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The Organization for Economic Co-operation and Development (OECD) recently published its 2022 version of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations for MNEs and Tax Administrations (TP Guidelines).
The TP Guidelines provide guidance on the application of the “arm’s length principle” for the valuation, for tax purposes, of cross-border transactions between associated enterprises. The TP Guidelines are geared towards minimising conflict between tax administrations and multinational enterprises and providing a means of resolving problems arising from interaction of laws and practices of different jurisdictions.
The TP Guidelines are intended to act as a compilation of all previous OECD reports addressing transfer pricing and related tax issues since 2017 when the guidelines were last revised.
The TP Guidelines affirm the arm’s length principle (ALP) as the gold standard in transfer pricing. The principal issue in application of ALP to the taxation of MNEs is the establishment of appropriate transfer prices. Transfer prices are the prices at which an enterprise transfers physical goods, intangible property, loans or provides services to related enterprises.
The ALP states that profits of related enterprises may be adjusted to ensure that the profits are similar to those profits that would have been made between independent enterprises in comparable transactions under comparable circumstances. The Guidelines at over 630 pages are an unpleasant read for any casual observer. It is no wonder then that transfer pricing professionals remain a rather limited club due to the extremely high barriers of entry posed by the costs of acquiring competence in transfer pricing.
Interestingly, the TP Guidelines document a long debate on the merits or otherwise of the global formulary apportionment (GFA) with a conclusive stance of rejection of the approach.
The GFA has historically received much support from academicians and civil society as a reasonable alternative to ALP. The GFA approach is to tax the MNE group as a whole as opposed to taxing the individual companies in the group as separate and distinct entities that make the group. Taxing the entity as a group means that if a MNE operates in thirty countries all over the world, then instead of each tax jurisdictions taxing the individual entity in its jurisdiction, the profits from each entity within the MNE are combined so that the MNE reports its profits as a group and proceeds to allocate income to each jurisdiction based on agreed parameters. The TP Guidelines reject the GFA and reassert that the ALP is the only feasible means by which the group income can be allocated across all jurisdictions.
Is the OECD on the right side of history on passing up the opportunity for a radical rethink of the ALP? The jury is still out on whether the more recent reforms introduced through the Base Erosion and Profit shifting project tackle the fundamental flaws of the ALP system in a coherent way particularly in the context of resource constrained economies in Africa.
Businesses in Africa are faced with burdensome costs of ensuring compliance with an ever increasing complex set of ALP rules to apply. African Tax administrations on the other hand are also faced with the pressure to develop and retain capacity to accurately implement the Rules in conformity with international standards. The growing complexity of transfer pricing rules has been met with a marked increase in uncertainty as businesses seek to anticipate what interpretation the tax administrations will adopt when reviewing their related party transactions.
There is a trend towards transfer pricing tax disputes as it becomes harder for businesses to comply with the ever-increasing complexity of the OECD TP Guidelines. The risks to businesses posed by the emerging tax uncertainty as more tax administrations implement these Rules in varying dimensions foreshadow economic stability and attractiveness of Africa and must be addressed.
Tax administrations in many African countries are faced with lack of specialised transfer pricing audit skills as well as lack of international instruments for exchange of information with other countries on MNE transactions. Likewise, tax administrations and businesses alike also lack access to quality public information on independent comparables from which to derive accurate adjustments to the transfer prices of related enterprises.
Both tax administrations and MNEs often face difficulties in obtaining adequate and appropriate information to apply the ALP in every tax jurisdiction they operate due to unavailability or incompleteness or confidentiality of information on independent party transactions in that market. It is often said that ‘transfer pricing is not an exact science’ but one that requires the exercise of professional judgment on part of both the tax administration and the taxpayer. However, this gives rise to subjective interpretations and the resulting disparities most often lead to protracted and costly disputes with attendant costs and disruption of business.
Advance Pricing Agreement regimes offer a feasible route globally for tax administrations for African governments to provide taxpayers with certainty. However, they do not present a silver bullet due to their resource intensive and a time-consuming nature. They have also posed some challenges particularly during periods of great economic uncertainty as we just experienced with the COVID-19 pandemic.
The main critique to the ALP has been that the relationship among members of a MNE group may permit members to establish special conditions in their intra group relations that markedly differ from those that would have been established had the group members been acting as independent enterprises in open markets. This introduces a measure of subjectivity in arriving at a fair result of what is considered arm’s length transfer prices.
For now, the ALP with its challenges remains the global consensus for the foreseeable future. Multinational businesses operating in Africa must adopt a proactive approach to addressing their transfer pricing risks engagement with their professional and legal advisors.
Should you have any questions regarding the the OECD transfer pricing guidelines 2022, please do not hesitate to contact James Karanja.
John Kiragu- Trainee Lawyer