Think you don’t need to worry about transfer pricing? Think again!

Be warned – transfer pricing disputes are at an all-time high as tax authorities globally continue to apply pressure on taxpayers, with a renewed focus on transfer pricing (“TP”) in the COVID 19 environment.  Many mid-size or smaller firms still think that somehow TP doesn’t apply to them, but it’s the soft middle that is currently being squeezed the hardest by tax authorities, especially in SA and across Africa.

TP disputes on the rise
Global tax disputes have recently focussed on many TP aspects, such as intellectual property (“IP”), substance, and the usage of conduit companies. Major business players have been locked in TP disputes this year, from Nike’s battle with the European Commission to Molinos Río de la Plata’s dispute with the Argentinian Supreme Court. The Nike case revolved around cross-border royalty payments and State Aid, and the Molinos Río case concentrated on the contentious issue of treaty shopping. Neither case ended well for the taxpayer.

We are witnessing the same trends now across Africa, with an increase in aggressive, and often spurious, assessments being raised, often with a “pay now, argue later” approach where full- or part-settlement of the tax is required upfront and the onus is then on the taxpayer to try to win his case following due process, which can take years.

Intangibles and what on earth is DEMPE?
With more and more focus on the taxation of IP and other intangibles, clear guidance is critical.  However, the OECD “guidelines”, although huge in volume, are frustratingly vague on how to allocate IP and concomitant revenue streams.  Ok we know we have to apply the famous DEMPE principle and thus consider where the IP is Developed, Enhanced, Maintained, Protected, and Exploited, and allocate accordingly.  But what does this actually mean in practice?  As we are seeing, through various disputes and court cases, nobody really knows, although, as usual, the taxman seems to have different views to the businessman.

To manage such risks, businesses need to ensure they have comprehensive support for their own assessment of DEMPE through in-depth reviews of functional contributions and processes. Thus, multinationals should consider amending responsibilities, clarifying internal guidelines, or changing their TP models to ensure robust and supportable on a go-forward basis.

Furthermore, and in line with the COVID 19 Guidance issued by the OECD last December, performing collaborative support through the use of complementary TP methods will help mitigate future controversy.

Beware of loss-making entities in Africa
Another key area of focus for the African tax authorities is loss-making entities. Tough timing as Covid has of course resulted in many losses so it’s frustrating that these are now used as a stick to hit businesses with TP queries. TP audits often focus on companies within a multinational group that book consistent losses over a number of years.

One of the key questions tax authorities are examining is at which point would an independent company not tolerate recurring losses?  Another impossible question to answer and thus ripe for tax disputes. Certainly, an independent company would cease activities at some point, and not continue to incur losses indefinitely. On the other hand, losses for reasonable periods can be justifiable from an arm’s length perspective. As such the TP narrative is critical in terms of understanding the reasons behind the losses to mitigate potential disputes.

Are you dispute ready?
TP disputes are not only on the rise, but they are also complex, time-consuming, and very expensive. They also tend to attract negative reputational perceptions. The first step in terms of being dispute-ready would be to ensure robust TP Documentation is in place, but this is just a good starting place! If you are keen to ensure you have done your TP due diligence, please contact us.