An updated version
In the wake of budgetary constraints, the Government of Tanzania is bolstering its transfer pricing enforcement actions in order to create and raise revenues and meet budgetary targets, a move that is expected to increase the administrative compliance cost and burden for multi-national companies and other taxpayers.
Indeed, the Government’s apex body charged with the administration of taxes, the Tanzania Revenue Authority (TRA), is strengthening the capacity of its International Taxation Unit to deal with multinational companies and to monitor the key sectors of the Tanzanian economy in all enforcement matters involving international taxation, including transfer pricing.
The International Taxation Unit at the TRA has been viewed by the Government as being very important in addressing the transfer pricing challenges that Tanzania faces; to wit, inadequate transfer pricing rules, limited knowledge and skills to enforce the rules, limited information on comparables, and the tightening of penalties for non-compliance.
The Government published on 27 April 2018 the Tax Administration (Transfer Pricing) Regulations, 2018, G.N. No. 166 of 2018 (the 2018 Regulations). The 2018 Regulations revoke and replace the Income Tax (Transfer Pricing) Regulations, 2014, G.N. No. 27 of 2014.
The 2018 Regulations require taxpayers with related party transactions above Tanzanian shillings (TZS) 10 billion in a year of income to file their transfer pricing documentation with the final corporate income tax return.
Although taxpayers that do not reach the threshold of TZS10 billion do not have to submit the contemporaneous transfer pricing documentation to the TRA, nevertheless they must have the documentation in place by the due date for filing the corporate income tax return for that year.
Upon request by the TRA, the transfer pricing documentation must be submitted to the TRA within 30 days.
The TRA has expressed commitment to provide clarity in the application of the 2018 Regulations and has also called upon stakeholders to collectively support the effort to administer transfer pricing aspects of cross-border transactions.
While a correct transfer pricing practice can save companies big tax dollars, an erroneous practice can lead to the imposition of heavier penalties than the original tax. Evidently, this risk is increasing with the unparalleled level of regulatory reform currently taking place in Tanzania under the presidency of Dr John Pombe Magufuli.
As a consequence, it’s no wonder that transfer pricing compliance has become a major concern for companies and other taxpayers operating in the country.
So then what could companies do to develop a complete transfer pricing practice that will cut their tax bills ethically and; at the same time, minimize the risk of a TRA audit?
In simple terms, transfer pricing involves the pricing of transactions between related parties to be conducted at a market rate, often referred to as an “arm’s length price”.
From the perspective of the TRA, the overarching objective here is to prevent companies from using intercompany pricing as a means of evading taxes by inflating or deflating the profits of a particular entity.
The 2018 Regulations provide a synopsis of all information that taxpayers should include in the contemporaneous transfer pricing documentation to support the arm’s-length character of controlled transactions.
Actual computational workings that were prepared when determining the transfer prices of controlled transactions are some of the records required.
The Regulations also grant the Commissioner General of the TRA wide power to request by notice in writing from a person—whether or not liable to tax—to supply “any other information.”
An entity outside Tanzania can be used as tested party only if all relevant information, including financial statements of that party, is provided.
The cost of performing the identified and rendered intragroup services shall be the designated method to determine the arm’s consideration for intragroup services.
If these services are supplied jointly to various associates, and it is not possible to identify specific services provided to each entity, then allocation is to be on the basis of reasonable allocation criteria.
The criteria shall be accepted as long as it is measurable and relevant to the type of the service.
In this sense, if indirect methods of allocation are in situations where services cannot be directly attributed to a specific entity, it will be challenging to convince the TRA with regard to supporting documentation for benefits received from intragroup services.
The 2018 Regulations require the determination of the arm’s length interest rate for intragroup financing regardless of whether there is consideration for such financing.
According the Regulations, the owner of a locally developed intangible that is transferred outside Tanzania should be compensated appropriately at the time of the transfer.
That intangible cannot attract a royalty when licensed back for use in Tanzania. This measure is in accord with the base erosion on profit shifting (BEPS) actions on intangible assets.
Controlled commodity transactions should be priced using the comparable uncontrolled price (CUP) method. Quoted spot rates obtained from a domestic or international commodity exchange market may be used as a benchmark to determine the arm’s length price for a controlled commodity transaction.
The Regulations stipulate that if the price agreed between associates is higher than the quoted spot price, then the agreed price shall be considered as the sale price.
This change is aligned to the approach adopted by many tax administrators in Africa for commodity transactions.
For companies dealing with commodities, the impact is likely to be significant; therefore, companies must revise their transfer pricing arrangements and consider the role of related parties in the supply chain.
If executed accurately, transfer pricing can save companies millions of dollars; on the other hand, if implemented incorrectly, companies increase their exposure for TRA audits, interest, and pecuniary (and imprisonment) penalties.
Tanzania’s international tax policy for cross-border transactions was originally provided for under Section 33 of the Income Tax Act, 2004. The 2018 Regulations govern the procedures for applying the arm’s length principle and have adopted the same methods as set forth in the OECD/UN model tax convention.
But, what do Tanzania’s transfer pricing regulations mean for businesses? Do the regulations take into account existing economic conditions? And, what about today’s world-wide internet business model that has rendered conventional geographical and governmental boundaries almost meaningless?
These questions are tied to many other issues that have established a sense of urgency to tackle economic policy, including taxation.
At present, the Government is targeting transfer pricing. By tightening up transfer pricing regulations, Tanzania has discovered that it can collect significant additional revenues every year.
Addressing Parliament in June 2018, Finance Minister Dr Philip Mpango unveiled the 2018/19 National Budget, which included proposals to boost tax compliance to deal with the “tax gap” i.e. the difference between the taxes owed and the taxes paid on time.
To put it briefly, the Government aims to eliminate tax loopholes and raise revenue for the unprecedented budget deficits.
The bottom line, however, is that Tanzania is adding more resources to collection and enforcement, and the TRA is auditing regularly and imposing stringent penalties. There’s general feeling amongst finance, tax and legal executives in Tanzania that tax audits are becoming more systematic.
Hence, companies’ tax practices are coming under tighter scrutiny and a heavier burden of tax compliance.
Non-compliance by companies can lead to transfer pricing adjustments with huge tax bills, and that’s why companies are keen to efficiently mitigate potential transfer pricing risks.
It is widely believed that there’s too much scrutiny by the TRA. The Government needs revenue and one of the targets for generating that revenue are multinational companies with branch or subsidiary operations in the country.
In that regard, the TRA will look for obvious ‘red flags’ in assessing transfer pricing risks.
Such red flags include, but are not limited to, unreasonable or unexplainable losses or low profitability, cross-border restructurings which shift profits outside Tanzania, poorly documented big year-end transfer pricing entries, and transactions with low-tax jurisdictions like British Virgin, Bermuda and Cayman Islands.
As a country seeking to enhance tax yields, Tanzania is paying special attention to transfer pricing.
To ensure that a fair share of tax on any international business conducted by related parties is collected, the TRA is increasing its audit teams; and because of this, companies of almost any size should be ready for a review and defense of their related party transactions.
Beyond the shadow of a doubt, Tanzania is systematically enforcing its transfer pricing regulations, which have a direct impact on the resources needed for companies to remain in compliance.
By ensuring that operations are conducted in step with proper transfer pricing policies (and agreements) and assiduously meeting contemporaneous documentation requirements to confirm the same, companies will not only save a lot of money by implementing a proactive approach to transfer pricing, but will also protect themselves against potential tax audit troubles.