What Is Transfer Pricing?
The transfer pricing is one of the most important issues in international tax. Transfer pricing refers to the rules, regulations, and methods prescribed by law for the pricing of transactions of goods, services, tangible and intangible assets within or between enterprises/corporates under common ownership or control. When independent parties deal with each other, independent market forces shape the commercial pricing of goods, services, and intangibles transacted between them. However, business transactions between associates may not always reflect the dynamics of market forces.
Due to the potential cross-border international controlled transactions carried out by corporations that can distort taxable income, for the purpose of taking advantage of the tax regulations in different countries. Moreover, the adjustment in the intragroup transfer prices within the corporate organization in multiple countries causes the prices to differ thereby reducing the sizable corporate tax risks.
At the same time, the transfer pricing is sometimes imprecisely portrayed as tax avoidance practice or technique, whereas the term “Transfer Pricing” refers to a set of substantive and administrative regulatory requirements imposed by the governments on certain corporate players.
For example: If a parent company transfers/sells goods & services to a subsidiary it is called downward transfer pricing, while a subsidiary division transfers/sells goods & services to parent company it is called upward transfer pricing.
Arm’s Length Principle (ALP)
The arm’s length principle is an internationally accepted & preferred basis for determining the transfer price of a transaction between associated parties, it commonly comes to play while the corporation deals with tax authorities on income tax regulations. An arm’s length transactions are the one in which the buyers and sellers of a product act independently and do not have any relationship to each other. The transactions based on the concept of an arm’s length principle “assures that both the parties in the deal are acting in their own self-interest and are or subjected to any pressure or duress from the other party, it also assures third parties that there is no collusion between the buyer and seller.”
New Transfer Pricing Regulations in Tanzania
The Government of Tanzania in East Africa has revamped its income tax regulations, that now comprise additional transfer pricing rules and requirements that were not included in the previous regulations, such as the introduction of transfer pricing following “arm’s length character of the controlled transaction” documentation filing obligation for taxpayers with related party transactions exceeding 10 billion TZS (Tanzanian Shillings) in a taxable year. The transfer pricing published by the tax administration in November 2018 revokes and replaces the previous income tax (transfer pricing) regulations of 2014.
Taxpayers that do not reach the TZS10 billion threshold do not have to submit the contemporaneous transfer pricing documentation to the Tanzania Revenue Authority (TRA) but must have it in place by the due date for fling the corporate income tax return for that year. Upon request, the transfer pricing documentation should be submitted to the TRA within 30 days.
The Regulations provide an overview of all information that should be contained in the contemporaneous transfer pricing documentation to support the arm’s-length character of the controlled transactions. For example, taxpayers must provide the actual computational workings that were prepared when determining the transfer prices of the controlled transaction. Further, the Regulations grant the Commissioner wide power to request by notice in writing from a person, whether or not liable to tax, to provide “any other information.”
Information for a Tested Party outside Tanzania
An entity outside Tanzania can be used as a tested party only if all relevant information, including financial statements of that person, is provided. Intragroup services and financing The Regulations provide requirements regarding the acceptability of allocation keys used when non-directly allocable services are performed for various related parties. In general, allocation keys should be acceptable, provided they are measurable and relevant for the type of service (e.g., number of computers for IT, number of cars for vehicle ﬂeet management, number of employees for HR).
Intragroup Services and Financing
The Regulations provide requirements regarding the acceptability of allocation keys used when non-directly allocable services are performed for various related parties. In general, allocation keys should be acceptable, provided they are measurable and relevant for the type of service (e.g., number of computers for IT, number of cars for vehicle fleet management, number of employees for HR).
Intangible Property and Sale Lease Back
The owner of a locally developed intangible that is transferred outside Tanzania should be compensated appropriately at the time of the transfer. Importantly, the Regulations provide that such an intangible cannot attract a royalty when licensed back for use in Tanzania.
Controlled commodity transactions should be priced using the comparable uncontrolled price (CUP) method. The quoted spot rates may be used as a benchmark to determine the arm’s length price for a controlled commodity transaction. The quoted spot prices can be obtained from a domestic or international commodity exchange market. If the price agreed between associates is higher than the quoted spot price, the agreed price shall be considered as the sale price.
The Regulations list the factors that should be considered when determining whether transactions are comparable. Further, the Regulations confirm that where domestic comparable data cannot be obtained, external comparable data may be used.
The Regulations stipulate that where four or less comparable data points are used, the average is the arm’s-length result, while in the case of more than four comparable data points, the arm’s-length result shall be the data point between the 35th percentile and 60th percentile. If the result falls outside the arm’s-length range, the price should be adjusted to the median point of the range.
Penalty for Non-Compliance
The currency point system is introduced to determine the penalty for taxpayers that fail to comply with the transfer pricing regulations. The penalty is set at a minimum of 3,500 currency points as prescribed from time to time by the Commissioner (currently 1 currency point = TZS 15,000) which results in a penalty of TZS52,500,000 (i.e., approximately US$23,000). This penalty is in addition to a possible penalty of 100% of the adjusted amount that is applicable for failure to comply with the arm’s-length principle when transacting with associates.
Benefits of Transfer Pricing in Taxation
The transfer pricing is probably the most important considerations for most of the MNC’s which operate internationally as the international corporate taxation across countries will impact the purchasing behavior of subsidiaries with tax implications for the corporate organization as a whole.
Tax laws and regulations throughout the world are designed to treat the results of a internal as well as cross-border transactions differently when parties are dealing when buyer & seller parties are dealing at arm’s length and when they are not. Similarly, the international sales between non-arm’s length companies, like two subsidiaries of the same parent company, must also be made for arm’s length prices to assure that each country collects the appropriate taxes on the transactions carried out with foreign countries.
- Helps in the coordination of divisional objectives
- Divisional performance made easier
- Information to the top-level management in making policy decisions
- Planned allocation of company’s financial resources
- Facilitates legal transactions internationally
- Long-term benefits, increases competition and maintains economy
The transfer pricing is created based upon the:
- Legal entity risk distribution
- Types of services performed by the subsidiary
- Comparable transactions in an uncontrolled environment between two unrelated parties (i.e., related parties arm’s length transactions)
- Stage of the contemporaneous documentation in parent and subsidiary
While the transfer pricing in itself is not illegal or destructive but it causes the manipulation or abusive transfer pricing in which trade mispricing, including re-invoicing, and other devious activities are carried-out to financially mask the irregularities.
It is estimated that about 60% of the international trade occurs within, rather than between, MNC, conglomerates, and corporates across national boundaries but within a same corporate group. For this reason, the governments across the world lose huge amounts of tax revenue which is several billion dollars annually which severely affects the ability of the government to excise its operations. Hence, the governments of each and every nation have formed their own forms of corporate law through which the transfer pricing is regulated with measures specifically made for the country’s economic scenario and trade partners.
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