Resolving Zimbabwean challenges in transfer pricing

A lot of debate about taxation in most developing countries is evolving on how to ease revenue leakages through offshore tax havens. But there is another hot issue called transfer pricing which developing countries have to be mindful of particularly if they want to avoid the risk of losing out on tax revenue from cross-border transactions carried out by Multi-National Enterprises.

Transfer pricing is defined as the price allocated to a transaction taking place between two related entities normally within an MNE, operating with entities in multiple tax jurisdictions or countries.

Due to globalisation, Zimbabwe and many developing countries have increased the opening of borders for business with international companies. Such cross-border business has helped significantly in economic development, whilst also growing immensely in intra-group business transactions due to large amounts of foreign direct investment.

However, there has been an exponential growth in tax issues that have been arising from profit shifting by MNEs from high tax jurisdictions to tax havens in order to avoid or minimise tax payment.

International efforts to ensure that corporations are taxed where economic activities occur and reduce profit shifting to low-tax jurisdictions have been criticised as not doing enough to stop this, a practice that is particularly debilitating for developing countries.

Widely publicised research released late last year by the SA-Tied (Southern Africa — Towards Inclusive Economic Development) project, suggests that 98 percent of the tax loss is linked to profit shifting by the biggest 10 percent of multinational corporations.

The country is not spared from the shenanigans and could be losing millions of United States dollars annually through tax leakages where big conglomerates are allegedly transferring their profits to other countries where tax rates are comparably lower.

Speaking at a tax conference last month in Victoria Falls, managing director of Tax Matrix, Mr Marvelous Tapera, said Zimbabwe faces a critical challenge of transfer pricing. Mr Tapera said multinational corporations are the biggest culprits as they shift profits to other countries to evade tax. "By transfer pricing we are talking about shifting profits from one company to the other and multinational corporations do that.

"A research about illicit financial movement was done in 2014 where it was established that the country could be losing millions per year to transfer pricing although I can't give figures at this stage," says Tapera.

How does it work? According to Caroline Silberztein, a tax expert, a large proportion of world trade is accounted for by cross-border trade taking place within multinational enterprises, where branches or subsidiaries of the same multinational enterprise exchange goods or services.

"These transactions within the group are not exposed to the same market forces as transactions between independent enterprises. They are referred to as controlled transactions. "If the prices of these transactions are artificially lowered or increased they may lead to taxable profits being shifted from one country to another," says Silberztein.

What it implies, for instance, take a beverage company located in Zimbabwe, which has a subsidiary in South Africa (SA).

Let's assume that the South African subsidiary pays royalties to the Zimbabwean headquarters for the rights to sell its drinks. Taxes are owed in SA based on the SA's subsidiary's results.

The higher the royalties paid by the SA subsidiary, the lower the taxable profits in SA. The SA tax authorities will be satisfied if they see that the royalties paid by the SA company to its headquarters in Zimbabwe are not higher than those that would be paid to an independent enterprise for a similar transaction. But if the royalties are too high, there is a possibility that profits are being shifted out of SA to reduce tax liabilities there.

As the example above illustrates, transfer pricing is a strategy frequently used by MNEs to make huge profits through illegal means.

The transfer price could be purely arbitrary or fictitious, therefore different from the price that unrelated subsidiaries would have had to pay. Since each country they operate in has different tax rates, multinationals can increase their profits with the help of transfer pricing.

By lowering prices in countries where tax rates are high and raising them in countries with a lower tax rate, multinational companies can easily reduce their overall tax burden, hence increasing their overall profits.

Painfully, over the years, Zimbabwe has been focusing its energies on finding ways of innovatively mobilising revenue from their own domestic sources. However, revenue generated locally is way below the actual amount of revenue required to finance the infrastructure development projects and provision of public services particularly water and sanitation, health, education, electricity and public transport in the country.

What needs to be done? The Government of Zimbabwe should start enacting laws that demand transparency and accountability from MNEs when reporting their operations and annual financial performances. They should also be a strict rule that transfer pricing between two subsidiaries must conduct their transactions on an "arm's length" basis.

This means that any transaction between the two should be priced as if the transaction were conducted between two unrelated companies, with no over or under-pricing being allowed to take place. Heavy penalties should be imposed for breach of the "arm's length" pricing system.

The international community should chip in also by stopping MNEs from engaging in transfer pricing from poor developing countries through the use of continental or regional trade agreements.

For example, the International Financial Reporting Standards Foundation and the International Accounting Standards Board — international organisations responsible for developing a single set of high-quality global accounting standards, known as IFRS Standards — should encourage country-by-country financial reporting. This will go a long way in enabling tax authorities, civil society and other regulatory authorities to monitor the activities of MNEs.

Zimbabwe together with developing countries, can also lobby the United Nations Security for the establishment of an international tax police system similar to the global police body Interpol and Kimberley certification process for diamonds to curb trade in blood diamonds. This process will work where there is suspicion that "arm's length" pricing was not followed, which would involve exporting countries certifying that the exports in question have been exported with due consideration of the country's tax laws.

The Zimbabwe Revenue Authority (Zimra) should also invest in competent tax personnel and investigators in the area of transfer pricing. This according to proponents of illicit financial flows could effectively deal with the documentation requirements, increased information exchange and increased audit or inspection of MNEs financial operations.

The tax collector should also undertake special tax audits from time to time to check and plug the leakages due to transfer pricing. Above all, the Government should increase participation of Zimbabweans in the ownership of the economy.