Africa is known to be a resourceful continent which is regarded by many investors as a destination offering great opportunities for growth and increased returns on their investments. As multinational enterprises (“MNEs”) tap into the opportunities offered by Africa, the need for appropriate transfer pricing (“TP”) regimes to be established and enforced by African countries also rise.
The need for effective TP regimes is further underpinned by a report issued by the United Nations (“UN”) Economic Commission for Africa, which indicates that the African continent is losing approximately USD 50 billion a year in the form of illicit financial flows, with abusive TP practices being identified as one of the main reasons for these losses.
This article highlights noteworthy changes and proposed changes to the South African (“SA”) TP regime and provides a brief update in respect of recent developments in the TP landscapes of other African jurisdictions.
South Africa: The SA Minister of Finance recently highlighted, in the 2020 budget, that TP and the activities of MNEs are regarded as a major concern for SA, given the aggressive tax planning applied by some MNE groups operating in SA, resulting in profits being recognised in low tax jurisdictions.
The SA TP regime is governed by section 31 of the SA Income Tax Act, which prescribes the application of the arm’s length principle between related parties and serves as anti-avoidance legislation in respect of cross-border related party transactions. The section broadly states that the onus of proof is on taxpayers to indicate that cross-border related party transactions are at arm’s length and that taxpayers have to be able to substantiate this.
In order to address the concern raised by the SA government, the SA TP regime has been subjected to some recent changes, with more amendments being proposed by the SA government to curb the shifting of profits.
I. Concept of Associated Enterprises in SA
In order to throw the net of taxpayers being subjected to the SA TP regime even wider and to align the legislation applied in SA with global standards, the concept of “associated enterprises”, as defined in the Organisation for Economic Co-operation and Development (“OECD”) Model Tax Convention, has been introduced into section 31 of the SA Income Tax Act to form part of the definition of what would constitute an “affected transaction” for TP purposes, with effect from 1 January 2021.
Those transactions which are subjected to the SA TP regime will consequently not be limited to transactions entered into between connected persons, as it currently stands, but will include transactions entered into between associated enterprises. Given that the definition of an associated enterprise includes an enterprise which participates directly or indirectly in the management, control or capital of another enterprise, it extends further than the definition of connected persons, which currently applies in SA.
II. Tax treatment of excessive debt financing in SA
The SA government recently issued a discussion document detailing the proposed tax treatment for SA companies that are excessively financed by way of debt. The changes are proposed given that debt funding can create opportunities for base erosion and profit shifting, as MNE groups can minimise their tax liabilities by placing the majority of interest-bearing debt in countries with higher corporate tax rates, such as SA.
In terms of the proposal, which is aligned with the OECD’s recommendations, net interest deductions by SA entities will be restricted to 30 percent of earnings before interest, tax, depreciation, and amortisation (“EBITDA”) for years of assessment commencing on or after 1 January 2021. Entities would be allowed to carry forward disallowed interest deduction amounts for a period of 5 years on an annual first-in-first-out basis.
It should be noted that the new rules will not be replacing the application of the current SA TP rules in respect of inbound loans, as the rules will have to be applied to net interest expenses that have already passed the arm’s length test.
TP update: Other African countries
From an African perspective, Botswana has led the way when it comes to the tax treatment of excessive debt financing, as it had already implemented the OECD’s recommendations in respect of excessive debt financing with effect from 1 July 2019, by restricting net interest deductions of entities forming part of MNE groups to 30 percent of EBITDA.
Botswana allows interest expenses which cannot be deducted in a particular year to be carried forward for a period of 3 years in the case of general companies, and for a period of 10 years in the case of mining companies.
TP legislation was gazetted in Botswana at the end of 2018. Specific regulations following the OECD Guidelines, however, took effect from 1 July 2019. The regulations do not, however, stipulate the year of assessment from which it will apply and it is expected that clarification in this regard will be provided.
The Botswana regulations set out the content requirements of TP documentation which is in line with the local file and master file requirements set out in the OECD Guidelines.
In terms of the regulations, the local file document has to be filed with the entity’s tax return (four months after the financial year-end), irrespective of the value of transactions with connected persons. The master file document is only required to be submitted by taxpayers whose transactions with connected persons exceed BWP 5 million. The Botswana TP regulations apply to transactions with all connected persons, both domestic and cross-border.
Nigeria issued revised TP legislation and regulations with effect from 12 March 2018. A specific regulation was issued with effect from 1 January 2018 in respect of Country-by-Country Reporting (“CbCR”).
On 9 February 2020, judgment was delivered by the Nigerian Tax Appeal Tribunal in the case of Prime Plastichem Nigeria Limited v Federal Inland Revenue Service.
This case is regarded as Nigeria’s first TP case and considered whether the appropriate TP method was applied in respect of connected person transactions. The Tribunal ruled against the taxpayer noting that the method applied by the Nigerian Revenue Service, which has the power to disregard the method adopted by a taxpayer in terms of the Nigerian TP regulations, was the appropriate one to apply given the circumstances.
The case illustrates the importance of properly recording the reasons for applying a specific TP method and the reason why other methods have been rejected. The case also reiterates that the burden of proof in respect of the arm‘s length nature of a controlled transaction is on the taxpayer and that the taxpayer consequently has to prove that its transactions satisfy the arm’s length principle.
