What transfer pricing could mean for your African business
Our co-founder and CEO Brendon Jones speaks to Cabrini McCarrick, Head of Transfer Pricing at Regan van Rooy, on why Transfer Pricing, Base Erosion and Profit Shifting continue to be top of mind for Africa-based businesses, against the backdrop of the OECD having released the revised guidelines for Transfer Pricing on the 20th of January 2022, as an update to those published back in 2017
To briefly introduce our expert for this Opportunité Africa podcast, Cabrini has over 15 years of transfer pricing and tax experience in London and across Africa. She studied law and then cross qualified as a Chartered Accountant before embarking on a tax career in the transfer pricing team at Deloitte, London. Soon thereafter, she moved with Deloitte to Johannesburg, where she fell in love with South Africa and made a career transition to Regan van Rooy to continue her work in an advisory firm with an African focus on international tax matters.
How has the concept evolved since its inception in 2017?
Transfer Pricing (TP) principles have always been firmly in place but have recently been formalised with legislation. The tax authorities in Africa have been working with various bodies like the OECD and the Africa Tax Administration Forum (ATAF) to get their resources upskilled so they can enforce transfer pricing. So, energies have been shifted towards ensuring that transfer pricing principles are being complied with by multinationals in Africa.
Conceptually, transfer pricing can be regarded as ‘a tug of war between tax authorities, with each jurisdiction trying to ensure that they are getting the appropriate share of the tax base and that multinationals are not eroding tax levies by artificially shifting profits.’ If an entity forms part of a group and engages in transactions with related parties, the main principle is that it must treat those transactions and the pricing of those transactions as if it were an independent party. TP ensures that groups which have an international presence (though in some cases in Africa, economies also enforce domestic TP which adds another layer of complexity) cannot merely say that such and such transaction is arm’s length, but that they now have an actual obligation to prove the arm’s length nature of how they transact. This is where TP documentation comes in, which in turn takes three forms:
- The local file: This contains specific legal entity information – what are the transactions, who does what with those transactions, how is the transaction priced, etc. The same step also encompasses conducting benchmarking studies – essentially comparing related-party data against independent data to prove that such transaction is arms-length.
- The master file: This is the group file that summaries the group wherever it may be – what is the group value chain, what are the group transactions, what is the group policy, what is the groups intangible and financial strategy etc.
- Country-by-country reporting: Another layer of complexity in the form of country-by-country reporting applies to very large multinationals that in turn looks at all the group’s data – universal aspects such as headcount, value of related party transactions, and so on.
What size should an enterprise be before it considers instituting TP policies?
In certain jurisdictions, there is a threshold beyond which detailed documentation requirements apply. In SA, for instance, ZAR100m per annum or more in related party transactions requires onerous documentation, while in Botswana, the comparable threshold is BWP 5m. The respective tax authorities have designed such thresholds based on their local economies and where they consider the highest risk to arise from. For example, in Malawi, the tax authorities focus on the export market because that’s where they consider the greatest likelihood of high-value related party transactions emerging from.
As a rule of thumb, the smaller a business is, the lower the level of compliance obligation that it faces. What is key is that a growing business must set up the right framework and TP model because such framework has the potential not just to support it in fulfilling compliance obligations but also to serve as the basis for a model that optimises the firm’s entire international structure. If a firm can do that from the outset, it would be placed in a much stronger position to move forward as the business scales up.
African jurisdictions that are more sophisticated in applying and policing TP principles
Mapping the sophistication of the TP policy framework to the incidence of TP-related disputes in the concerned economy, SA, Kenya, Nigeria, Tanzania, Zambia, Zimbabwe, Malawi, Ghana, Senegal, and Ivory Coast are countries where TP legislation appears to be evolving faster than in others on the continent. Conversely, there are only a few African countries that have no strict documentation requirements, namely Lesotho and Mauritius.
Thus, it would appear at first glance that the countries with more disputes dotting the landscape are those that are enforcing TP principles at the highest levels. However, here one must strike a note of caution, as TP is a nascent area where disputes are subject to the court’s interpretation rather than long-established historical precedent. Hence, it is not unusual for tax authorities to be tempted to take companies to court based on the potential tax incidence that could be levied upon a successful outcome, rather than on an actual conviction on such tax authority’s part of a grievous breach of TP principles.
Penalties in case of non-compliance with TP principles
If one fails to comply with TP legislation or prepare relevant documentation to demonstrate such compliance, fines are indeed levied by the tax authorities, but those are not the high value penalties faced by a potential offender. The high value penalties arise when an actual TP adjustment is indicated. Indeed, adjusting the price of a related-party transaction to an arms-length price might run into an outgo of hundreds of millions or indeed billions of Rands when one considers secondary adjustments and penalties on top of that, given that penalties in TP are typically between 100-200% of the value of adjustment.
In addition to that, one must consider the time, energy, and resources that it takes to deal with a TP dispute. The tax authority will necessarily solicit all manners of information not only pertaining to the local entity but also the international group entity that such local entity deals with. Indeed, it can take as much as six months to a year to put together such information and it usually ties down resources, time and effort for a business that could be better used elsewhere.
What must African firms do to address the issue of TP and get it right from the start?
At the outset, one must speak to a specialist to understand what TP is and what are the transactions that are likely to come under it. This implies an overarching need to design the appropriate model from the start, especially with a view to dealing with complex TP transactions arising on more esoteric fronts such as Intellectual Property (IP), for instance.
Ultimately, TP is a key concern that no business in Africa with international transactions can ignore and needs must place a framework around – setting up policy and documentation mandates and developing an understanding of what this requirement means for the business. Most crucially, adhering to TP principles is all too often about upskilling one’s own people because TP is not a mere report that sits on a shelf – it is a process that is ingrained into the very fabric of the business and feeds off how the local entity functions by leveraging support from group entities.
Finally, all business, including those in Africa must wake up to the fact that TP and BEPS are concepts that are universal – and are here to stay. All countries, including those in the continent are certainly becoming more aware of, and enforcing, TP policies. If a business gets Transfer Pricing wrong, it is not only the cost of the fines – but also the time it takes to defend itself against such dispute – that can be most punitive indeed.