13th August 2007 (East African Standard)
In many developing countries, multinational corporations hold a large swathe of the economy - agriculture, manufacturing and tourism being the most visible.
In Kenya, for example, foreign multinationals dominate agriculture, especially horticulture. There is much debate between those who consider globalisation to be a malignant influence on poor nations and those who find it a positive force.
The debate focuses not just on trade, but also on multinational corporations. And one of the most controversial but least understood of a multinational's operations is transfer pricing. This governs transactions among divisions in a company.
For a company operating in a single tax jurisdiction, transfer prices track internal transactions and allocate costs to different activities. In this case, transfer prices are mainly used to evaluate division managers' performance based on profits generated.
They also help coordinate the divisions' decisions to achieve the organisation's goals to ensure goal congruence, make decisions and preserve autonomy. However, for a multinational company with affiliates in different tax jurisdictions, transfer prices serve more than tracking internal transactions for accounting purposes.
They determine tax liabilities of the affiliates in different countries, and hence the liability of the entire multinational. When a part of a multinational organisation in one country sells goods, services or know-how to another part in another country, the price charged is called 'transfer price'.
This may be a purely arbitrary figure, and may be unrelated to costs incurred or operations. Internationally accepted transfer pricing provisions require any income from an international transaction between two or more associated enterprises to be at arm's length price and be comparable to similar transactions among unrelated enterprises.
This means that a company must be able to demonstrate that the price at which it trades with affiliated companies is comparable to the prices and terms that would prevail in similar transactions among unrelated parties.
As inter-company transactions across borders keep growing and becoming more complex, compliance with the requirements of multiple overlapping tax jurisdictions is becoming a complicated and time-consuming task.
At the same time, tax authorities in each country impose strict penalties, new documentation requirements, increased information exchange and audit or inspection.
One of the major arguments against transfer pricing is that it and tax havens, individually and in combination, adversely affect the ability to raise revenues. Research has shown that in some instances, increasing the arbitrary transfer price boosts a multinational's after-tax profit.
This is done without changes to procedures, operations or added value, but by mere change of book entries. Increased profitability arises from tax avoidance. In other words, it is possible for a multinational company to minimise its liability for corporation tax by transfer pricing.
This is legal unless a jurisdiction legislates to prevent the practice. In principle, all income that crosses international borders could be taxed by the country where it originates (the source country) or by the country of residence of the recipients - the home country.
If the two countries taxed such income, double taxation would occur. To forestall this, domestic laws and bilateral tax treaties have provisions to prevent this. Treaties also provide for exchange of information between tax administrators of source and residence countries.
Most treaties among developed countries are based on the OECD Model Treaty. Those between developing countries are more likely to follow the UN Model Treaty, generally more favourable to source countries.
Under the treaties, income is taxed depending on how it is characterised. Source countries ordinarily tax net business income, but only if it is earned by a 'permanent establishment' in the country. By comparison, source countries tax interest, dividends and royalties, if at all, on a gross basis (without regard to deductions for expenses of earning the income), commonly via withholding taxes.
The taxes are generally reduced, sometimes to zero, under treaties. In some jurisdictions, if a company or a branch did not transact business 'at-arm's-length', tax authorities can add to its taxable basis the advantage granted to an affiliated company; or challenge the deductibility of tax losses.
In practice, whether a company has engaged in improper transfer pricing depends on the circumstances of the transaction. Despite the general requirement of 'at-arm's-length', various jurisdictions have in some cases been willing to accept that companies of the same group may interact with one another in a way that independent parties would not.
Developing nations face several layers of overwhelming problems in transfer pricing. Laws may not deal adequately with the issue. The UN reports that transfer pricing regulations, guidelines and administrative requirements of 41 per cent of developing countries do not address services and regulations of two-thirds do not address technology transfers.
Even where laws for monitoring transfer pricing exists, a developing nation may lack the administrative capacity, including specially trained economists, to deal with the problem.
The writer is a business analyst with The Standard Group
No comments:
Post a Comment