The Minister of Finance & Economic Development, Dr K Matambo published the much-awaited Transfer Pricing regulations through Income Tax (Transfer Pricing) Regulations 2019 on July 12, 2019.
The regulations took effect as from the date of publication (July 12, 2019) but were expected sometime in March 2019 as the Transfer Pricing law contained in the Income Tax Act could not be implemented without the regulations.
The regulations therefore came very late as the transfer pricing laws were supposed to commence on July 1, 2019, hence the expectation that the regulations should have been out about three or so months before commencement to give taxpayers time to acquaint themselves with the laws.
What is transfer pricing?
Transfer pricing is the analysis of the prices at which MNEs transfer goods and services between and amongst themselves. Taxmen worldwide, Botswana Unified Revenue Service (BURS) included, worry that MNEs can use their relationships with subsidiaries to engage in tax base erosion and profit shifting. Presenting the 2019/2020 budget, Dr Matambo stated that, ‘The amendment to the Income Tax Act also introduced Transfer Pricing Rules. Transfer Pricing Rules guard against attempts by multi-national corporations to minimise their tax liability by transferring profits to low tax jurisdictions in order to pay less tax or where costs are charged to a company in a high tax jurisdiction to reduce profits and thereby pay less tax.’
The tax authorities fear that MNEs can use their relationships with subsidiaries to manipulate prices in a way that would prejudice tax revenue collections in Botswana.
The most common example is the overstatement of management fees charged on Botswana companies by non-resident parent companies, which results in what is called Base Erosion, being the reduction of Botswana taxable profits arising from inflated head office costs. Taxmen also fear that transfer pricing can also be used to shift profits from high tax regimes to low tax regimes, which results in reduced group tax costs, allowing shareholders to take more in dividends. This may be done by understating prices of goods sold by a Botswana entity to its non-resident parent and reflecting the true value of goods in the low tax regime, thereby shifting profits outside Botswana.
The stipulations of the regulations
The regulations require that all MNEs and IFSC companies (including subsidiary or entities related to IFSC companies) keep transfer pricing documentation which stipulates how the prices of the goods and or services they trade amongst each other are arrived at.
It is worth noting that transfer pricing will only apply between or amongst entities which are controlled by non-resident parent MNEs or those which control non-resident subsidiaries. Control, for Income Tax purposes envisages instances where the other entity holds at least 51% shareholding in the other.
Every entity which enters into a transaction covered by transfer pricing is required to use any one of the five OECD (Organisation for Economic Cooperation & Development) methods, being the Cost Plus, Comparable Uncontrolled Price, Resale Price, Transactional Net Margin and Transactional Profit Split methods. These are complicated price determination methods that require the skilled input of specialised tax consultants to assist in implementation.
In order to apply the above stated OECD methods, corporates need to be prepared to fork out large sums of money to get the transfer pricing documentation prepared.
This is so as such corporates will have to pay heavy costs to access online data from international transfer pricing databases which give prices of comparable transactions from global trends.
There are no such databases in Botswana; meaning that corporates will rely on international suppliers who charge handsomely for access to such information.
The other onerous aspect about the transfer pricing documentation is that it has to be updated annually, which entails significant continuous investments into tax compliance. Further, the regulations stipulate that the
Whilst the transfer pricing provisions come with onerous obligations on MNEs, most of the subsidiaries in Botswana will not need to prepare the documentation from scratch as they mainly consume services from their parent entities.
Effectively, they just need to notify their parent entities to provide them with transfer pricing documentation which complies with the regulations. However, local enterprises with non-resident subsidiaries as well as IFSC entities will need to create the documents from scratch and these are the ones who will feel the weighty tax compliance obligations brought about by the regulations.
Affected corporates are then required to file the transfer pricing documents with each of their annual income tax returns.
BURS can also request for the transfer pricing documents at any time and failure to avail such documents attracts a penalty of P500, 000, which may be negotiated to not less than P250, 000.
The reason for filing of the transfer pricing documents with the income tax returns is to allow BURS to do pricing verification to detect any tax leakages.
In the event that BURS detects any tax leakages due to transfer pricing, it can charge penalties equivalent to 200% of the underdeclared tax as well as annual effective interest of 18.96%.
These penalties and interest can literally cripple businesses, hence the need to ensure compliance with the tax laws.
To show that the taxman is particularly worried about management fees charged to local MNEs by their parent companies, the regulations stipulate, amongst other various requirements, that any service in respect of which payments are made can only be those which are, ‘actually rendered.’
This is a clear indication that BURS will pay particular attention on management fees charged by parent entities to Botswana subsidiaries.
The first challenge with the regulations is that they came out too late, i.e. way after the commencement date of transfer pricing, which is July 1, 2019. This does not give affected taxpayers time to prepare the onerous documentation and file them with income tax returns.
The obvious effect is that some corporates may be found without the required documentation and be liable to penalties, if BURS does not provide commencement date concessions.
Secondly, the regulations do not provide transitional arrangements, which leaves some taxpayers in a quandary, especially those who have financial years ending immediately after July 1, 2019 such as July 31, 2019 or September 30, 2019.
Such taxpayers will not know whether they should prepare transfer pricing documentation for the three months of trading from July 1, 2019 to September 30, 2019 or wait for the next year with the full 12 months trading results.
Ideally, transfer pricing documents should cover a full year. BURS needs to clarify how these taxpayers will be treated, otherwise there will be panic in industry.
The other challenge with the law is that the Income Tax Act stipulates that the Minister of Finance & Economic Development shall stipulate the taxpayers and conditions under which such taxpayers may enter into advance price agreements with BURS.
The regulations are however silent on the matter and taxpayers and tax practitioners alike do not at this moment know how this will be handled.
Agreeing prices with BURS is advantageous to companies as they avoid attacks during BURS audits since they would have agreed the prices to be used in their transactions in advance with the taxman.
*Jonathan Hore is managing consultant at Aupracon Tax Specialists