The pricing policies for goods, services, and intellectual property, otherwise known as transfer pricing, within a group of companies remain a focal point for tax authorities in Africa, with a noticeable increase in audit and review activities.
Several countries have introduced new transfer pricing regulations or have been updating existing legislation in recent years.
“As modern transfer pricing regulations have developed, we have seen tax authorities shift their focus to multinational companies and their pricing practices applied to intercompany transactions,” says Michael Hewson, director at Graphene Economics.
“There has been a notable increase in audit activity, with tax authorities performing detailed transfer pricing reviews and audits, with a common focus on intra-group services.”
The challenges facing multinational enterprises (MNEs) were recently unpacked during a three-day webinar hosted by the South African Institute of Taxation (Sait).
Graphene Economics has found that MNEs operating in various African countries are being subjected to increased scrutiny in relation to intra-group service costs and are being asked to provide evidence to support business decisions taken in respect of such costs.
Sait CEO Keith Engel said during the webinar the transfer pricing team at the South African Revenue Service (Sars) has slowly been regaining expertise lost during the state capture era. It has become far more focused in recent times.
Other revenue authorities that are also quite active in terms of transfer pricing reviews and audits are in Kenya, Nigeria and also Tanzania.
Engel says officials often challenge the commercial sense of transactions. The problem is that few officials have worked in commerce or industry and do not understand some of the very complicated business transactions.
“Unfortunately, when transactions seem to be too complicated they [revenue officials] challenge it. But sometimes business is just complicated.”
He says some of the trigger points that may lead to challenges, reviews and even audits include documentary inconsistencies, contradictory public statements in different tax jurisdictions, excessive losses over many years and sudden unexplainable changes in the financial numbers.
“The bigger the group the more the companies need to sing from the same song sheet,” remarks Engel.
Tax authorities are increasingly sharing information and when things do not tie up individual companies in the group may end up in the spotlight.
He adds that consistency is not always as straightforward as one would like it to be, mainly because of the difference in tax legislation from country to country.
More cost queries
Hewson says they are also seeing more and more tax authorities querying the costs attributed to executive activities. In recent audits performed by the Tanzania Revenue Authority (TRA), these types of charges have been challenged.
In such cases, MNEs are being asked to trace back executives’ activities (sometimes as far back as six years ago) to justify what they have done for the benefit of the Tanzanian subsidiaries.
Providing a high-level explanation of their activities has not proved adequate to satisfy the Tanzania Revenue Authority (TRA) that the service was rendered and the charge is appropriate.
As a consequence, says Hewson, the groups may be at risk of losing their full tax deduction (or a part thereof). “In the worst-case scenario, the TRA may even implement a transfer pricing adjustment and levy an equivalent penalty for the more recent years.”
Engel says disputing adjustments or even going to court becomes costly and can be extremely time-consuming.
A risk assessment or verification process by a tax authority can take six months.
“However, when it comes to disputes and litigation it takes even longer – anything from two to three years and more. One case has been dragging on for eight years,” he notes.
Keep the evidence
Hewson says the tax implications of supporting subsidiaries in Africa can become very complex. Most businesses do not keep detailed timesheets for every employee or request an invoice per software licence purchased.
“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 physical evidence that tax authorities are requesting,” he says.
Hewson says MNEs operating in Africa must obtain appropriate evidence to substantiate services rendered and to ensure that charges are warranted in a way that meets revenue authority requirements.
Engel agrees that taxpayers must assemble their transfer pricing in full before filing tax returns. These documents must be kept and ready to be submitted when Sars requests information. If they are not ready or complete, it may raise suspicion about the accuracy of previous tax returns that were based on them.
“Unfortunately, transfer pricing documents are dense and not for the faint-hearted. Yet it must be done as an essential part of cross-border tax risk management,” he says.
“This is just not a Sars thing – it is the new global standard.”