Multinationals face quandary over transfer pricing

The inexact science’ is regarded as the big culprit in reducing global companies’ tax exposure

Tax collection from transfer pricing audits has become more common in Africa, with little sign that it will abate in the near future.

The transfer pricing policies of many multinational companies have attracted widespread attention in the recent past, to the extent that it is considered the “criminal child of tax”.

Transfer pricing is the way a company prices goods and services supplied to a company within the same group. The price should be aligned to a price that the company would offer to a third party.

Nishana Gosai, senior transfer pricing executive at Baker McKenzie, says that despite having transfer policies in place, most large multinational companies find it difficult to control every aspect of its business.

Gosai, former head of the transfer pricing unit at the South African Revenue Service (SARS), says there is a rising perception that transfer-pricing transgressions are criminal and should be met with criminal sanction.

In Tanzania, failure to keep transfer pricing documentation is considered an offence. The punishment is a fine of $30,000 or six months’ imprisonment, or both.

In SA, the revenue authority settled a transfer-pricing dispute with a subsidiary of Kumba Iron Ore to the tune of R2.5bn in 2016. The initial assessment was R6.5bn.

In Tanzania, a large mining company recently received a $190bn tax assessment.

Transfer pricing has been regarded as the major culprit in base erosion and profit shifting (Beps) in which profits are shifted from high-tax jurisdictions to lower tax jurisdictions to limit a global group’s tax exposure.

Gosai emphasises that transfer pricing is not an exact science. “It requires judgment and discretion. No one can define the exact price.”

Finding middle ground requires pragmatism. Information is important in any transfer-pricing dispute, but it seems the burden of proof is becoming insurmountable, she says.

“We are moving into a space where tax administrations are demanding documented proof and evidence to substantiate routine commercial realities,” Gosai says.

Andrew Wellsted, head of the tax team at Norton Rose Fulbright, says that if a company’s affairs or record-keeping are not up to scratch, it faces a long, time-consuming process of getting what the revenue authorities require.

If taxpayers have followed incorrect practices, knowingly or otherwise, it will expose them to tax liabilities and potential disputes.

“If the audit is conducted in an aggressive fashion, it can be very disruptive to the day-to-day operations of the taxpayer. This needs to be carefully managed by taxpayers and the authorities,” says Wellsted.

Deloitte recently published its survey on the views of multinational companies regarding the greater interest in “responsible tax” and Beps among the media, and political and activist groups.

In the 2017 survey, 460 people in 38 countries responded. The results show that respondents are expecting a major effect on their compliance requirements due to the additional reporting requirements arising from the Beps action plans developed and published by the Organisation for Economic Co-operation and Development.

The survey shows that 94% of the respondents believe that the additional transfer-pricing reporting requirements will substantially increase their compliance burden when it comes to corporate tax.

More than 90% of the respondents agree that tax structures are under greater scrutiny by tax administrations than a year ago.

“Irrespective of any actual legislative changes, 93% of respondents believe that tax authorities will increase tax audit assessments as a result of proposed Beps initiatives,” Deloitte’s survey found.

Gosai says many multinationals make the mistake of not fully understanding what they are submitting to a revenue authority, the context of such submissions, the potential ways that it could be interpreted by a revenue official and, most importantly, that once submitted, such disclosures cannot be retracted.

Companies tend to over-comply when faced with a request for information from SARS, especially if it is not specific about its scope.

There is a danger that information offered by the taxpayer that is not relevant to the question asked may lead to further questions or may create the wrong impression.

This can potentially trigger a dispute. “Because of the complexity of a transfer pricing inquiry, specificity is key in dealing with any inquiries,” Wellsted says.

Most tax disputes turn either on a legal interpretation of legislation, or a factual issue. The dispute is often centred on whether or not an arm’s-length price (the price offered to an unconnected third party) has been charged.

“This involves complex and detailed economic analysis and is invariably very subjective,” Wellsted says.

“Thus finding the objectively right answer as to what an arm’s-length price could be, is almost impossible,” he says.