Resolving African Challenges in Transfer Pricing

ATAF makes critical contribution to affect global tax standards

The Organisation for Economic Cooperation and Development (OECD) Working Party 6 held a meeting on Transfer Pricing in November 2017 in Paris, France. Two delegates from the ATAF Cross Border Taxation Technical Committee, Matthew Gbonjubola (Nigeria) and William Nkitseng (Botswana), supported by Tracey Brooks, Technical Adviser on International Taxation of the ATAF Secretariat, attended to make contributions from an African perspective.

The meeting discussed the public consultation held by Working Party 6 on two issues that are key to protecting the tax base of developing countries from tax avoidance strategies used by some multinational enterprise taxpayers. These issues, reported on by ATAF members, include:

• Additional guidance on the attribution of profits to a permanent establishment; and
• Revised guidance on the use of the profit split method for transfer pricing purposes.

The attribution of profits to a permanent establishment

Many multinationals do business in African countries without forming a company or other legal entity. To tax the profits of those business activities, the country must have domestic tax legislation in place that enables it to tax the profits. It should be noted that such domestic taxing rights may be restricted if there is an applicable tax treaty depending upon the wording of that treaty. In many cases, a country’s domestic legislation mirrors the wording of its treaties.

The ATAF, OECD and UN Model Tax Conventions all address this issue. It states that the country in which the business activities are carried out, may tax the profits of those business activities by the non-resident entity if those activities constitute a permanent establishment (PE). If the country has the appropriate PE legislation and the tax administration can establish that a PE of the non-resident entity exists in its country, then it can tax that part of the profits of the non-resident entity attributable to the PE.

If a PE is identified in an African country and it has domestic legislation to tax the profits of the PE, the next step is to determine how much of the non-resident entity’s profits should be attributed to the PE. This is one of the most complex issue in international tax matters and there is no standard methodological approach used by all countries and no standard approach by all African countries.

“Many African countries have reported that transfer pricing is one of the most significant risks to their tax base.”

Some countries, such as OECD countries, apply the Authorised OECD Approach (AOA) for attributing profits to PEs. However, it is reported that this is not the approach taken by many other countries and some ATAF members have reported it is not the approach taken in their country. It should be noted that the approach taken to attributing such profits will be governed by the domestic law of the country and any applicable tax treaty.

The additional guidance on the attribution of profits to a PE drafted by Working Party 6 did not, in the opinion of the Technical Committee, adequately acknowledge that many countries do not apply the AOA.

Following intensive negotiations at the Working Party 6 meeting, the ATAF delegates were successful in having additional text included in the guidance that stated that it should be noted that many tax treaties contain a version of Article 7 that does not require the use of the AOA. In cases governed by those treaties, the method of attributing profits to a PE for the purpose of Article 7 of the applicable treaty might differ significantly from the AOA.

Matthew Gbonjubola of Nigeria’s Federal Inland Revenue Service and the chair of the ATAF’s Technical Committee, explained that, “The majority of countries in the world, and particularly in Africa, do not follow the AOA. However, guidance produced by the OECD is increasingly being viewed by business as the standard to be applied in all countries around the world. It is therefore crucial that ATAF has achieved this outcome of ensuring the new guidance reflects the different approaches countries use on attribution of profits. This gives the guidance broader acceptance among tax jurisdictions around the world, including in Africa. So it is a positive outcome for both ATAF and OECD members.”

The use of the profit split method for transfer pricing purposes

Many African countries have reported that transfer pricing is one of the most significant risks to their tax base. Almost all such countries report that they use the global standard of the arm’s length principle to address transfer pricing risk and broadly follow the guidance set out in the OECD Transfer Pricing Guidelines (Guidelines).

The Guidelines prescribed five methods for determining the arm’s length price. One of which is the profit split method. In 2016, Working Party 6 commenced work on revising the guidance on the application of the profit split method to clarify and strengthen the Guidelines.

ATAF members have stated that they find it difficult to apply the current guidance on profit splits and that this, in their view, often leads to the African taxpayers only being allocated a routine return in its taxable profits and all of the residual profit, often referred to as economic rent or super profit, is allocated to the other party to the transaction which is located in a foreign, often low tax, jurisdiction.

“…for the first time in the 22 year history of the OECD Transfer Pricing Guidelines, there will be an African-based example.”

Clearer and stronger guidance on this issue will assist African tax administrations to ensure that in appropriate circumstances the profit split method is applied to transactions and the appropriate amount of the residual profit is included in the taxable income of the African taxpayer.

The draft revised guidance included a number of examples designed to provide illustrations of when it might be appropriate to use the profit split method and when it might not be appropriate. ATAF’s Technical Committee was concerned at the lack of examples that reflected the types of transactions seen in African countries and that this limited the value of the examples to ATAF members. The Technical Committee therefore submitted an example that was more typical in Africa where the African taxpayer is providing in the transaction a unique and valuable contribution relating to the exploitation of natural resources in the African country.

Following the ATAF delegation’s explanations of how the exploitation is a unique and valuable contribution that creates at least some of the residual profit they were successful in persuading WP6 to include this example in the revised guidance. This is a very significant moment for transfer pricing in Africa as for the first time in the 22 year history of the OECD Transfer Pricing Guidelines, there will be an African-based example.

William Nkitseng, ATAF delegate and also from the Botswana Unified Revenue Service, said, “We are delighted that after much discussion, Working Party 6 has agreed to include this example in the Transfer Pricing Guidelines. The example illustrates the value that the natural resources of Africa bring to the profits of multinational enterprises operating in African countries and will assist tax administrations to ensure that the right amount of profits is included in the taxable income of the African taxpayer. This success demonstrates the impact ATAF is having in bringing the African perspective into the global tax agenda and ensuring the global standards meet the specific challenges faced in Africa.”

The ATAF Technical Committee will continue to participate in the work of the various OECD Working Parties in 2018 to ensure the views of African countries are taken into account in the global standard setting process. It will also support the newly elected African members of the United Nations Tax Committee in their important work on international taxation issues form a developing country perspective.

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