Experts’ views on how to improve tax collection in Africa

Thirty-eight African tax authorities recently converged in Abuja for the International Conference on Tax in Africa. The group discussed ways to boost revenues in Africa, in particular and how to improve collection of corporate income tax, reports Nduka Chiejina (Assistant Editor)

Tax collection has never been a piece of cake and tax collectors can attest to this fact. Thus government bodies saddled with this onerous task of tax collection have had to design aggressive strategies designed to increase “tax efficiency.”

The need to make tax collection more efficient and effective was the overarching theme of the International Conference on Tax in Africa which held in Abuja recently.

Crux of the matter

At issue is that there has been an increase in multinational investment in Africa over the past decades, which has boosted the risk of transfer mispricing, which occurs when two related parties distort the price of a good or service to reduce their taxable income. As a result, the regulatory environment in Africa around the phenomenon is quickly evolving.

For example, assume company A, a multinational which produces a product in Africa and sells it in the United States, processes its produce through three subsidiary companies: X (in Africa), Y (in a tax haven, usually an offshore financial center) and Z (in the US), each of which acts under instruction from A. Company X sells its product to Company Y at an artificially low price, resulting in a low profit and a low tax for Company X in Africa. Company Y then sells the product to Company Z at an artificially high price, almost as high as the retail price at which Company Z then sells the final product in the US. As a result, Company Z also records a low profit and, therefore, a low tax.

Most of the apparent profit is made by Company Y, even though it acts purely as a middleman without adding much (if any) value to the product (it is likely that the products never pass the country Y, but are shipped directly from X to Z) Because Company Y operates in a tax haven, it pays very little tax, leading to increased profits for the parent Company A. Both jurisdictions of companies X and Z are deprived of tax income, which they would have been entitled to if the product had at each stage been traded at the market rate.

About 60% of capital flight from Africa is from improper transfer pricing. Such capital flight from the developing world is estimated at ten times the size of aid it receives and twice the debt service it pays. The African Union reports estimates that about 30% of Sub-Saharan Africa’s GDP has been moved to tax havens.

One tax analyst believed that if the money were paid, most of the continent would be “developed” by now.

Solutions include corporate “country-by-country reporting” where corporations disclose activities in each country and thereby prohibit the use of tax havens where real economic activity occurs. Progress is being made in this direction, as documented on a map. Whereas appropriate transfer pricing of tangible goods can be established by comparison with prices charged for similar goods to unrelated parties, transfer pricing of intangible goods, products of intellectual efforts, rarely has comparable equivalents. Transfer prices then have to be established based on expectations of future income. Mispricing is rife.

Between 1995 and 2014, the number of African countries with transfer pricing rules has grown by 600%, according to Ernst & Young. Thus many governments within the continent are developing stand alone transfer pricing regulations; building specific expertise; setting up specialised transfer pricing units; and working together to share best practices through the African Tax Administration Forum (ATAF).

Way forward

To combat this problem, ATAF and Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) GmbH, on behalf German Federal Ministry for Economic Cooperation and Development (BMZ) have in Abuja, released the Toolkit for Transfer Pricing Risk Assessment for the African Mining Industry.

The kit addresses for instance the use of offshore marketing hubs: cases where a mine sells its product to a related company that then sells to a final customer. The risk is that the marketing hub pays an artificially low price to the mine, reducing profits in the host country, and sells the product onto a third party at market rate, allowing profits to accumulate with the hub, often in a low-tax jurisdiction.

This is just as experts contend that setting the right price for a product is a crucial step towards achieving profit, and since retailers are in business to make gains, knowing when and how to fix the prices of such products may be difficult.

For instance, the Institute of Chartered Accountants of Nigeria argues that in medium and large organisations, there are opposing opinions between marketers and accountants in the area of pricing, owing to the believe that accountants do not understand the importance of competitive pricing.

On the other hand, accountants are also of the view that marketers, often times ignore costs when setting prices.

But another financial expert, a marketer, Ms. Gold Ajiere says that fixing the selling price could be based on a value basis or a cost plus basis with either basis subject to modification according to market conditions.

She noted that value basis is used to set selling prices according to the amount the customer intends to pay for the products and the value of such products or services being provided.

Ajiere contended that using a value basis that fixes the product prices above the general market level requires support and a marketing strategy to demonstrate the benefits that prospective customers will receive.

To establish the most profitable level at which selling prices could be fixed, he notes that it is important to conduct market research in order to determine the general level of pricing within the product area.

“In many cases, the existing competition has already set a price for the product. Each business has to decide whether to accept this price according to the expected volume and the gross profit margin generated or charge a higher or lower price with the consequential effect on sales volume.”

Little wonder accounting giant, PricewaterhouseCoopers in a 2011 report stated that “transfer pricing arrangements and analysis play a significant and diverse role in financial reporting. The impact of transfer pricing spans multiple areas, from business restructuring to valuation allowances. Transfer pricing can also have unique relevance in separate company financial statements and in acquisition accounting. When preparing financial statements and disclosures, attention should be given to the cause-and-effect relationship of transfer pricing to both pre-tax and income tax accounts. Cross-functional coordination is crucial to ensuring that all significant financial reporting implications have been addressed.”