Thursday, August 5, 2021

Can transfer pricing rules stop illicit financial outflows?

GABORONE – Botswana is estimated to be losing billions of pulas every year through illicit financial flows. 

And this is where it gets complicated: There is little information on how these funds are lost from the country. However recent regulations passed such as the transfer pricing rules might help slow the outflows.

According to Global Financial Integrity’s most recent data contained in the March 2019 report, the world’s top diamond producer by value has reportedly lost US$610 million in financial outflows in 2015. 

Botswana was dealt a heavy blow in 2018 by the Financial Action Task Force (FATF) which placed it in the notorious list of countries grey-listed for lacking strategic Anti-Money Laundering and Counter-Terrorism Financing (AML/CFT). Furthermore, Botswana was blacklisted  by the European Commission (EU) this year, citing reasons similar to FAFT

The developments have led to debates about Botswana’s lax financial regulatory laws, with many of the critics attributing much of the legal and illegal financial flows to the country’s lack of foreign exchange controls, which allows individuals and companies to ship large sums outside the country.

In response and under pressure to close the identified strategic deficiencies, the Botswana government has in the past two years passed a raft of laws to plug the loopholes. One of the key pieces of legislation passed was the Income Amendment Act in 2019, which introduced the price transfer regulations that became effective on 12 July 2019. 

When pushing for the regulations, former minister of Finance and Economic Development Kenneth Matambo said the bill was aimed at ensuring that Botswana met international obligations as required by the OECD Forum on harmful tax practices. He stated that the rules would not only assist in curbing shifting of income or profit from Botswana to other tax jurisdictions but would also ensure that tax laws were responding to other international taxation requirements or minimum standards.

The amended Income Tax also limits the amount of net interest that could be deducted as an expense in a year, with deductions of an interest expense not to  exceed 30 per cent of the tax earnings before interest, tax, depreciation and amortisation. 

According to OECD transfer pricing guidelines, transactions between directly or indirectly connected persons should be consistent with the arm’s length principle. A transaction with a connected party is considered to be consistent with the arm’s length principle if the conditions of the transaction do not differ from the conditions that would have applied between independent persons in a comparable transaction conducted in comparable circumstances.

“The rule attempts to ensure that prices charged by associated parties in a certain transaction reflects market conditions and not inflated or deflated to shift profits. Shifting revenues may affect collection efforts of tax administrators hence it is important for them to always conduct Transfer Pricing audits to counter those practices,” said Tumelo Rannau, a former KPMG tax specialist and founder of The Tax Platform, in an interview.

He disclosed that the transfer pricing rules will apply to businesses whose parent companies have a controlling stake and have non-resident associated parties. In case of a minority shareholder having a management contract no control is assumed and therefore no need to submit transfer pricing documentation, Rannau added. 

One industry that will be impacted by the new rules is the lucrative banking sector, which is dominated by international banks. The top three leading commercial banks in Botswana shell out millions of pulas through service level agreements that exist between them and their beneficial owners. Prior to 2019, these service level agreements or franchise fees were not vetted by the Botswana tax authorities since there were no legal enforcement of such. 

“Prior to the transfer price rules in Botswana, firms could get away with unexplained expenses paid to related companies. This was because there was no law that bound those companies to comply with transfer pricing rules as espoused by OECD and UN rules,” Rannau added. 

Going forward, transfer pricing documentation will be an important source of information when conducting inter-party related transaction audits by tax authorities, suggested the tax specialist,  and explained that transfer pricing case law has shown that facts of each audit are important and therefore when doing transfer pricing adjustment, tax authorities should be conversant with arrangements of the taxpayers and how they have arrived at their conclusions.

“In light of this, taxpayers also consider the risks that may arise from their arrangements when preparing transfer pricing documentation and choosing a method to apply in their group arrangements. This minimizes the chances of transfer pricing adjustments in the future though it does not necessarily stop the tax authority from making those adjustments. A thoroughly prepared transfer pricing document and policy though is likely to anticipate all these risks and therefore becomes a great risk mitigation tool,” said Rannau in a written response. 

Pusetso Morapedi, founder and executive director of Botswana Centre for Public Integrity (BCPI), a non-governmental organisation said transparency on how the system would work was critical to fighting corruption.

Morapedi said as an advocacy organisation promoting transparency and public accountability, they welcomed the introduction of transfer pricing regulations which would mitigate loss of revenue, as more taxes collected would go towards helping ordinary citizens. 

“If companies are going to use transfer pricing to lower their tax liabilities, it also erodes the national revenue base,” she said in an interview.

“It affects resource mobilisation of a particular country and how much money goes to citizens in terms of service delivery. So, we do care very much about what happens with issues of transfer pricing,” she added.  

This story was produced by The Telegraph. It was written as part of Wealth of Nations, a media skills development programme run by the Thomson Reuters Foundation in partnership with The African Centre for Media Excellence. More information at www.wealth-of-nations.org. The content is the sole responsibility of the author and the publisher.

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