When the words “benchmark”, “Africa” and “transfer pricing” are used together, the conversation invariably steers towards the fact that it is extremely difficult to obtain ‘perfect’ comparables in Africa because of the lack of data. We will discuss the challenges of data in Africa and the suggested approaches to overcome this in future editions of this publication. For now, we will focus on the importance of having a benchmarking study in place to support the arm’s length nature of transactions.
A transfer pricing study generally begins with reviewing the relevant features of a cross border transaction between two or more related parties. The next step is to determine what is the appropriate price for that transaction. This can usually be determined either by considering what one of the related companies would have charged, or paid to, an independent third party in the same situation or, alternatively, it can be determined by considering the prices charged or profits achieved by independent third parties for the same (or sufficiently similar) activities under sufficiently similar conditions. This second approach would usually require a benchmarking study to be performed to identify a set of comparable independent companies so that their profitability can be compared to that of the company in question.
The Organisation for Economic Cooperation and Development’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrators (OECD Guidelines), as well as many countries’ local regulations, indicate that the cost of preparing transfer pricing support should not outweigh the benefit. In other words, where the value of a transaction is relatively small and where local regulations don’t stipulate a need for a thorough analysis for each transaction, a pragmatic approach may be taken to only perform a more detailed analysis for larger material transactions. This approach is commonly applied in most countries across the world.
It is interesting that on 12 February 2018, a Danish Tax Tribunal concluded that a company’s transfer pricing documentation was inadequate because it lacked a detailed comparability analysis involving a benchmarking study. The result was that the Danish tax authority performed its own benchmarking study which it used to make adjustments to the income of the Danish entity. The conclusion was that the taxpayer should in fact have prepared a detailed benchmarking analysis.
Although any transfer pricing ruling is very fact-specific, there are a couple of important applications of this ruling for companies operating in Africa.
1. While a pragmatic approach is often required when analysing the arm’s length nature of transactions (especially if the transaction is not the most significant one), it is necessary to be aware that the revenue authorities may view transactions differently and choose to perform their own detailed analysis on that transaction and then seek to make adjustments.
2. Even where the local regulations to not stipulate any consequences for not preparing transfer pricing documentation in a particular country, if the transaction is material to your business, it is advisable to prepare detailed support for the transactions. In most cases, this will mean that the revenue authorities in that country will at least need to first consider the analysis and information that the taxpayer has performed before performing their own analysis.
3. Where a group has operations in several continents, often the entities in Africa are not quite as material to the Group as entities in other regions. Also, there are sometimes important differences that exist in the local operations in Africa compared to the operations in other countries (for example, there may be additional local warehouses because of the distance or logistical challenges associated with moving goods across the continent). Therefore, before simply applying any benchmarking studies that have been prepared for other regions to determine the profitability of entities in Africa, carefully consider whether they will indeed be appropriate for the entities in Africa. If there are additional important features of the transaction, authorities may argue that the benchmarking study is not adequate or appropriate and may reject it in favour of their own benchmarking analysis.
If you’d like more information on the above, or to chat to someone at Graphene Economics about meeting your cross-border transaction compliance requirements, please get in touch.