With more and more multinational enterprises (MNEs) becoming more flexible at placing their enterprises and/or business activities anywhere in the world, transfer pricing is now the in-thing as the number of companies entering into intra-group transactions with connected entities worldwide increases. This article seeks to highlight some of the main issues that one needs to know about transfer pricing in Tanzania.
Transfer pricing involves the price charged by one part of an entity for a product or services that it supplies to another related part of the same business entity. For example, artificially deflated or inflated prices on transactions would reduce or increase the taxable income of associated entities in other jurisdictions. Such practices are considered as unacceptable tax avoidances.
Tanzania’s economy has started to rebound and cross-border trade is flourishing, especially due to developments in both the mining sector and emerging oil and gas sector, which are expected to pose greater transfer pricing challenges.
While the government wants to attract more MNE investments, it also wants to ensure that its legitimate rights over the tax receipts due from their business activities within its tax jurisdiction are protected. Therefore, the Tanzania Revenue Authority (TRA) may question the transfer pricing on international transactions if they lead to unacceptable losses in tax revenue.
The ‘arm's length’ principle of transfer pricing states that: “The amount charged by one related party to another for a given product must be the same as if the parties were not related”, as stipulated under section 33 of the Income Tax Act, 2004 CAP 332 (R.E 2011). An arm's length price for a transaction is therefore what the price of that transaction would be on the open market.
Thus, a large number of international transactions are no longer governed primarily by market forces, but by forces driven by the ordinary interests of the entities of a group, hence leading to transfer pricing. In recent years, alarming headlines have appeared in the print media about how multinationals are taking advantage of Africa and tapping billions from the continent through tax manipulations enabled by transfer pricing.
Transfer pricing can be used to shift profits between companies in the same group, in an attempt to pay less taxes. This shift of profits is achieved by transacting with connected entities at prices that are not at ‘arm’s length.’
As former TRA commissioner general Rished Bade once said: “Multinational companies have been very notorious in evading tax; they (regularly) declare losses in Africa but the same companies declare profits in their mother companies. We need to come up with a strategy that will help us monitor them effectively and see to it that they pay their taxes accordingly.”
In his own report on the matter of transfer pricing as presented to parliament, opposition legislator Zitto Kabwe said: “In January 2008, as a member of the Presidential Mining Review Commission, I visited the Resolute Goldmine in Nzega, western Tanzania. At the time, gold prices were around $1,200/ounce, but the company was selling at $530/ounce. They told us that they hedged at that price.”
“Later we found out that they were selling to a sister company offshore. This denied Tanzania millions of dollars in royalties (at the time the royalty was three per cent charged at netback value), as well as tax revenues. The mine was closed in 2012 after exporting $3.5 billion worth of gold and paying corporate tax only once since it started operations in 1997”.
While transfer pricing in itself does not necessarily involve tax avoidance, it can give rise to tax avoidance and evasion when the pricing is not in accordance with international rules or even domestic law, thus leading to mispricing.
As many countries including Tanzania come to realize how much they are suffering in terms of tax revenue losses incurred through international transfer pricing that don’t follow the ‘arm’s length’ principle, more and more national legislation are being enacted to regulate transfer pricing transactions.
The government of Tanzania has in recent years taken various measures towards curbing such negative effects of transfer pricing in the country. On February 7, 2014, the Ministry of Finance and Planning published The Income Tax (Transfer Pricing) Regulations under the Income Tax Act through Government Notice No. 27.
The regulation provides a framework for TRA to enforce the arm’s length principle and sets out the compliance requirements to curb any revenue losses through transfer pricing. Tanzania is the latest nation in the East African regional bloc to enact this transfer pricing regulation; Kenya was first in 2006, and Uganda followed in 2011. In South Africa, the introduction and implementation of transfer pricing legislation came into effect on July 19, 1995.
In May 2014, TRA issued detailed transfer pricing guidelines on how the legislation shall be applied. Moreover, there has been a significant focus on transfer pricing in terms of increased resources, the establishment of the International Taxation Unit (ITU), and transfer pricing investigations and tax audits.
Predominant international players that have and will continue to affect the transfer pricing policies of African nations include the Organization for Economic Cooperation and Development (OECD), the United Nations, and the International Monetary Fund (IMF). While these organizations have distinct characteristics and goals, it appears that all support the arm’s length principle as the basis for transfer pricing policy and domestic laws.
In general, transfer pricing is still a very challenging concern in Tanzania, and is probably the most significant aspect in international taxation today. The methodology is still developing and there are several unanswered practical questions.
The complexity of transfer pricing regulations, lack of comparable transactions in the open market, lack of information to detect related parties, and continuously changing transfer pricing environment make it all very, very challenging.
Tanzania tends to follow Kenya’s lead in situations involving new approaches to tax enforcement. Hence, the TRA has indicated that it will follow the approach taken by the Kenyan High court in the landmark case of Unilever Kenya Limited versus The Commissioner for Income Tax (Income Tax Appeal No. 753 of 2003).
With greater globalization in future, transfer pricing is expected to become an even more complex issue in international taxation. There is a need to ensure that the compliance rules are not excessive, and are applied responsibly by taxpayers.
Moreover, the rules should ensure adequate protection for taxpayers against potential economic double taxation, plus greater cross-border co-operation on transfer pricing issues. The actions of TRA should not adversely affect international trade and business activities.
From a Tanzanian perspective, the government must seek to enhance TRA’s capacity in terms of staff skills in the area of transfer pricing, not only for the purpose of keeping abreast of emerging tax planning trends, but also to ensure that adequate measures are put in place to grapple with cases of tax avoidance through transfer pricing whenever they arise.
Many private companies operating in Tanzania are subsidiaries of multinational enterprises that have engaged in foreign direct investment in the country. The tax authorities are generally of the view that these multinationals are focused on repatriating as much profits out of Tanzania as possible, while suffering the least possible tax costs. For this reason, the tax authorities are aggressively challenging transactions between these local subsidiary operations and their non-resident parent firms.
However, the tax laws relating to transfer pricing and related party transactions remain considerably underdeveloped, and the expectations of the tax authorities with regard to these transactions are different from one case to the other. This creates quite a degree of unpredictability with regard to potential tax costs relating to investing in Tanzania.
The author is Chief Accountant of The Guardian Limited