Transfer pricing in the natural resources sector

The industry is beset with its own complexities. We offer advice to multinationals on how to navigate transfer pricing at a time of increased scrutiny. 

Natural resources companies operate in a fast-moving and increasingly regulated market. There are many opportunities, but in challenging times the sector is undergoing change. Growing economic and public pressures mean companies are introducing more ESG-friendly policies. Established business models are being reviewed. Disruptive new players are entering the market. Getting the right funding is also becoming increasingly complex. 

The evolving impact of transfer pricing rules is particularly important in the natural resources sector. The high volume and value of cross-border trade makes tax compliance, and efficiency, risk management and reputation top priorities.  

Understanding value chains

From initial stages of exploration through to production, and from IPO to growth and expansion, natural resources businesses may have to manage a multitude of cross-border operations and stakeholders.  

As a result, these businesses can have a diverse range of value drivers and processes in their upstream, midstream and downstream activities: 

• upstream: exploration; mine / field development; mining and concentration / extraction
• midstream: transport; refining, processing and smelting / liquefaction and regasification; and storage 
• downstream: distribution; marketing; trading and sales.

Each natural resources business has its own value chain, which should be mapped to critically evaluate the transfer pricing implications. 

Transfer pricing considerations

Most countries apply transfer pricing rules to ensure that internal transactions by multinationals are priced at arm’s length. That means on terms which would have prevailed between independent parties. Mispricing such transactions can distort the profit and tax reporting outcomes across tax jurisdictions.  

Failure to anticipate and plan for transfer pricing risks can lead to tax authority audits and disputes. These, in turn, may mean fines, penalties, economic double taxation, and time-consuming procedures that drain the company’s management resources. Company auditors, investors, regulators and customers also expect compliance as part of corporate governance. 

Transfer pricing rules require that intra-group flows (which are typically in goods, services, financing, and use of intangibles) comply with the arm’s length principle. In the natural resources sector, the related party transactions typically arise through:  

• centralised operations hubs: procurement, sales and marketing, IP management or other value-driving activities in a strategic hub location 
• intra-group services: management and back office, R&D, technical and scientific services (e.g. site development, refining) 
• use of intangibles: exploration licences, patents, know-how, trademarks, supplier contracts, and customer lists  
• ownership and leasing of equipment: infrastructure and capital-intensive assets (e.g. drilling rigs, vessels, construction and transport equipment)  
• intra-group financial support: loans, financial and performance guarantees, hedging, and cash pooling arrangements. 

As noted in our article discussing withholding taxes on extraction funds, correct financial recognition of the intra-group services and financial support may give rise to profit extraction opportunities for the group, and drive additional tax efficiencies.   

The transfer pricing policy challenge

Developing a transfer pricing policy can be difficult in the natural resources sector. This is because of factors like volatility in commodity prices, complex supply chains, long-term contractual commitments, and significant expenditure on infrastructure and equipment assets.  

This complexity is increased by the sector’s large international presence. It encompasses both developing and developed countries, each with its own tax and regulatory requirements. 

Transfer pricing requires profit and tax reporting outcomes to correspond to each group entity’s value creation. The natural resources sector is characterised by senior management who are geographically spread, and by skilled personnel temporarily based at project sites who may create or use valuable assets. When business arrangements or market conditions evolve but internal tax policies do not keep pace, the risk of misreporting tax positions can increase significantly. 

The implications of greater scrutiny

International initiatives are also increasing scrutiny and there’s a greater risk of challenge by more and well-trained transfer pricing specialists from tax authorities.  

One example is the Fiscal Transition Support Programme in West Africa (FTSP). It is funded by the European Union and, as the name suggests, its objective is to implement fiscal transition programmes in West Africa after the implementation of regional trade liberalisation policies. Under the programme, the OECD and the Global Forum on Transparency and Exchange of Information for Tax Purposes are helping West African states to fight tax base erosion, profit shifting, and illicit financial flows. Their aim is to mobilise domestic resources and improve tax transparency by multinationals. 

Regular reviews, proper development and robust execution of transfer pricing policies with supporting documentation, all help towards compliance and to defend companies against the risks and adverse outcomes of tax audits. Record keeping requirements to support compliance with transfer pricing rules are typically an obligation (rather than an expectation) of tax authorities. Multinationals with significant intercompany transactions should prepare and annually update transfer pricing documentation, based on standards set by the OECD (known as the Group Master File and Local Country File) or otherwise in accordance with local rules. 

Next steps

The natural resources sector offers opportunities. But it also requires careful consideration of the industry’s unique characteristics and challenges if multinationals are to optimise their tax and transfer pricing positions. 

If you would like further guidance, please contact Farhan Azeem in the UK. He collaborates with local experts across PKF Global.