African revenue authorities are taking an increasingly hard line on transfer pricing but how much does the practice actually cost the continent?


An eye-watering $50 billion is the estimated amount that flows illicitly out of Africa every year. This figure is based on trade data from the World Bank and IMF as quoted in the Report of the High Level Panel on Illicit Financial Flows from Africa, released earlier this year.

Commissioned by the AU and the UN’s Economic Commission for Africa, the report is commonly called the Mbeki Report, due to former SA president Thabo Mbeki’s involvement as chairperson.

Illicit outflows are estimated to have cost the continent $1 trillion over the past 50 years – an amount roughly equal to all the official development assistance Africa has received over that same period.

Amid a growing focus on transfer price manipulation by multinational corporations with operations in Africa, revenue authorities across the continent are tightening up legislation in this area and, increasingly, playing hardball with companies.

Transfer price manipulation as well as base erosion and profit shifting (BEPS) form part of a tax evasion landscape that promotes these illicit flows of money, most often out of developing countries and into developed economies.

Transfer pricing is the price of transactions between companies within the same multinational group, usually occurring cross-border. In other words, it is the price at which divisions within the same company transact with each other in the form of goods, services or labour.

Rules for transfer pricing are generally based on what is known as the ‘arm’s length principle’, where transfer prices charged between related entities are compared to prices of similar transactions between independent entities.

This is important because transfer pricing can be abused for tax purposes when a company manipulates the price of goods and services so as to make most profitable those divisions that are in lower-tax jurisdictions – effectively shifting profits from higher-tax to lower-tax jurisdictions.

On a similar playing field, BEPS is defined by the Organisation for Economic Co-operation and Development (OECD) as ‘tax planning strategies that exploit gaps and mismatches in tax rules to make profits “disappear” for tax purposes or to shift profits to locations where there is little or no real activity but the taxes are low, resulting in little or no overall corporate tax being paid’.

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Due to these areas of tax law being relatively new in a number of African jurisdictions, countries are particularly vulnerable to abuse by large commercial corporations with highly professional legal, tax and accounting teams behind them.

‘The only way to reduce transfer price manipulation is to beef up the transfer pricing specialists employed by the African tax authorities,’ says Wally Horak, head of tax at Bowman Gilfillan.

According to the Mbeki Report, evidence suggests that abusive transfer pricing is occurring on a substantial scale in Africa. In one instance, an African president told the panel that a multinational in his country hadn’t paid taxes for 20 years because it consistently reported losses. ‘He was certain that this could only have been due to profit shifting, since no business entity could remain in operation if it were making losses for such a long time,’ the report notes.

The report also highlights that the political will of governments – and not only technical capacity – is critical to ending illicit financial flows, as is their support in the countries where these flows end up. ‘The exchange of information between African tax authorities and the authorities where the multinational is based would greatly enhance their ability to police transfer price manipulation,’ says Horak.

The political will of African governments appears to have strengthened in this arena, with some commentators warning against an overly aggressive approach.

Speaking to Business Day in September, SA Institute of Tax Professionals deputy CEO Keith Engel said ‘governments have been given a free licence to audit and challenge multinationals on cross-border pricing, even where no evidence of profit shifting is evident. This creates uncertainty and affects real investments’.

Horak says that where local tax authorities apply transfer pricing guidelines ‘haphazardly [and] without any consistency, it may well deter multinationals from investing since they require certainty about the application of such rules’.

He adds that generally, African jurisdictions have accepted the OECD guidelines on transfer pricing – that is, applying the arm’s length principle. However, he notes that African authorities often lack their own economic data to effectively challenge the transfer prices charged by multinationals.

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African authorities often lack their own economic data to effectively challenge the transfer prices’


In contrast, EY argues that it is difficult for multinationals to obtain data on independent enterprise transactions in the African marketplace and benchmark themselves against that. Alongside the OECD’s guidelines, EY says that some African governments also consider the UN’s transfer pricing manual.

While transfer pricing regulations are at varying levels of development across the continent, they do appear to be growing in consequence and clout. According to EY, the Kenya Revenue Authority has established a transfer pricing audit unit and set itself up as a hub for training officials from other revenue authorities, with talk of jointaudits of multinationals.

Tanzania published transfer pricing regulations only in February 2014. Failure to comply with certain documentation requirements can lead to six months imprisonment or a minimum fine of $30 000.

In Nigeria, transfer pricing regulations were introduced in September 2012 and continue to develop, with a specialist transfer pricing team now established and policy drafting beginning in January 2014, according to EY. The Ghana Revenue Authority also recently set up a specialist transfer pricing audit unit, while Gabon and Guinea have both introduced documentation requirements.

In general, EY flags increased tax audit risks in countries with new transfer pricing documen-tation requirements, saying audits will focus on all cross-border intercompany transactions.

Among the audit triggers listed by EY are activities in or involving tax havens or low-tax countries; losses over a number of years or low contribution to the income tax base; and large royalty and management fees.

In the wake of the Mbeki Report, and in a context where the revenue and budget deficits of many of the continent’s governments are under pressure, the African Tax Administration Forum launched the African Tax Research Network in early September.

Speaking at the launch of the research network, SARS commissioner Tom Moyane said that at the heart of BEPS lies transfer pricing, which ‘perpetuates tax avoidance and tax evasion’ through trade mis-invoicing, whereby African exports are under-invoiced ‘so that income accrues abroad’ and imports into African countries are over-invoiced in order to have the same effect.

In an article first published by the Thomson Reuters Foundation, Global Financial Integrity president Raymond Baker says that trade mis-invoicing drained $730 billion in ‘dirty money’ from poor countries in 2012, based on economic and trade data filed by governments.

Baker also comments on a hypothetical multinational in the article: ‘It buys equipment and material from its own associated procurement companies in Europe, paying excessively high prices in order to move money abroad. And it sells its production to its own associated marketing companies in Europe, receiving far less in Africa than world market prices, again moving money abroad.

‘With these mechanisms so easily utilised, foreign and even domestic companies can operate for years in the developing world without showing profits and paying taxes, yet accumulating huge funds in foreign coffers.’

SARS’ Davis Tax Committee has a dedicated BEPS sub-committee, indicating just how seriously the local revenue authority takes the issue of transfer pricing and its related abuses.

While these issues remain contentious – with some analysts contending that figures on illicit financial flows are untrustworthy and often inflated, precipitating irrational responses from regulators – they are now firmly placed on the African trade and development table, forcing a significant rethink by some multinationals as to how they play their cards.

By Hanna Barry
Image: Andreas Eiselen/HSMimages