Tanzania: In Compliance With Proper Transfer Pricing to Avoid Penalty

IN the wake of budgetary constraints, the government of Tanzania is tightening transfer pricing regulations and bolstering its tax enforcement actions in order to create new revenues, and in doing so, has increased the administrative compliance cost and burden for companies.

Indeed, the government’s apex body charged with the administration of taxes, the Tanzania Revenue Authority (TRA), is continuing to build the capacity of its International Taxation Unit (ITU) to deal with multinational companies and to monitor the key tourism, banking, telecoms, mining, oil and gas sectors in all enforcement matters involving international taxation, including transfer pricing.

The ITU has been viewed by the government as being very important in addressing the transfer pricing challenges that Tanzania faces; to wit, inadequate transfer pricing rules, limited knowledge and skills to enforce the rules, limited information on comparables, and the tightening of penalties for non-compliance.

Last year, during a oneday training seminar on transfer pricing, the TRA Commissioner for Large Taxpayers Neema Mrema expressed commitment to provide clarity in the application of the Income Tax (Transfer Pricing) Regulations, 2014, which were issued by way of a gazette notice published on 7 February 2014.

During the seminar, Ms Mrema also called upon stakeholders to collectively support the effort to administer transfer pricing aspects of cross-border transactions.

While it’s true that a correct transfer pricing practice can save companies from big tax dollars, an erroneous practice can lead to the imposition of heavier penalties than the original tax. Evidently, this risk is increasing with the unparalleled level of regulatory reform taking place in Tanzania.

As a consequence, it’s no wonder that transfer pricing compliance has become a major concern for companies and other taxpayers. So then what could companies do to develop a complete transfer pricing practice that will cut their tax bills ethically and; at the same time, minimize the risk of a TRA audit?

In simple terms, transfer pricing involves the pricing of transactions between related parties to be conducted at a market rate, often referred to as an “arm’s length price”.

From the perspective of the TRA, the overarching objective here is to prevent companies from using intercompany pricing as a means of evading taxes by inflating or deflating the profits of a particular entity. However, arriving at the most precise approximation of an arm’s length transfer price acceptable by the TRA remains a challenge.

Yet, if executed accurately, transfer pricing can save companies millions of dollars; on the other hand, if implemented incorrectly, companies increase their exposure for TRA audits, interest, and pecuniary (and imprisonment) penalties. Tanzania’s international tax policy for cross-border transactions was originally provided for under Section 33 of the Income Tax Act, 2004.

Earlier, in 1979, the Organization for Economic Cooperation and Development (OECD) developed transfer pricing guidelines. And, thirty five years later, in 2014, the TRA issued regulations governing the procedures for applying the arm’s length principle and specified the appropriate transfer pricing methodologies, documentation requirements, deadlines and penalties.

But, what do Tanzania’s transfer pricing regulations mean for businesses? Do the regulations take into account existing economic conditions? And, what about today’s world-wide internet business model that has rendered conventional geographical and governmental boundaries almost meaningless?

These questions are tied to many other issues that have established a sense of urgency to tackle economic policy, including taxation. At present, the government is targeting transfer pricing. By tightening up transfer pricing regulations, Tanzania has discovered that it can collect significant additional revenues every year.

Addressing Parliament recently, Finance Minister Saada Mkuya released the 2015/2016 National Budget projections, which included proposals to boost tax compliance to deal with the “tax gap” that, according to a document entitled “IMF Revenue Mobilisation in Developing Countries (March 8, 2011)”, may now be above 5% of GDP.

The tax gap is defined as the difference between the taxes owed and the taxes paid on time. To put it briefly, the government aims to eliminate tax loopholes and raise revenue for the unprecedented budget deficits. Bottom line: Tanzania is adding more resources to collection and enforcement, and the TRA is auditing regularly and imposing stringent penalties.

Indeed, the latest survey commissioned by Kibuuka Law Chambers’ Tax Services practice suggests that over 70 percent of finance executives in Tanzania feel that tax audits are becoming more systematic. Hence, companies’ tax practices are coming under tighter scrutiny and a heavier burden of tax compliance.

Non-compliance by companies can lead to transfer pricing adjustments with huge tax bills, and that’s why companies are keen to efficiently mitigate potential transfer pricing risks.

It is widely believed that there’s too much scrutiny by the TRA. The truth is that the government needs revenue and one of the targets for generating that revenue are multinational companies with branch or subsidiary operations in the country.

In that regard, the TRA will look for obvious ‘red flags’ in assessing transfer pricing risks. Such red flags include, but are not limited to, unreasonable or unexplainable losses or low profitability, cross-border restructurings which shift profits outside Tanzania, poorly documented big year-end transfer pricing entries, and transactions with low-tax jurisdictions like Singapore, British Virgin, Bermuda, Cayman Islands, Mauritius, Netherlands, and Monaco.

As a country seeking to enhance tax yields, Tanzania is paying special attention to transfer pricing. To ensure that a fair share of tax on any international business conducted by related parties is collected, the TRA is increasing its audit teams; and because of this, companies of almost any size should be ready for a review, and defence, of their related party transactions.

Beyond the shadow of doubt, Tanzania is systematically enforcing its transfer pricing regulations, which have a direct impact on the resources needed for companies to remain in compliance.

By ensuring that operations are conducted in step with proper transfer pricing policies (and agreements) and assiduously meeting contemporaneous documentation requirements to confirm the same, companies will not only save a lot of money by implementing a proactive approach to transfer pricing, but will also protect themselves against potential tax audit troubles.