Tax systems are complex and have historically tended to change slowly. However, in the wake of rapid digitisation, global geopolitical instability, financial crashes, and then the COVID-19 pandemic, the pace of change in business, and thus in entire financial systems, including taxation, has increased too.
In the five years since my company was founded, we’ve seen that tax authorities around the world have increasingly begun to place greater focus on transfer pricing and the role it can play in base erosion profit shifting (BEPS). We’ve also seen a definite increase in interest in transfer pricing from revenue authorities on the African continent.
Two mega trends on the continent
I spoke to Emily Muyaa, Chief of the Capacity Development Unit at the United Nations (UN) Financing for Sustainable Development Office, about trends she’s observed, and she flagged two major trends worth noting on the continent relating to intra-group services and dispute avoidance and resolution.
She explains that recent developments in transfer pricing of intra-group services, especially around the OECD BEPS Project, focused on ‘low value-adding services’ (LVAs). The recommendation for a simplification measure for LVAs is contained in both the OECD Transfer Guidelines and the UN’s Practical Manual on Transfer Pricing.1 The objective of this measure, which provides for a reimbursement of costs involved in rendering LVAs and a modest cost-plus mark-up, was to try to simplify transfer pricing compliance for multinational entities (MNEs) and administration for tax authorities. However, there has been a relatively low uptake of it by countries in Africa. As far as Emily is aware, only Zambia has something in their regulations on this. Aside from LVAs, she believes intra-group services generally continue to be a big issue on the continent in terms of two broad angles – withholding tax and transfer pricing.
Looking at this from a transfer pricing perspective, most MNEs rely on intra-group services in one way or another for the sake of operational efficiency. When we see transfer pricing audits that flag intra-group services, it usually relates to centralised services for certain parts of the business. For example, it may make sense to use shared IT or HR services for the whole group. This could be because certain skills are not widely available in each country in which the MNE operates, to create synergies and uniformity within the group, or purely as a cost-saving measure. But there are tax complications that need to be considered.
Most businesses don’t keep detailed time sheets for every employee who is involved in rendering services to group companies. Given that most tax audits also happen a few years down the line, it can often be difficult to remember why certain decisions were taken or to find specific evidence that tax authorities are requesting.
Companies that have cross-border-related party transactions need to carefully consider their intercompany transactions to ensure that they are compliant with transfer pricing regulations in the various countries where they operate.
Disputes on the rise
In terms of dispute avoidance and resolution, Emily notes that there have been a few influential transfer pricing court cases in the past five years – the first such cases on the continent. Some of these cases dealt with another pertinent transfer pricing issue across most developing countries, marketing and distribution activities. She says that one of the main challenges has been how to determine the true level of risk that an entity should be rewarded for taking on: is it really a fully-fledged distributor or more of a limited-risk distributor? Often, we find that companies regarded as limited-risk distributors are actually doing more than what would be expected for such a characterisation.
From my perspective, we’ve seen an increasing number of transfer pricing audits taking place, and these generally happen a few years down the line, when exposure may have mounted. Transfer pricing audits may result in a tax amount payable, plus interest and penalties, and what many people don’t realise is that transfer pricing affects many aspects of a multinational business, from operations to finance, the brand and reputation, and the stakeholders.
Emily flagged withholding tax disputes as another big theme worth considering. For example, she says, there have been a couple of cases involving withholding tax on services in a number of countries. The issue at hand is often whether the service that gives rise to the payment was performed in the country. The issue of permanent establishments is another topic that continues to gain prominence in discussions on tax in Africa.
Emily adds that transactions involving certain aspects often referred to as ‘mobile income’, such as management fees, royalties and interest, are also some of the issues that are prone to controversy globally.
She notes that the tax world is also grappling with the effects of the pandemic and other crises that have impacted transfer pricing more specifically. On the upside, we’ve seen huge technological advancement, which promotes effectiveness and efficiency. On the downside, it has complicated the already difficult exercise of benchmarking studies. For example, factors such as the effects of inflation and energy prices need to be considered more keenly.
Updates and capacity development
At the end of last year, South Africa released draft guidance on advanced pricing arrangements (APAs). Some other countries in Africa have elements of APAs in their domestic legislation, but South Africa has issued more advanced draft guidance. APAs can be an effective tool in avoiding tax disputes, thereby providing certainty.
Morocco is another African country that has an APA mechanism in place (since 2018), with a unit dedicated to APAs.
Aside from policy considerations, most developing countries cite a lack of capacity to implement or administer APAs as one of the reasons for the low uptake of this mechanism. In order to address this, as part of its capacity development strategy for tax, the UN is organising practical and integrated training sessions for governments on dispute avoidance and resolution, based on guidance developed by the UN Tax Committee in the Handbook on Dispute Avoidance and Resolution.2 The training sessions will focus on various aspects including mutual agreement procedures and APAs. They will take place in every region around the world, and Africa is part of the 2023 schedule.
The UN Transfer Pricing Manual was updated in 2021 and includes some new guidance. For example, Emily says, there is now a chapter on financial transactions – another critical topic for developing countries. A new section on centralised procurement has also been added to the chapter on intra-group services. The manual gives very practical examples of financial transactions and centralised procurement. The guidance on procurement was specifically developed in response to requests by many developing countries, notably from Africa.
What do the next five years hold?
Emily believes we should also be thinking about climate discussions, which have intensified globally. This plays into another interesting topic that’s emerging – the transfer pricing considerations for CO2 certificates. The UN Tax Committee is considering this issue both from transfer pricing and pure environmental tax perspectives.
It’s been an interesting and eventful five years. There is so much going on in the tax world at the moment across the world, but also in Africa.
Notes
- https://www.un.org/development/desa/financing/sites/www.un.org.development.desa.financing/files/2021-04/TP_2021_final_web%20%281%29.pdf
- https://www.un.org/development/desa/financing/what-we-do/ECOSOC/tax-committee/thematic-areas/dispute-resolution#:~:text=The%20new%20UN%20Handbook%20on,tax%20laws%20and%20tax%20treaties
Author
Michael Hewson is the founder and director of Graphene Economics, a specialist African transfer pricing advisory firm.
