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Transfer pricing poses a reputational risk for multinational enterprises

Johannesburg, 17 July 2013 - On 13 February 2013, the OECD published a report which presented studies and data regarding the existence and extent of base erosion and profit shifting (BEPS). The report provided an overview of global developments that have an impact on corporate tax matters in moves to ensure that enterprises pay their “fair share” of taxes.

Professional services firm Deloitte cautions that the developments regarding transfer pricing (TP), and BEPS in particular, are of special significance to businesses operating in South Africa. While BEPS strategies are generally not illegal, they tend to exploit inconsistencies in tax law to shift profits from locations where the activity actually takes place to locations where the tax regime is more favourable. The inconsistencies largely occur because global tax legislation has lagged the changes in the business environment, specifically, the dramatically higher cross-border transactions and the rising importance of intangibles. The current discussion is unprecedented since behaviour by multinationals, which in most cases is clearly within the boundaries of the law, is measured against standards of ethics and morals.

“The issue has been provoked by concerns regarding the fairness and equity of the extent to which multinationals, in particular, are paying tax,” explains Deloitte international TP expert, Dr Heinz-Klaus Kroppen. “There is a perception that some corporates are paying too little tax and this has led to fears that this would undermine voluntary compliance by others.”

“The fear of business is that the current debate will lead to legislators enacting unilateral measures to counter what they perceive as unethical tax behaviour. Such unilateral measures have a large risk of creating double taxation because they are not reconciled with the laws and measures of other jurisdictions,” adds Dr Kroppen.

In addition to the current ideas being discussed are the following issues:

  • Tightening the rules for the attribution of income from intangibles;
  • Introducing restrictions on the deductability of royalties (royalty barriers) and withholding tax on royalties;
  • Taxation of digital activity without a permanent establishment;
  • Introducing measures against hybrid structures; and
  • Base taxation on access to market instead of value created within a market.

“With an open economy, global trends impact on South African multinationals and clearly multinational enterprises (MNEs) operating in South Africa will be subjected to the SA tax regime,” notes Deloitte SA TP Leader, Billy Joubert. “In particular, some BEPS related principles are being included in draft South African tax law. Even the wording of the OECD document has crept into the SA draft bill, with the issue of excessive debt being tackled in the legislation.”

One of the points currently being discussed is whether the traditional ways of doing transfer pricing – including the arm’s length principle itself – need to be completely overhauled and replaced with a new methodology. One option that has been put forward is the so-called formulary apportionment approach – involving the mechanical application of a formula for attribution of profits along the value chain (from R&D to manufacturing to distribution etc). However, it seems unlikely that agreement will ever be reached in relation to the elements of such a formula. For example, a country with a labour intensive environment  like China is likely to favour a head count methodology whereas this would clearly not suit a country where wages are higher and industry relies more heavily on technology.

“In South Africa, and globally, the ‘arm’s length principle’ has always been the cornerstone of transfer pricing,” adds Joubert. “We believe that, if applied properly, this approach would be sufficient to tackle the problem. There may sometimes be difficulties with applying the arm’s length principle – for example, the service rendered does not exist on the open market, as can be the case when a head office provides a service to a branch – but by probing a bit deeper, a solution can be found.”

For MNEs operating in Africa, there is added pressure from the strong perception on the continent that profit shifting practices by multinationals are eroding the tax base in developing countries. This issue has also been taken up by NGOs and the African Tax Administration Forum (ATAF).

Transfer pricing is a definite area of reputational risk for multinationals. A number of high profile cases have been in the media, both in South Africa and globally, which serve to highlight the possible risks for corporates and the need for them to monitor and understand global trends in tax reform.

With the strong African footprint that Deloitte has and the work which the firm has already completed in Africa, the firm is in a unique position to inform and debate the issues surrounding TP and BEPS.

Notes to editor:

Additional TP and BEPS information:

  • The OECD report called for the development of a comprehensive action plan to eliminate the loopholes which allow companies to pay little or no taxes through:

    • identifying actions needed to address BEPS,
    • setting deadlines to implement these actions and
    • identifying the resources needed and the methodology to implement these actions.
  • Although not included in the 34 OECD member countries, South Africa has observer status at the OECD and is a G20 nation. The two bodies are working in concert to upgrade tax systems to suit a globalised world. South Africa has observer status in the work of the Committee of Fiscal Affairs (CFA) and has close ties with the management and staff of the Centre for Tax Policy and Administration (CTPA).

  • 120 jurisdictions are already exchanging tax information on request, based on more than 1000 agreements signed in the last few years. Four years ago there were only 50.

  • African Tax Administration Forum (ATAF), the pan-African tax authority body, has developed a multilateral tax treaty which will allow African countries to work together to investigate the tax affairs of MNEs operating across the continent.

  • On 4 July, the 2013 draft Taxation Laws Amendment Bill and the Tax Administration Laws Amendment Bill were published and public comments may be submitted until 5 August 2013.

  • Formulary apportionment is a method of allocating the profit or loss of a corporate entity between different national tax jurisdictions.

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