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Tanzania Introduces Transfer Pricing Regulations

Following in the steps of its East African neighbors

Following in the steps of its East African neighbors, and in line with global trends, Tanzania has formally issued transfer pricing regulations. The Income Tax (Transfer Pricing) Regulations 2014 were issued by way of a gazette notice published on 7 February 2014, and take effect on the publication date.

Tanzania Introduces Transfer Pricing Regulations

Following in the steps of its East African neighbors, and in line with global trends, Tanzania has formally issued transfer pricing regulations. The Income Tax (Transfer Pricing) Regulations 2014 were issued by way of a gazette notice published on 7 February 2014, and take effect on the publication date.

Who is affected by the Regulations?

The regulations apply to taxpayers dealing with related parties located both inside and outside the United Republic of Tanzania. The application of transfer pricing to related parties within Tanzania will impose a compliance burden on taxpayers even when there is no significant risk of loss of tax revenue. Most transfer pricing rules focus on cross-border transactions when the parties are located in different countries, thereby creating a potential for shifting profits from one country to the other.

Under Section 3 of the Tanzanian Income Tax Act (ITA), an entity is generally deemed to be related to another when a person, directly or through one or more interposed entities, controls or may benefit from 50 percent or more of the rights to income or capital or voting power of the other entity. Therefore, indirect control would also be considered in determining whether two parties are related for transfer pricing purposes.

The definition of related parties also covers relatives of individuals and partners in partnerships, as well as an entity that may reasonably be expected to act in accordance with the intentions of another.

Branches or permanent establishments are to be treated for purposes of the regulations as separate and distinct entities from the head office, and are therefore regarded as associates.

Recognition of OECD Guidelines

The regulations recognize the application of Article 9 of the OECD Model Tax Convention on Income and Capital, as well as the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations and the UN Transfer Pricing Practical Manual for Developing Countries, except when they are inconsistent with the ITA. This is useful, because it allows taxpayers to rely on the detailed guidance contained in the OECD guidelines and, when appropriate, on existing documentation prepared in line with the OECD guidelines.

Determination of Arm’s Length Price

The regulations are largely consistent with the OECD transfer pricing guidelines and the UN transfer pricing manual, and similarly provide five methods to be applied in the determination of the arm’s length price in controlled transactions.

These methods include the traditional transaction methods:

  • The comparable uncontrolled price (CUP) method – a transfer pricing method that compares the price for property or services transferred in a controlled transaction to the price for the same goods or services in a transaction at arm’s length entered into on similar terms. If the terms are different, adjustments may be made to reflect those differences;
  • The resale price method – a method that involves the comparison of the resale margin that a purchaser of property in a controlled transaction
  • earns from reselling the property in an uncontrolled transaction with the resale margin that is earned in a comparable uncontrolled transaction; and
  • The cost plus method – a method that compares the mark-up on costs directly or indirectly incurred in the supply of goods or services in a controlled transaction to the mark-up on the costs directly or indirectly incurred in the supply of goods or services in a comparable uncontrolled transaction.

The regulations also include transactional profit methods:

  • The transactional net margin method – a method that involves comparing the net profit margin relative to the appropriate base such as costs, sales, or assets that a person achieves in a controlled transaction with the net profit margin relative to the same base achieved in a comparable uncontrolled transaction; and
  • The profit split method – a method that involves comparing the division of profits or losses that a person achieves in a controlled transaction with the division of profits or losses that would be achieved when participating in a comparable uncontrolled transaction. This method is particularly suitable when there are several related parties involved in the supply chain.

The regulations allow a taxpayer to apply any other method if the taxpayer can establish that the above methods cannot be reasonably applied, and that the alternative method gives rise to a result that is consistent with that between independent persons engaging in comparable uncontrolled transactions.

The regulations on the one hand suggest a hierarchy of methods by stating that a person should first apply the traditional transaction methods before considering the transactional profit methods, but on the other hand state that one should apply the most appropriate method having regard to the nature of the transaction and the functions performed by the related parties. Further, the regulations stipulate that when the controlled transaction involves the sale or licensing of intangible property, the arm’s length price should be determined by applying the CUP method or if the property is highly valuable or unique, the residual profit method.

