The Impact of COVID19 on Transfer Pricing Arrangements for MNEs in Tanzania
Many businesses have been disrupted as a result of COVID19 and are currently adopting to the new normal, which includes among other things, working remotely and taking advantage of digitization to ensure productivity. While some industries are subsisting, others have been utterly affected by the pandemic. Corporations that are affected by the impact of COVID19 among others, are MNEs.
MNEs are groups of companies operating worldwide through locally incorporated branches or subsidiaries or other structures such as JVs and partnerships. They aim at optimizing the value chain of their goods or services through synergies.
For e.g. a group that sells cars establishes a manufacturing industry in China due to cheap raw materials, an assembling plant in India due to low labor cost and a distribution company in Europe due to high demand for cars. As a result of these arrangements, the price charged for the movement of goods, services, funds and intangible assets between the MNE entities from one country to another, is called a transfer price.
A transfer price is required to be at arm’s length from a tax perspective. Arm’s length means, the price charged by the MNE entities, should be similar to the price charged between unrelated companies under similar circumstances.
COVID-19 may have the following impact on the transfer pricing arrangements of MNEs in Tanzania:
a) Cash flow constraints leading to demand for financial support from related parties
Following the impact of COVID19 on businesses, MNEs may face cash flow constraints and hence rely on their sister companies for financial support. The financial support may be in the form of loans or extended credit terms, to mention a few. Such arrangements have to be conducted at arm’s length in order to avoid payment of additional taxes in the future.
Intragroup loans may be provided at reduced interest rates, or sister companies may ease the terms provided under existing intragroup loan agreements e.g. providing loan moratorium. Such terms in a perfect world, may be considered non-arm’s length especially if the borrower is unable to obtain similar terms from third party lenders. However, the current environment makes it more likely for an MNE to obtain reduced interest rates or loan moratorium from third party lenders and hence conclude that such transactions are reasonable from an arm’s length perspective.
b) Reporting of operating losses
Reporting of operating losses by an MNE with related party transactions, is a red flag for non-arm’s length transfer pricing arrangements. The TRA Transfer Pricing Guidelines require reasons for loss making to be explained in the transfer pricing documentation.
As MNEs are vulnerable to global economic fluctuations, they too may report operating losses as a result of COVID19. Hence, MNEs should maintain documentation with regard to all changes that had to be adopted amidst the pandemic, especially if such changes had an impact on the financial results of the company.
If the operating losses are attributed to related party transactions, then further assessment should be done to determine whether unrelated parties entering into similar transactions are also making operating losses during the same period, to conclude the arm’s length nature of the MNE’s transactions.
c)Risk of failure to prepare and file transfer pricing documentation by the due date
An MNE with related party transactions is required to prepare and maintain (or file with the TRA if total magnitude of related party transactions is TZS 10 billion or more) a transfer pricing documentation, by the time of filing their final tax return (i.e. six months after the financial year end).
Transfer pricing documentation is often prepared after the financial year end. The preparation process is typically long and thorough, as it requires deep understanding of the transactions, the functions performed and risks borne by each party in the transactions, among other things. Such understanding is obtained through field visits and by conducting interviews with key personnel of the company. Most of the times it also involves personnel from the group. The process of benchmarking the transactions and concluding whether they are at arm’s length or not, is also tedious. As such, the standard documentation period is typically not less than six weeks.
As a result of the measures taken by individuals and companies to minimize the spread of COVID19, the transfer pricing documentation process could take longer than the standard time and therefore expose the MNE to the risk of failure to have the documentation in place or file it with the TRA by the due date. The above exposes the MNE to a penalty of not less than TZS 52.5 million.
Conclusively, MNEs should proactively manage their tax affairs and ensure they are tax compliant at all times irrespective of any existing crisis. For those who do not know how to navigate the challenges brought about by the COVID19 in fulfilling their tax obligations, we advise you to contact a seasoned tax consultant to assist you fulfil your obligations to the Government. The Government should also ease the process of tax compliance and provide fiscal incentives to taxpayers.