By: Peter Kelly AGBEEHIA
In Africa, transfer pricing has come to stay in so far as multinationals continue to do business in Africa and their constituent entities continue to trade between and amongst themselves.
Many African countries are rapidly adopting transfer pricing legislation. While some countries have adopted the provisions of the OECD Guidelines, the UN Practical Manual on Transfer Pricing and the framework set out by the ATAF on wholesale basis, others have also adopted a phased approach with a view to assessing the global terrain and seeing which aspects of TP legislation and best practices they can adopt at each point in time to suit their own circumstances.
Others also do not have copious TP legislation in place but their Income Tax Legislation somewhat stresses on the application of the arm’s length principle and other anti-avoidance rules.
For example, Ghana, Nigeria, Kenya and South Africa have more detailed transfer pricing legislation in place which broadly align with the OECD Transfer Pricing Guidelines whereas Mauritius does not have any copious TP legislation in place. Its Income Tax Act only stresses on the application of the arm’s length principle.
This write-up identifies the key elements you will see in transfer pricing legislation across Africa, the key transfer pricing risks businesses face and how they can have a smooth sail if they decide to “fulfil all righteousness.”
What you’ll generally see in TP Legislation across Africa
- The arm’s length principle: In all legislations I have come across, you will see explicitly the insistence on the application of the arm’s length principle to controlled transactions or transactions between constituent entities of a multinational group. The arm’s length principle simply means when constituent entities of a multinational group or persons within the scope of transfer pricing rules are operating, they are not supposed to allow their existing relationship or other familiar ties to influence the prices they charge and other terms of the arrangement. They are required to conduct business like any independent person will do. In Ghana and South Africa, the application of the arm’s length principle is found in section 31 of both Ghana’s and South Africa’s Income Tax Acts.
- Comparability analysis: There should be a yardstick for measuring whether related party transactions comply with the arm’s length principle. To determine this, the prices and terms of the arrangement between the constituent entities of a multinational group must be measured with prices and terms of similar arrangements between unrelated independent companies (“Comparables”). In performing this analysis, several factors (“Comparability factors”) come to play. This include analyzing legal agreements and contractual terms to see whether the terms reflect commercial terms; analyzing the functions performed, the assets deployed and the risks assumed (supported by a value-chain analysis) in the related party arrangement to identify the level of compensation due the parties; analyzing the characteristics of the property being transferred in the related party arrangement to see the relative value and importance of the asset and what must be received for its use; analyzing the economic circumstances under which the related party arrangement occurred and how specific market and industry factors impact the terms of the arrangement; and examining the business strategies pursued by the related parties to see if, for example, an entry or penetration strategy adopted by MNE necessitates lower pricing from the market norm.
- Persons falling within the scope of TP: TP rules generally apply to associated enterprises and connected persons. The definition of associated enterprises is sometimes very wide and stretched and, in some jurisdictions, covers persons in low tax jurisdictions and other preferential tax regimes as in the case of Kenya’s TP legislation. Associated enterprises are generally defined by relevant shareholding percentage or some level of financial control and influence one entity has in, or wields over, the other as in the case of Ghana and South Africa.
- Controlled/covered transaction types: Controlled transactions are transactions between persons who are related with respect to each other. In Zimbabwe, for instance, a controlled transaction is defined as an operation or scheme with an associated person. Covered transactions are controlled transaction in scope for TP analysis for a particular financial period and for which a transfer pricing analysis is required. Controlled/ Covered Transactions can be transactions between a parent company and its subsidiaries, branches and affiliates.
Controlled/covered transactions will usually include the rendering of services (either strategic or routine), purchase or distribution of goods, manufacturing, the development and exploitation of significant intangible assets, financial transactions and joint arrangements that may allow constituent entities to contribute to execute a particular project and split profits or revenues per their respective market positions and create a balancing charge where the contribution falls short of an arm’s length contribution.
Mauritius, for instance, is considered a key hub for financial transaction flows, the concentration of significant intangibles and the protection of significant trade assets.
It is also important to note that in certain jurisdictions in Africa like Zimbabwe, transfer pricing applies to both inbound (i.e transactions between two resident entities who are related) and outbound transactions with associated persons.
- Transaction thresholds and safe habour rules: Transaction thresholds usually serve as the basis for preparing various transfer pricing documents. Sometimes, related party transaction(s) may not meet the prescribed thresholds but TP laws may require only a high-level analysis, disclosure and compliance with the arm’s length principle and not a detailed TP documentation justifying the arm’s length nature of the transaction (“Safe Habour Rules”). Sometimes also, a simple disclosure of such transactions in transfer pricing or corporate income tax returns will suffice.
In Ghana, a Local File and Master File ought to be prepared and filed within four months after the relevant financial year where the related party transactions (whether one or in aggregate) exceeds the Ghana Cedi equivalent of two hundred thousand United States Dollars.
