Tax authorities are examining transfer pricing with increased attention. This hard-line approach, explains Fabrizio Lolliri, has resulted in a rise of transfer pricing cases being resolved in court

Whilst positive macroeconomic indicators strengthen hopes of recovery, many corporations were still feeling the squeeze on their profit margins at the end of FY 2014. As companies attempt to limit the erosion of their profit margins, tax efficiency has become increasingly important; however, governments are continuing to tighten their taxation systems in an attempt to tackle their large budget deficit. Tax authorities are also examining transfer pricing with increased attention. This hard-line approach has resulted in a rise of transfer pricing cases being resolved in court.

With this increase in cases and the extensive press coverage of the taxation practices of large companies, transfer pricing has become a much discussed topic. In Africa there has been a lot of publicity on the negative economic impact caused by supply chain transformation projects and transfer pricing shifting profits to jurisdictions outside the continent. Some even suggested that transfer pricing should be banned.

However, transfer pricing is not really the problem and without transfer pricing regulating intragroup transactions, the African economy could face an even higher risk. Transfer pricing is ALL about ensuring profits are taxed where value is created. The solution is more about ensuring transfer pricing is applied properly and is promoting creativity and creating value in Africa to ensure the margins remain locally.

Over the years, several African countries have started implementing transfer pricing regulations and increasing their focus on transfer pricing audits. But in 2015, what should companies reviewing their intra-group transactions be worried about? What are the most contentious transfer pricing issues? Most vitally, how can companies get their house in order to minimise the risk of a costly and lengthy tax dispute in 2015 and the years to come?

This article attempts to answer these questions by extracting the trends displayed in recent transfer pricing cases worldwide and revealing the key issues that companies should be most concerned about nowadays. As always, it is good practice to look back at the history and the trends in other jurisdictions where transfer pricing regulations have been in place for much longer, and where a multitude of cases have already been fought in court. Furthermore, African countries are still in an embryonic phase when looking at data’s availability and extent of development of their transfer pricing systems. Therefore, this study will focus on what is happening around the world and in particular in jurisdictions where transfer pricing has been in force for a long time. This should provide an insight on where the African businesses should focus their future efforts when managing their transfer pricing risk as TP regulations in Africa catch up with the rest of the world. Hogan Lovells carried out a statistical study to understand what tax authorities are focusing on when conducting a transfer pricing audit.

Transfer pricing brings together economic modelling and black letter law. Generally, cases concerning the transfer pricing policies of large companies can be founded either on the economic model used to determine arm’s-length pricing or on the interpretation of legislation which regulates the intra-group transactions under scrutiny. So, when reviewing their transfer pricing policies, should companies be more concerned with their choice of economic model or the interpretation of specific legislation?

With 46,67% of recent transfer pricing cases resting on legal contentions, it is more important than ever for companies to remain vigilant on how tax agencies and the courts around the world interpret legislation and define specific phrases within relevant Acts. Therefore, it is essential that companies looking at the legal supportability of their transfer pricing policies not only understand domestic legislation concerning taxation, but can also justify the choice of economic model employed to calculate the prices used for intra-group transactions. In Africa, transfer pricing legislation is still in its infancy state and owing to resource constraints, tax authorities are more likely to concentrate on high-value transactions (that is, with higher potential for adjustments) and transactions where the African entities are ‘described’ in the intragroup agreements as more routine (for example limited risk manufacturing and distribution, outsourcing services, etc). Under these circumstances, both the legal and economic interpretation of the transaction become crucially important in case of a dispute.

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Another important consideration for companies looking to review their transfer pricing policy is where in the supply chain have tax agencies brought forward most cases? The table on the left summarises where in companies’ operations, cases have most frequently been forwarded.

With over a quarter of cases related to companies’ financing, businesses need to ensure that the way in which they finance their subsidiaries is transparent, fair and adheres to all relevant legislation. In Africa, tax authorities are considering limiting the use of financing structures for cash extraction purposes by introducing withholding tax on interest.

Furthermore, the data illustrates that tax agencies also pay particular attention to the pricing of intra-group services, intellectual property and the distribution of goods. But what was the nature of the cases in each area of the supply chain? The summary table and spider chart on the left illustrate the share of legal and economic cases in each part of the supply chain.

Whilst the specific share of legal and economic cases fluctuates across each area of the supply chain, in every area but one, cases have been founded on both legal and economic issues. The chart also shows how there is a particular focus on IP, which is reflected in the changes in the new chapter 6 of the OECD Guidelines. IP transactions are usually more complex and require ensuring substance is aligned with profits, which is also a common theme in BEPS (base erosion profit shifting).

As the graph demonstrates, the majority of financing and distribution cases were driven by legal considerations, with most cases turning on the interpretation of legislation. Therefore, companies, when assessing their methods of intra-group financing and distribution, should largely focus on the legislation governing these areas, ensuring that all relevant regulations have been followed. In contrast to this, two thirds of cases brought to court regarding IP and the provision of intra-group services are based on the economic calculation used in determining arm’s-length terms.


Another important concern for companies reviewing their transfer pricing policies ahead of 2015 are the judgments given in these recent cases from courts. How often does the company (the taxpayer) successfully argue their point?

As the summary table below illustrates, the tax authorities around the globe are 10% more likely to have judgment go in their favour compared to the taxpayer. Although companies are quite often successful in disproving the case against them (40%), there is still a greater probability they will be held liable to pay the disputed tax payment, further highlighting the need for companies to closely review their tax practices going into 2015. In African countries where the financial crisis has deeply affected the state of the economy and the lack or infancy of the transfer pricing regulations, disputes are more likely to take longer with a more aggressive approach of the tax authorities towards the taxpayer.

The results of the dataset are largely mirrored when examining the outcomes of the economic and legal cases separately. Whilst it reveals that the tax authorities are 15% more likely to succeed in cases based on legal matters, the numbers still largely follow a similar trend. The increased likelihood for cases, based on economics, resulting in a judgment in favour of the taxpayer, is most probably the product of large companies hiring expert economists to support their case. Furthermore, the increased complexity of these cases results in more drawn-out and contentious lawsuits with 18,75% of these cases still ongoing at the time of writing of this article.

In both categories of these cases there is a higher likelihood of victory for the tax authority, this again emphasises the need for companies to get their house in order as they enter 2016.


This study has illustrated that transfer pricing cases are not simply dominated by economic contentions, but are far more diverse than this. The rise in transfer pricing cases is a result of tax authorities questioning both the economic and legal legitimacy of company’s transfer pricing practices. These trends are likely to be replicated in the African jurisdictions. Those companies looking to get their house in order should closely examine both the legal and economic legitimacy of their company-wide transfer pricing policy, paying particular attention to their practices relating to financing, intellectual property and the provision of intra-group services. Furthermore, it is imperative to pay attention to aligning substance and profit as artificial arrangements (mostly driven by contractual allocation of risk not mirroring the actual function and risk profile remaining in the African subsidiaries) as African tax authorities will be putting all their efforts to test the substance requirements. Running a risk assessment and looking at those intragroup transactions that are more likely to lead to a larger adjustment in case of audit should be prioritised. It is all about implementing transfer pricing policies that reflect true commercial planning.

2015 won’t be the end of all transfer pricing planning, but it will certainly make artificial and purely tax-driven planning an endangered species. As Africa catches up with the other jurisdictions, transfer pricing compliance is likely to increase and businesses will have to manage their transfer pricing risk more efficiently.


AUTHOR : Fabrizio Lolliri is European director of transfer pricing Hogan Lovells