Inside Tax : Issue 16 - Transfer pricing schemes and the use of tax havens
Is the future looking good?
The expression “tax haven” describes a country or territory that offers foreign individuals and businesses little or no tax liability. Tax havens do not require that an individual reside in or a business operate within that country in order to benefit from its tax policies. The relevance of the “tax haven” in the transfer pricing scheme is twofold. First is that the jurisdiction exposes the entity to little or no tax liability. Second is that tax havens provide little or no financial information to foreign tax authorities.
For instance, company 'A' located in Country 'A' with a company income tax (CIT) rate of 30% has a subsidiary, company 'AB' in country 'B', which is a tax haven with a company income tax rate of 5%. Prices for transactions between these two entities may be so manipulated that the income of Company A (CIT of 30%) is relatively low, and income of Company AB (CIT of 5%) is relatively high. The end intention may be that a small income is exposed to a high tax rate in country 'A' while high income is exposed to low tax rate in country 'B'.
Where the operations of multinational companies/enterprises are concerned, the threat of transfer pricing is the potential to shift profits from a high tax jurisdiction to a low or no tax jurisdiction across several locations with a view to managing the Group's effective tax exposure.
It would also be most simplistic to assume that there is no design to a transfer pricing scheme which traverses several jurisdictions and borders, with the transactions that occur in Nigeria only representing an insignificant point in the larger scheme. As far as such a scheme is concerned, the intent may be for those transactions, which occur in Nigeria to satisfy arm's length requirements in Nigeria even though the benefit of the transactions accrue elsewhere.
Whilst the TP regulations appear all encompassing, the reality is that the Nigerian tax authorities would need greater collaboration with other tax jurisdictions and authorities to unravel complex transfer mis-pricing structures and schemes involving multinational groups with Nigerian affiliates or related parties. The concept of tax havens may appear on the surface to represent only low tax jurisdictions but it may also come in other forms such as tax holidays for local groups or other tax regimes (such as personal income tax at lower rate) even within individual companies.
The story of Radamel Falcao illustrates the impact of tax haven at personal income tax level. The Colombian striker recently transferred his services from Atletico Madrid to AS Monaco whilst turning down offers from top clubs in England and Spain. As far as recent history is concerned, AS Monaco is not a top team in Europe. The club was only runner-up in the 2004 European Champions League final. However, Monaco is a tax haven for foreigners and for Falcao, his 14 million euros earnings per annum (approximately 270,000 euros per week) would not be subjected to tax in Monaco.
The following developments in the international space provides optimism that the end may be in sight for capital flight or tax revenue losses/leakages that once appeared intractable due to transfer mis-pricing arrangements:
- Increased awareness and discussion of the effect of transfer mis-pricing in MNCs operations and its dominance on the agenda of Organization for Economic Cooperation and Development (OECD), G8 and G20 countries. The theme of the recently concluded G8 summit was 'Tax Evasion and Transparency'. It was reported that agreements were reached on curbing global tax evasion and data sharing, shell companies would now be required to disclose their owners. Corporate and individual tax information would be automatically shared so as to detect fraud and tax evasion. The time may now have come for “tax havens” to shift focus to other areas for revenue.
- Recent release of OECD's Action Plan on Base Erosion and Profit Shifting, aimed at preventing artificial avoidance of Permanent Establishment (PE) or taxable presence by MNCs and ensuring that transfer pricing results between related parties are in line with economic value creation.
- Increasing conclusion of Tax Information Exchange Agreements (TIEAs) and Mutual Legal Assistance Treaties (MLAT) between countries, which provide foreign governments
with confidential information about investors' offshore accounts.
- Increasing momentum around establishing full inclusion mechanisms in countries international tax laws, as against the current prevailing territorial tax systems. This entails a framework that will ensure a group's global income is taxed in its home country, that is, there will be no more room for shifting income for tax purposes. This would surely have its challenges, but then this is equally another step towards checking the adverse consequences of transfer mis-pricing. Most MNC/MNEs now consider Africa and especially Nigeria as a “priority market”. The tax authorities must therefore ramp up their efforts at ensuring that there is a vast network of TIEAS and MLATs that can be leveraged whenever complex transfer pricing schemes come up for evaluation.