Crackdown on profit-shifting
Companies facing transfer pricing queries should try to resolve them without delay
COMPANIES that fail to take transfer pricing risks seriously face a bleak future. Transfer pricing came under scrutiny in SA as far back as 1995 when the authorities became concerned about multinational companies manipulating prices within their group of companies to reduce taxes by “parking” profits in favourable tax jurisdictions. This prompted the promulgation of legislation, which has recently ramped up. It is now an issue of such major significance companies that flout these rules are facing a firestorm of criticism in the press, by regulators and even in the communities in which they operate.
It is an important issue for all developing countries due to their heavy reliance on corporate income tax, particularly from multinational enterprises. But while the compliance burden on taxpayers is increasing, the clarity of rules across jurisdictions remains blurry.
Yet cries to stamp out these types of practices are being heard around the world as lobby groups and nongovernment organisations in particular rail against the very low levels of corporate tax some companies have paid over the years.
The Organisation for Economic Co-operation and Development (OECD) sums up the extent of the problem well when it says shifting profits is a global problem which requires global solutions.
The problem is getting all governments singing from the same song sheet. They have certainly stuck to that mantra and have started making serious inroads into addressing the challenges, but there is a long way to go yet. The OECD is striving and driving for a clear policy that is implemented uniformly by countries, though this has not always happened as smoothly as they would have liked, especially in Africa.
A set of measures and reports were released in September 2014 and a workshop for developing country representatives took place last December in Paris.
From January this year developing country representatives have also been attending the meetings of the relevant subsidiary bodies, such as working party 1 on tax treaties, working party 2 on tax policy and statistics, working party 6 on transfer pricing, working party 9 on consumption taxes, working party 11 on aggressive tax planning, the Forum on Harmful Tax Practices and the Task Force on the Digital Economy.
According to the OECD these measures will give countries the tools they need to ensure that profits are taxed where economic activities generating the profits are performed and where value is created, while at the same time give business greater certainty by reducing disputes over the application of international tax rules, and standardising requirements.
That is to be commended as companies will not want to face drawn out disputes and a conflict resolution process that ultimately damages their reputation and relationships.
There is little doubt South African revenue authorities are going to take stronger aim at transfer pricing practices, especially as we have been one of the early adopters of the global rule changes. The South African Revenue Service (SARS) has also established a team to deal with transfer pricing.
The OECD makes the point that in an increasingly interconnected world, national tax laws have not always kept pace with how global corporations have developed nor with the rise of the digital economy, leaving gaps that can be exploited to generate double nontaxation. This undermines the fairness and integrity of tax systems. The lack of transfer pricing comparable data and the granting of wasteful tax incentives have also been identified as areas of particular concern for developing countries.
However, the OECD says more work will be needed in future to make progress on these areas and will be analysed further by the G20.
The best advice for companies facing transfer pricing queries is to act on them and try to resolve them without delay before they escalate and an assessment is issued. By then it will be too late to prevent a broader fallout and will become more difficult to find a resolution with the authorities.
But just how real are some of the numbers being bandied about? Tax director from Deloitte Billy Joubert made an important point in an article in the FM a few weeks ago. He said there is a universal, but very possibly untested, perception that countries (particularly developing countries) are losing billions in tax revenues
because of base erosion and profit shifting — the Siamese twin of profit shifting. Wild numbers are thrown around of the billions of dollars that abusive transfer pricing practices are allegedly costing the African continent as a whole. Joubert says, however, that it is very difficult to see how anyone can possibly back up this statement with definitive evidence.
Davis Tax Committee head Judge Dennis Davis was recently quoted as having said that during 2012 SARS probed about 40 corporate taxpayers on their transfer pricing practices and collected more than R1bn in additional tax revenue.
According to Joubert, if one considers that total corporate tax collections for the financial year ended February 28 2013 was R156.3bn (according to the 2013 budget review), an extra R1bn of corporate tax revenue from a focus on transfer pricing represents about 0.64% of total corporate tax collections. “This figure does not, in itself, seem to indicate transfer pricing is an area of rampant noncompliance by South African corporate taxpayers,” says Joubert.
But the OECD is right to be worried and companies themselves need to prepare in advance for a harder line. It is not so much about the fines than the scandals that erupt around an investigation. The continuing HSBC fallout and reports Walmart may have $76bn in offshore tax havens is going to increase the pressure on corporates, including those in Africa, to ensure their pricing practices meet more universally stringent reporting requirements.
The OECD is beginning to make inroads, including in the developing world, and those companies that fail to take heed of these developments will be caught up in a groundswell of negative press they can well do without. But it will also be important for the authorities to realise that focusing all their attention on legal multinationals may not realise the bounty they had anticipated.