting between any related parties.
Why is transfer Pricing an area of focus for the Tax Man?
Several companies operating in Tanzania are subsidiaries of multinational enterprises that have direct foreign investments in Tanzania. The Tax Authority is generally of the view that these Multinationals are focused on repatriating as much profits out of Tanzania to enable them to suffer minimum tax costs.
For this reason, the Tax authority is aggressively challenging transactions between Tanzania operations and their non-resident related parties. With the development of tax laws relating to transfer pricing, there is now a degree of predictability regarding potential tax costs relating to potential transfer pricing liabilities in Tanzania.
Over the years, transfer pricing has been perceived to be one of the tax avoidance schemes through tax planning. The scheme has resulted to significant revenue losses by Governments across the globe and especially in Africa and that is why is has become an area of main interest to the tax man.
The schemes are undertaken in the various groups of related MNEs and hence they differ in quantum. The TRA has been conducting comprehensive and complex tax audits to uncover any forms of tax planning through transfer pricing arrangements in Tanzania.
To date, there are several transfer pricing cases that have formed a precedence to how businesses will in the future manage TP matters, some of the cases have also positively contributed to the revenues of the Government.
Though the issued transfer pricing assessments may be appealed, the assessments prompt a payment of one third tax deposit of the assessed tax or payment of tax not in dispute whichever amount is greater before the objection is admitted and pending the final determination of the objection by the Commissioner.
Transfer Pricing a simplified scenario To better understand how transfer pricing impacts a company’s tax bill, let’s consider the following simple scenario.
Let’s say that a Computer manufacturer has two divisions: Division A, which manufactures software, and Division B, which manufactures computers.
Division A sells the software to other computer manufacturers as well as its parent company. Division B pays Division A for the software, at the prevailing market price that Division A charges other computer manufacturers.
Let’s say that Division A (software manufacturer) decides to charge a lower price to Division B (computer manufacturer), instead of using the market price. As a result, Division A’s sales or revenues are lower because of the lower pricing. On the other hand, Division B’s costs of goods sold (COGS) are lower, increasing the division’s profits.
In short, Division A’s revenues are lower by the same amount as Division B’s cost savings— so there’s no financial impact on the overall corporation. However, let’s say that Division A is in a higher tax country (higher tax rate country) than Division B.
The overall company can save on taxes by making Division A less profitable and Division B (located in a favorable tax rate country) more profitable.
By making Division A charge lower prices and pass those savings on to Division B, boosting its profits through a lower COGS, Division B will be taxed at a lower rate.
In other words, Division A’s decision not to charge market pricing to Division B allows the overall company to evade taxes.
The scenarios can get more complex. In short, by charging above or below the market price, companies can use transfer pricing to transfer profits and costs to other divisions internally to reduce their tax burden or even erode profits.
Tax authorities have strict rules regarding transfer pricing to attempt to prevent companies from using it to avoid taxes. What businesses need to know about transfer pricing to remain compliant in Tanzania.
Key take aways Transfer pricing occurs when goods or services are exchanged between divisions of the same company. A transfer price is based on market prices in charging another division, subsidiary, or holding company for services rendered.
Companies use transfer pricing to reduce the overall tax burden of the parent company. Companies charge a higher price to divisions in high-tax countries (reducing profit) while charging a lower price (increasing profits) for divisions in low-tax countries.
The Income Tax Act and Transfer Pricing Regulations, states that transfer pricing should be the same between intercompany transactions as it would have been had the company done the transaction outside the company.
Any person participating in a controlled transaction, is required to prepare contemporaneous transfer pricing documentation as prescribed in Regulation 7.
Regulation 7 prescribes documents which must be prepared and accompanied with the final income tax return for that year. For companies with related party transactions that exceed 10 billion Tanzania shillings, the contemporaneous documentation must be filed together with the Income Tax return for that year at the due date of filing.
In any case, the documentations must be in place even for companies with a lesser than 10 billion related party transactions threshold prior to the due date of filing the final income tax return for that year because upon request of the documentation by the Commissioner, the documentation is required to be submitted within 30 days from the date of the request.
The contemporaneous documentation includes records and documents that provide description of the following: (a) organization structure, including group and operational structure that (or the) role and shareholding percentages;
(b) nature of the business or industry and market conditions;
(c) description of the controlled transactions including volumes and values involved;
(d) strategies and assumptions workings factors that influenced the setting of any pricing policies;
(e) the actual computational workings carried out in determining transfer prices;
(f) details of the functions performed, assets employed and risks assumed by each person in relation to the controlled transaction;
(g) comparability analysis;
(h) selection and application of the transfer pricing method tested party and the financial indicator; financial statements for the parties to the controlled transaction including where the tested party has been selected outside the country;
(i) documents that provide the foundation for or otherwise support or were referred to in developing the transfer pricing analysis;
(j) index to document; and
(k) any other information, data or document considered relevant by the person submitting the documents. It is advisable that MNEs review their internal processes and systems and ensure efficient and accurate capture of the increased information required by tax authorities to minimise any potential tax exposures. In our next article we will focus more on transfer pricing matters in Tanzania.
• The writer, Godvictor Lyimo is Tanzania Association of Accountants and Auditors President, reachable via email: firstname.lastname@example.org