Africa’s Natural Resources pose transfer pricing issues for MNEs
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Transfer pricing is a critical issue for multinational enterprises in Africa’s natural resources sector. The immense scale of exports of Natural Resources by African companies to offshore group companies and pushdown of costs from such companies makes transfer pricing a priority for African governments.
Multinational enterprises in this sector often engage in complex internal transactions, which can lead to challenges in ensuring that profits are appropriately taxed in the countries where the resources are extracted.
Developing a transfer pricing policy can be difficult due to the special attributes of the Natural Resources sector. This is because of factors such as volatility in commodity prices, complex supply chains, long-term contractual commitments, and high expenditures on infrastructure and equipment assets. This complexity is increased by the sector’s trade flows with both developing and developed countries, each with their 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 characterized by senior management who are geographically spread, and by skilled personnel based temporarily at project sites who may create or use valuable assets. When business arrangements or market conditions evolve but internal tax policies don’t keep pace, the risk of misreporting tax positions can increase significantly.
Considering the extractive industries value chain, multinationals can have a range of operations and processes across their African and overseas companies. As established by the Organization for Economic Cooperation and Development and the Intergovernmental Forum on Mining, Minerals, Metals and Sustainable Development, or IGF, the main transfer pricing risks at the various stages of natural resource exploitation include:
Exploration. Charging above a market price for the provision of intercompany technical services or rental of specialized equipment
Development. Improperly pricing any intercompany:
- Financing, such as loans, financial and performance guarantees, hedging, and cash pooling arrangements
- Services, such as management and back office, research and development, technical and scientific services, such as site development, and refining
- Licensing of intangibles or use of other specific technologies, such as exploration licenses, patents, know-how, trademarks, supplier contracts, and customer lists
- Acquisition or rental of capital-intensive assets, such as drilling rigs, vessels, construction and transport equipment
- Purchases of consumables such as fuel
Production. Transfer prices on sales to related parties, especially in offshore sales and use of centralized operations hubs—such as procurement, sales and marketing, intellectual property management or other value-driving hubs—that may inappropriately charge service fees or commissions, improperly price products or receive undue discounts on the sales price
Processing, logistics, sales and post-production. The risks are as in the production stages, plus excessive charges at group processing facilities, such as:
- Allocation of charges for transportation of products to different locations, including freight and insurance costs
- Mispricing of fluctuations in exchange rates during international transactions
- Inadequate transfer of rehabilitation and abandonment costs
Each multinational in Africa should perform a value chain analysis to critically evaluate the key functions, assets and risks across the related parties and their transactions globally. A deep understanding of the economically significant activities should follow, resulting in a robust allocation of profit (or loss) to each party.
African Initiatives
In collaboration with leading intergovernmental organizations, the transfer pricing regulations and the audit practices of tax authorities in Africa are improving rapidly. A well-publicized example is the joint OECD and UN Development Program initiative, which continues working successfully with developing countries to boost tax revenue and mobilize domestic resources.
African countries are particularly strong beneficiaries, given the Tax Inspectors Without Borders cooperation with the African Tax Administration Forum. Together, TIWB and ATAF have assisted African countries to collect more than $1.8 billion in additional tax revenues and $4.3 billion in additional assessments.
Another example is the partnership between the OECD Centre for Tax Policy and Administration and the IGF to deliver the Base Erosion and Profit Shifting in Mining Program. The aim of the program is to equip resource-rich developing countries in Africa and elsewhere with the knowledge, skills, and tools to build and administer a robust mining tax system.
In the past year, South Africa enacted rules introducing advance pricing agreements , which aim to provide taxpayers with greater certainty when embarking on large international transactions with transfer pricing implications.
Ethiopia’s transfer pricing directive, effective from January, provides for a penalty equal to 20% of a taxpayer’s annual tax payable for taxpayers who fail to maintain contemporaneous transfer pricing documentation.
Impacts for Multinationals
Transfer pricing in the Natural Resources sector remains complex but is crucial for tax compliance by multinationals in Africa.
A key challenge faced by tax authorities and multinationals can be how to properly allocate profit (or loss) across the industry’s value chain. Diverging views and potential conflict can emerge between the stakeholders.
An emerging trend is for taxpayers to demonstrate transfer pricing compliance by preparing robust documentation, analysis and record keeping, in line with international standards.
The political agenda is to increase the scrutiny of multinationals in Africa, alongside international initiatives with recommended solutions to mitigate the transfer pricing risks. By understanding the regulatory landscape, addressing implementation challenges, and adopting best practices, multinationals can develop robust and future ready transfer pricing arrangements.
Moreover, by accurately transfer pricing and paying their fair share of tax on extractive activities, multinationals can contribute to greater prosperity in Africa while demonstrating that tax compliance and efficiency, as well as risk management and reputation, remain top priorities.
Copyright [2024] Bloomberg Industry Group, Inc. (800-372-1033) www.bloombergindustry.com. Reproduced with permission.