Common transactions with transfer pricing risk in Africa

January 2020 | EXPERT BRIEFING | CORPORATE TAX

financierworldwide.com

There has been mounting pressure on the tax authorities in Africa to increase tax revenue to meet domestic development needs. In a bid to meet the ambitious revenue target set by many African governments, transfer pricing has been identified as an additional source of revenue. To this end, there has been an aggressive tax drive by African tax authorities focused primarily on transfer pricing reviews. Certain transactions which were previously considered low risk have begun to attract the attention of tax authorities.

Management fees

Most multinationals (MNEs) operating in Africa have service level agreements (SLA) for recovering the cost of centrally managed processes. The services are provided centrally for the benefit of the entire group. Some of these services include, but are not limited to, corporate strategy, human resources, strategic finance planning, treasury and information technology (IT). Accordingly, tax authorities in the jurisdiction in which MNEs are headquartered expect most of these costs to be charged out to the beneficiaries of the services. There is an increasing case of denial of tax deduction for these costs as the Africa tax authorities increase their scrutiny of such costs.

Management fees were previously considered tax deductible if considered reasonable. However, recently African tax authorities have sought to perform more reviews of transactions from an economic substance perspective. The local subsidiary of an MNE is now often required to justify how management fees contribute to the growth of revenue for the local affiliate, and also that the local company will be willing to pay for a similar service if provided by an unrelated service provider. Once the justification has been provided, the local company is required to show evidence that the services stated in the invoice were provided before consideration of the reasonableness of the pricing.

It is important that management fees charged to a local subsidiary in Africa are consistent with the contract terms and conditions. Furthermore, management services rendered should be evidenced by relevant documentation such as emails, memos and the minutes of the meeting.

Financing transactions

There is a greater focus on intercompany financing transactions, especially if provided by a non-financial entity. Thin capitalisation rules are on the increase and more African tax authorities are seeking to recharacterise debt to equity. This is to forestall tax deduction of the interest expense. In addition, the foreign exchange regimes in most African countries make it difficult to repay loans and interest. Mozambique for example does not grant deductions anymore for interest on shareholder loans.

Procurement services

The procurement function has taken a strategic cost leadership position that supports the value proposition and competitive advantage of MNEs. Over the years, the procurement department has moved from requiring core competencies in strategic sourcing and commodity management to demanding advanced capabilities in risk management, global supply and business outsourcing. Today’s procurement function has succeeded in becoming an important internal stakeholder driving value to the business.

With these developments, tax authorities in Africa are increasingly seeking to consider this a value-adding activity that involves the local subsidiary. As such, there has been increased scrutiny of the basis for the pricing based on the type of procurement services rendered. For instance, those considered pure service provision involving sourcing, purchasing and distribution functions will be priced differently from a ‘buy-sell’ procurement where the provider of the service bears the risk of the goods purchased. For example, the Federal Inland Revenue Service in Nigeria will request allocation keys, evidence of the procured services, the form of procurement services rendered and where the risk lies in determining the transfer pricing methodology. The days of accepting blanket transfer pricing methodology seems to be over in Africa, with increasing queries on the type of pricing methodology selected by taxpayers.

MNEs operating in Africa are encouraged to assess transactions and track appropriate documentation to support and justify their dealings. Further, MNEs’ transfer pricing files should properly document the nature of the transactions, vis-à-vis the intercompany agreements, to ensure consistency in documentation and practice.

The tax departments of MNEs should also pay attention to where a function creates a lot of synergies with a view to plan and mitigate any unplanned transfer pricing exposure. It should also be noted that transfer pricing dispute resolution mechanisms are still in their infancy in Africa. It is important, therefore, to prevent avoidable transfer pricing disputes by tracking transfer pricing legislation and ensuring full compliance.

Sebastine Odimma is the Africa head of tax controversy at MAERSK. He can be contacted on +2348 18793 9272 or by email: sebastine.odimma@maersk.com.

Sebastine Odimma

MAERSK