Zambia’s government gazetted revised TP legislation and regulations, which follows the OECD Guidelines and the UN TP model, on 6 April 2018. Practice Note No. 2/2018 on TP and Documentation Rules was also released in November of 2018 to provide additional guidance in relation to the regulations.
Recent news in respect of the Zambian TP landscape includes the judgment delivered by the Tax Appeals Tribunal of Zambia on 28 March 2019, in the case of Nestlé Zambia Trading Limited v Zambia Revenue Authority.
The case dealt, amongst others, with the question of whether the Revenue Authority incorrectly characterised Nestlé Zambia as a limited risk distributor for TP purposes. The taxpayer succeeded on all grounds of appeal, except for the latter, in that the Tribunal found that the entity was correctly characterised by the Revenue Authority. The case serves as a reminder that the business facts and circumstances have to be clearly evidenced by a taxpayer to support the TP classification and pricing of related party transactions.
Revised TP legislation and regulations have been in place in Malawi since 1 July 2017.
In terms of major developments since the introduction of the revised TP regime, the judgment delivered in the Malawian High Court on 28 July 2018 in the case of State v Commissioner General of Malawi Revenue Authority Ex Parte: Eastern Produce Malawi Ltd should be noted.
The judge, in this case, ruled in favour of the taxpayer by agreeing that the OECD Guidelines could not be applied as being the applicable law in Malawi and that the Malawian TP regulations, as referred to above, had to be applied. The judge noted that in applying the OECD Guidelines as law, the Revenue Authority acted illegally and out of the powers afforded to it in terms of the Malawian Taxation Act.
On the 10th of May 2019, Zimbabwe issued revised TP regulations which deal, inter alia, with the content requirements of TP documentation, the time limits for submission thereof and the power of the Zimbabwean Commissioner of Taxes to request additional information in respect of TP.
The regulations require taxpayers to have contemporaneous documentation in place that verifies that the terms and conditions applying to transactions between related parties are consistent with the arm’s length principle. It should also be noted that the Zimbabwean TP regime applies to both in-country and cross-border related party transactions and that transactions between unrelated parties may be deemed to be controlled transactions where a party is a resident in a jurisdiction considered to provide a taxable benefit.
The Zimbabwean Revenue Authority has also recently released a copy of the TP return which all taxpayers with controlled transactions, activities of a branch or permanent establishment in Zimbabwe or transactions with countries as listed in the return have to file with their annual corporate tax return for the year ended 31 December 2019. The return requires information in respect of domestic and international related party transactions, including revenue and expenditure items, acquisitions and disposals, loans and any non-monetary consideration provided or received.
Ghana has had TP legislation and regulations in place since 2012, with no recent updates being made. Noteworthy developments since the introduction of TP legislation and regulations in 2012, is the judgment which was delivered on 13 July 2018, in the case of Beiersdorf Ghana Limited v The Commissioner-General Ghana Revenue Authority.
In the case, the Ghana High Court had to consider whether royalty payments, made by the taxpayer in respect of the use of a trademark to the owner thereof, had to be disallowed in full. The Revenue Authority argued that since the agreement in terms of which the payments had been made was not registered as required by Ghanaian law, all payments should be disallowed. As a result, it argued that the amounts paid should be included in the taxpayer’s profits and taxed accordingly.
As the agreement was not registered, the judge concluded that the payments by the taxpayer had been unauthorised and that it had to be disallowed as tax-deductible expenses and treated as taxable profits in the hands of the taxpayer.
This case illustrates the importance of having cross border related-party transactions properly analysed for TP purposes, not neglecting the commercial and legal aspects and considerations in respect of payments in this regard.
Kenya has applied TP legislation and regulations since 2006. Updates thereto have however been proposed in terms of a draft Income Tax Bill, published in 2018. In terms of the Bill, taxpayers will be required to prepare contemporaneous TP documentation to substantiate the arm’s length nature of their transactions – a requirement that does not apply in terms of the current Kenyan TP regime.
The new schedule on the taxation of cross-border transactions, as set out in the draft Bill, also provides additional TP provisions in respect of transactions which have been concluded with parties which benefit from a beneficial or preferential tax regime, irrespective of whether the parties are regarded as related-parties of the taxpayer or not.
The draft Income Tax Bill also proposes the introduction of a CbCR requirement, where the threshold of KES 1 billion in group revenue has been met in the previous year of assessment as well as new rules in respect of services between associated persons and transactions involving intangible property.
The draft Bill has however not been passed into law since its publication and there is uncertainty as to the timing of when the Bill will be passed.
Mozambique adopted new TP regulations with effect from 1 January 2018. Mozambique is not a member of the OECD and does not consider any guidance under the OECD Guidelines or the UN TP model in respect of its TP regime.
All Mozambique resident taxpayers and permanent establishments with related party transactions and annual net turnover and other income of equal to or greater than MZN 2,5 million in the preceding fiscal year, are required to prepare and maintain transfer pricing documentation every year.
The TP documentation should present the arm’s length consideration of transactions between cross-border as well as domestic-related parties, and were requested by the revenue authority the documentation will have to be translated into Portuguese where it has been prepared in another language.
Considering the changes being made to the SA TP regime, along with the recent developments and judgments being delivered in other African jurisdictions, it is clear that the African continent is gearing-up and has already taken decisive steps to effectively curb the shifting of profits by way of their TP regimes.
Manager Tax Consulting and SA Lead Transfer Pricing
Tax Consultant, Transfer Pricing
Malan Du Toit
Tax Consultant, Transfer Pricing