In South Africa, if a taxpayer’s potentially affected transactions for the year of assessment (without offsetting) exceed or are reasonably expected to exceed ZAR 100 million, a Local File and Master File must be prepared and filed with the South African Revenue Service (SARS) within 12 months from the date of the relevant financial year end (with the annual tax return) to support its TP position.
In addition to meeting the ZAR 100 million threshold, an entity in SA is required to submit a Master File only if it is an Ultimate Parent already resident in SA or if another entity which is a member of the Group already has the Master File.
Furthermore, in respect of each transaction that exceeds or is reasonably expected to exceed ZAR 5 million but not ZAR 100 million, the Local File and Master File must only be prepared and retained by the taxpayer pending any request by SARS.
- Types of Transfer Pricing documents required: Many jurisdicitions in Africa prescribe in their TP legislation a three-tier documentation which includes a local file, master file and country-by-country report. In addition to the transfer pricing documents, a transfer pricing return may be filed or declarations made in corporate income tax returns. The three-tier documentation is consistent with the OECD Transfer Pricing Guidelines.
Due to the huge compliance burden imposed on businesses, some countries in Africa have not adopted regulations for preparing country-by-country reports and other countries either require the preparation of a country-by-country report only or only the preparation of Local File and Master File.
For example, Botswana and Uganda have not yet adopted Country-by-Country Reports whereas Mauritius has adopted Country-by-Country Reporting for Multinational Enterprises (‘MNE’) with an annual consolidated group revenue of or exceeding EUR 750 million.
The CbCR reports are required to be filed by MNEs having their Ultimate Parent Entity (‘UPE’) or Surrogate Parent Entity (‘SPE’) in Mauritius.
Also, in countries such as Tanzania, Kenya and Zambia, the TP documents are to be prepared and only to be submitted to the relevant tax authorities upon written request.
Usually, taxpayers are allowed to prepare and retain TP documents and only submit them upon request when the intercompany transactions are considered not to be of significant values.
For example, in South Africa, a retention requirement is imposed in respect of each transaction that exceeds or is reasonably expected to exceed ZAR 5 million but not ZAR 100 million.
- Transfer pricing methodologies: Most TP laws across Africa resonate with the five OECD TP Methods. The most appropriate pricing method should be selected on a transaction-by-transaction basis, providing the most reliable measure of an arm’s length result in each case.The TP methods can be broadly classified into two: The Traditional Transaction Methods [1] which include the Comparable Uncontrolled Price Method (CUP), the Resale Price Method (RPM) and the Cost-Plus Method (CPM) as well as the Transactional Profit Methods [2] which include the Transactional Net Margin Method (TNMM) and the Profit-Split Method (PSM).
In recent times, the TNMM has assumed wider usage due to its robustness, suitability for common types of transactions such as services, distribution of goods, manufacturing as well as its ability to test the arm’s length results on a full-entity basis.
In Ghana, regulation 4 and 5 of the TP Regulation embraces the five TP methods and considers the factors necessary for choosing an appropriate transfer pricing method.
- Penalties for wrong declarations and filings: Penalties apply for wrong declarations and late filing of transfer pricing documents. For example, in Botswana, penalties apply up to 200percent of the additional tax arising from a transfer pricing adjustment or a fine of BWP10,000 whichever is greater. Penalties of up to BWP 500,000 also apply for failure to submit transfer pricing documentation and the penalties may be reduced to an amount of not less than BWP 250,000.
Also, in Ghana, failure to prepare and submit the required documentation will attract a penalty of GH¢500.00 plus GH¢10.00 each day as long as the failure continues.
Transactions not conducted at arm’s length will lead to an adjustment by the Commissioner General as per section 39 of the Revenue Administration Act (RAA) and the taxpayer shall have thirty days, from the date on which the notice of assessment is served, to make up for the tax shortfall and any interest thereon.
A tax shortfall attracts interest at 125percent of the Bank of Ghana Monetary Policy Rate (Statutory rate), compounded monthly.
In some African jurisdictions, the sanctions for wrong declarations and filings are grave. For example, in Uganda, non-compliance with the arm’s length principle may lead to a conviction and imprisonment for a term not exceeding 6 months or a fine not exceeding 25 currency points.
- Dispute Resolution, Mutual Agreement Procedures (MAP) and Advanced Pricing Arrangements (APAs): MAP is a process which allows competent authorities to interact with the intent to resolve international tax disputes involving cases of double taxation (juridical and economic) as well as inconsistencies in the interpretation and application of a double tax convention. The objective of the MAP process is to negotiate an arm’s length position that is acceptable to both tax authorities and seek to avoid double taxation for taxpayers. Taxpayers have a right to enter the MAP process for transfer pricing disputes (but only where a DTA provides for such). In Nigeria’s Transfer Pricing laws, there are administrative or internal procedures as well as MAP for the resolution of transfer pricing disputes.