Documentation Requirements

The regulations require affected taxpayers to prepare and maintain contemporaneous documentation, that is, documentation prepared at the time of the transaction. The documentation must be in place prior to the due date for submission of the tax return for the year in question. This implies that taxpayers must update their transfer pricing documentation on an annual basis. The documentation should be submitted within 30 days from the date of request by the Tanzania Revenue Authority.

Documentation should include records and documents that provide a description of the organization’s structure, nature of the business or industry and market conditions, the controlled transactions, strategies and assumptions regarding factors that influenced the setting of any pricing policies, comparability, functional and risk analysis, and the selection of the transfer pricing method and its application.

Comparability Analysis

The regulations stipulate that when applying comparability factors in determining the arm’s length price, the results of a controlled transaction should be compared with the results of uncontrolled transaction for the same basis year for a year of income. While the term “basis year” has not been defined in the regulations, we assume it implies a calendar coinciding with the year to which the transfer pricing documentation relates. This is likely to pose challenges in practice, as publicly available information or databases may not contain current-year data.

Intra-Group Services

The regulations stipulate that in justifying the arm’s length nature of intragroup services, the taxpayer should demonstrate the benefit conferred or the commercial value to the taxpayer’s business. In line with the OECD transfer pricing guidelines, the TRA will disregard charges if they involve shareholder or duplicative activities.

However, the regulations empower the TRA’s commissioner to deem services received as “not appropriate” and disregard the charges for such services. This provision gives the TRA wide discretion, and may be misapplied, with adverse consequences to taxpayers.

Deemed Interest

The regulations give the TRA the right to impose a deemed interest expense on intragroup financing that is interest-free. Related persons involved in intragroup financing either directly or indirectly, with or without consideration, are required to determine the arm’s length rate for such assistance. This also raises the possibility of the imposition of real withholding tax on deemed interest expenses.

Advance Pricing Agreements

The regulations contain provisions for advance pricing agreements (APAs), which allow taxpayers to apply for binding rulings with regard to the determination of transfer prices for future controlled transactions over a specified duration.

Taxpayers that wish to enter into an APA may apply to the commissioner, enclosing specified information pertaining to the controlled transactions and proposed transfer prices. The commissioner can accept, reject, or modify the proposal. If accepted, the APA will be in force for a period not exceeding five years.

The regulations empower the commissioner to cancel an APA by way of notice if the taxpayer fails to materially comply with the fundamental terms of the agreement, or if there is a change in tax law or a breach in one or more critical assumptions.

The recognition of APAs is a welcome development, because it provides taxpayers with a degree of certainty regarding their transfer pricing arrangements. However, flexibility on the number of years may have been a particularly important feature, because APAs with long terms are sometimes necessary to accommodate a taxpayer’s business cycle.

Corresponding Adjustments

To eliminate double taxation, the regulations allow Tanzania taxpayers to apply for a corresponding adjustment under the following circumstances:

  • A transfer pricing adjustment has been made in another country with which Tanzania has a double tax treaty with regard to transactions that affect a Tanzania taxpayer; and
  • The adjustment results in taxation in another country of income that is also taxable in Tanzania.

This is also a positive measure, although Tanzania has a very limited number of double tax treaties. Currently, nine treaties are in force: with Canada, Denmark, Finland, India, Italy, Norway, South Africa, Sweden, and Zambia.

Penalties

The regulations impose stringent penalties for noncompliance. Noncompliance with the arm’s length principle incurs a penalty equal to 100 percent of the tax underpayment. Additionally, a taxpayer that fails to prepare and maintain transfer pricing documentation commits an offense and is liable on conviction to imprisonment for a term not exceeding six months or a fine not less than TZS 50 million, or both.

Conclusion

With the introduction of the transfer pricing regulations, more formal, rigorous, and perhaps more frequent TRA transfer pricing audits appear to be looming on the horizon. Despite the possibility of harsh penalties, there is much positive in the regulations. They have removed significant uncertainty by revoking section 33 (1) of the ITA. For taxpayers, it is time to put in place appropriate transfer pricing documentation before the first tax return under the regulations is due to avoid the prospect of a run-in with the TRA that may result not only in financial penalties

Carla van der Merwe
Associate Director
Tax: Transfer Pricing
Email:
cavandermerwe@deloitte.co.za
Tel: +27 11 806 5230

Billy Joubert
Director
Tax: Transfer Pricing
Email:
bjoubert@deloitte.co.za
Tel: + 27 11 806 5352

 

 

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