The transfer pricing framework
With the evolution of international tax regimes and the increasing globalization of multinational corporations has left numerous gaps in local country tax laws around the world. This has given multinational enterprises (“MNE”) the ability to artificially reduce, and even eliminate, their corporate tax burden through “artificially” shifting profits to low or no-tax jurisdictions where there is little or no economic activity through transfer pricing.
Introduction in Tanzania
On 7 February 2014 the Government of Tanzania published The Income Tax (Transfer Pricing) Regulations under the Income Tax Act through Government Notice No. 27 in an attempt to reduce tax avoidance. These regulations expand on the rules found in section 33 of the Income Tax Act that deal with transactions between related persons.
These regulations govern the procedures for applying the arm’s length principle and specify the appropriate transfer pricing methodologies, documentation requirements, deadlines and penalties.
In view of the regulations, companies that transact with related entities both in and outside Tanzania will be required to put in place a robust transfer pricing policy that supports their transactions using one the accepted transfer pricing methods provided for by the regulations.
Transfer pricing in practice
To justify that the transaction with the related party is in accordance with the arm’s length principle, a transfer pricing study is usually conducted. In conducting a transfer pricing study, one looks at the following:
- Industry analysis
- Functional analysis
- Selection of method
- Economic analysis
The conclusions from the above are used to characterise an entity into a certain functionality . Why do we characterise entities for transfer pricing purposes?
- To utilize a common taxonomy
- To select and apply the appropriate transfer pricing methodology to the appropriate tested party
Selection of methods
After characterising a company, the most appropriate transfer pricing method needs to be selected such as:
a. Traditional transaction methods:
- Comparable Uncontrolled Price Method (CUP);
- Cost Plus (CP); and
- Resale Price Method (RPM).
b. Profit methods:
- Profit Split Method (PSM); and
- Transactional Net Margin Method/ Comparable
Profits Method (TNMM).
- According to the Income Tax (Transfer Pricing) Regulations, 2014, Section 7;
- Any person participating in a controlled transaction shall prepare contemporaneous transfer price documentation. (* Controlled transaction means a transaction between associates)
- The contemporaneous documentation shall include records and documents that provide description of the
a. Organization structure, including an organization chart covering persons involved in a controlled transaction;
b. Nature of the business or industry and market conditions;
c. The controlled transactions;
d. Strategies and assumptions regarding factors that influenced the setting of any pricing policies;
e. Comparability, functional and risk analysis;
f. Selection of transfer pricing method;
g. Application of the transfer pricing method;
h. Documents that provide the foundation for or otherwise support or were referred to in developing the transfer pricing analysis;
i. Index to document; and
j. Any other information, data or document considered relevant by the commissioner.
- The documentation for a year of income shall be in place priorto the due date for filing the income tax return for that year.
- The documentation shall, upon request by the Commissioner be submitted within thirty days from the date of request.
Transfer Pricing Risk Areas (TP Risk Flags)
a. Intellectual Properties
- Companies paying large management fees
- Companies paying royalties or other charges for the use of intellectual property
b. Structural issues
- Companies with innovative business structures
- Transactions with tax havens or shelters
- Loss making companies in commercial relationship with taxpayer where the loss is as a result of payments to that entity
- Companies making losses over a number of years
- Sustained losses by Tanzanian entities, but (overall) profits in the group
- Margins suddenly decrease with no rationale
- Debt levels, intra-group loans and guarantees that are ‘un-commercial’
- No formal agreement for services or finance provision with no recharge of costs
- Secondments undertaken on ‘un-commercial’ terms (i.e. no recharge and no agreements)
- Trading debtor balances – intercompany, long term, interest free
Penalties and Fines
According to the Income Tax (Transfer Pricing) Regulations, 2014; Section 5; A person who fails to comply with these regulation commits an offence and is liable on conviction to imprisonment for a term not exceeding six months or to a fine not less than Shillings fifty million shillings or to both.
In addition, the penalty for any transfer pricing adjustment made as part of a tax audit is 100% of the underpayment of tax.