An APA is an arrangement that determines, in advance of controlled transactions, an appropriate set of criteria for the determination of the transfer pricing for those transactions over a fixed period of time. APAs prevent transfer pricing disputes since they serve as a proactive approach to agree transfer prices with the relevant tax authorities.
APAs are not yet common or effective in many African countries. For example, Ghana and several other African countries do not have an APA in place. In South Africa, APA is still a work-in-progress since the proposal for its introduction in the year 2023. Nigeria, on the other hand, has an APA in place pursuant to Regulation 9(12) of the Income Tax (Transfer Pricing) Regulations 2018.
The Dos and Don’ts
Unsound TP practices can land you into trouble with the tax authorities! The exposures stem from areas such as old and dusty legal agreements which have not been updated to reflect current transfer pricing policies; legal agreements which do not in fact represent the actual TP practices of the entities concerned; wrong functional characterization of entities and the misapplication of transfer pricing methods and policies.
An economic analysis and benchmarking studies which is not robust enough to support pricing policies of the entities concerned can also lead to transfer pricing adjustments. For example, In Ghana, section 15 of the Transfer Pricing Regulations allows the Commissioner General to adjust the chargeable income of persons where it is believed that the transactions were not conducted at arm’s length.
Transactions involving valuable intangibles and high- value financial transactions have also come under serious scrutiny in recent times as non-arm’s length interest charges and royalty charges/license fees have far-reaching impact on taxable bases.
For example, in the case of Innodis Ltd and the Assessment Review Committee (ARC), where the appellant appealed to the Supreme Court in respect of the application of the arm’s length test on domestic companies and deemed interest on interest-free loans, the Supreme Court upheld the application of arm’s length test on domestic companies and deemed interest on interest free loans.
Also, in Mauritius vs Avago Technologies Trading Ltd, where the issue was whether or not the royalty payments made by Avago to GEN IP were at arm’s length, the tax authorities determined that the payments were not at arm’s length and issued an assessment of additional taxable income.
In order to determine the arm’s length royalty payments, the tax authorities disregarded the Transactional Net Margin Method (TNMM) used by Avago and instead used the CUP method. The Assessment Review Committee on appeal upheld the tax assessment and dismissed Avago’s complaint.
Other factors that can lead to TP exposure include low remuneration for entities having significant people function, housing core assets of the group, assuming more risks and negotiating and concluding key intra-group arrangements.
Lastly, wrong declarations, late filings, consistent loss-making positions and the absence of contemporaneous documentation to support intercompany transactions are key TP audit triggers. To mitigate the risks, entities must reverse the trend and ingrain sound TP practices and policies in their daily operations.
A broad risk-based approach is required by realigning the functional profiles of entities within the multinational group as well as the transfer pricing policies for key intercompany transactions in line with the arm’s length standard.
Conclusion
Transfer pricing has become a crucial aspect of tax compliance for multinationals operating in Africa, with many countries adopting regulations aligned with OECD and UN guidelines.
The arm’s length principle remains the foundation of these regulations, ensuring fair pricing in intercompany transactions. Businesses must be aware of the complexities surrounding documentation requirements, penalties, and dispute resolution mechanisms to avoid costly adjustments.
Sound transfer pricing policies, supported by robust functional and economic analyses, are essential for managing tax risks. Common pitfalls include outdated agreements, misapplied pricing methods and policies, and insufficient documentation.
To navigate these challenges, companies must adopt proactive, risk-based transfer pricing strategies. By doing so, they can ensure compliance, mitigate disputes, and maintain tax efficiency across jurisdictions.
>>>the writer is an Independent Consultant in Ghana with extensive experience in Transfer Pricing, Taxation and Business Regulation. He has Certification in Rethinking International Tax Law; a course jointly sponsored by Coursera and the University of Leiden, Netherlands.
Peter also holds a Bachelor of Commerce (B.COM Accounting) Degree from the University of Cape Coast, Ghana and studied essential courses such as Company Law, Commercial Law, Contract Law, Law of Taxation, Law of Natural Resources, Tort Law, Criminal Law, Ghana’s Legal System and Constitutional Law in his Post First Degree Law Programme.
In his capacity as a consultant, Peter has advised clients on various company law provisions they need to comply with (especially with the promulgation of Ghana’s new Companies Act, Act 992 of 2019) and has been performing other compliance reviews in the form of Tax Health Checks, Tax Audit Support and Company Law Compliance Audits. Peter has a thorough understanding of the Company Laws of Ghana and other laws affecting business. He has also acted as a Company Secretary for companies engaged in Real Estate, Marketing Consultancy and Events Management, Utilities and Medical Supplies.
Overall, Peter has cross-sector experience working for clients in the areas of Mining, Petroleum Sub-contracting Services, Telecommunications, Financial Technology (FinTech), Education Technology (EdTech), Engineering Consultancy, Labor Sourcing, FMCG, Maritime, Manufacturing, Renewable Energy, Utilities and Not-for-profit Causes. If you found this article useful and would like to discuss further, kindly reach out to the author via [email protected]
