How Businesses Are Swerving Taxes

Ghana cedi

“Madam Speaker, it is estimated that developing countries lose about US$160 Billion through transfer pricing fraud. Recent studies in the mining sector show that Ghana loses about US$36 Million through transfer pricing,” theses were the words of Dr. Kwabena Duffuor, Minister for Finance and Economic Planning when he presented the budget statement and economic policy of the Government of Ghana for the 2012 financial year to parliament on Wednesday, 16th November, 2011.

Transfer pricing refers to the allocation of profits for tax and other purposes between parts of a multinational corporate group.

Consider a profitable company group that buys gold or diamond, bauxite, timber or oil from its own subsidiary in Ghana: how much the foreign parent pays its subsidiary – the transfer price – will determine how much profit the Ghanaian unit reports and how much local tax it pays.

If the parent pays below normal local market prices, the Ghanaian unit may appear to be in financial difficulty even if the group as a whole shows a decent profit margin when the processed gold is sold.

Foreign tax administrators might not grumble as the profit will be reported at their end, but their Ghanaian counterparts will not to have much profit to tax on their side of the operation.

This problem only arises inside corporations with subsidiaries in more than one country; if the Foreign Company bought its gold, bauxite or diamond from an independent company in Ghana it would pay the market price, and the supplier would pay taxes on its own profits in the normal way.

It is the fact that the various parts of the organization are under some form of common control that is important for the tax authority as this may mean that transfers are not subject to the full play of market forces.

The good news is that Dr Duffuor said his ministry together with the Ghana Revenue Authority, had drafted regulations to strengthen existing tax legislation to deal with taxation of multinationals and minimize the incidence of abuse of transfer pricing.

Internationals Interventions

Organization for Economic Co-operation and Development, (OECD) is one of the leading institutions that is championing a Model Tax Convention.

To help countries in their treaty regimes, the OECD proposed a model tax treaty in 1963 known as the OECD Model Tax Convention, which is a draft model for double taxation agreement.

The OECD intended the commentary that is included in the model convention to form the basis of double taxation agreements between member countries.

Generally, it was to serve as the building block of most tax treaties and the basis of many of the articles related to transfer pricing.

In 1979, in response to governments and Multinational Enterprises (MNEs) interest in transfer pricing issues, the OECD made a publication on Transfer Pricing and MNEs.

The OECD introduced the guidelines to assist interested parties by indicating ways to find mutually satisfactory solutions to transfer pricing cases, thereby minimizing conflict and therefore costly litigation.

Many developed countries in the world, including the United States, have adopted the principles and approaches contained in the 1979 OECD Report.

The 1979 OECD Report endorsed the arm’s length principle as the international standard for dealing with transfer pricing issues. In the report, the OECD stated that ―the arm’s length principle should govern the evaluation of transfer prices among associated enterprises and global formulary apportionment does not represent a realistic alternative to that principle.

The arm’s length principle is set out in Article 9 of the OECD Model Tax Convention. Guidelines on how this principle should be put into practice were issued in 1979 and updated regularly, with the latest update made in.

OECD Guidelines outline five methods to determine the arm’s length nature of transfer prices:

1. Comparable uncontrolled price (CUP) method; which is based on the comparison of prices charged in a controlled transaction to the price charged in an uncontrolled transaction in comparable circumstances for comparable products and services.

2. Resale price method (RPM); which is based on the resale price at which a product purchased from a related party is sold to an independent enterprise. The transfer price of the inter-company transaction is calculated by deducting the resale price margin from the resale price in the uncontrolled transaction.

3. Cost plus method (CPM); which uses the costs incurred by the supplier of property/services in a controlled transaction. A mark-up taking into consideration the functions performed, risks assumed and assets employed is added to the costs to determine the arm’s length price in the controlled transaction.

4. Transactional net margin method (TNMM); which examines the net profit margin relative to an appropriate base (e.g. cost, sales, and assets) realized from a controlled transaction.

5. Profit split method (PSM); which is based on identification and appropriate split of the profit realized by related entities from a controlled transaction.

Sophisticated Guidelines

Due to the sophistication of the guidance and the economic importance of the participating countries, the OECD Guidelines have the potential to serve as a universally recognized approach to TP.

Furthermore, the OECD has a Global Relations programme, which promotes global dialogue on TP and aims at promoting good practice, building country transfer pricing capacity and feeding non-OECD country views into the OECD‟s work in this area.

From an economic perspective, the establishment of global standards and methods in the area of TP should be clearly advocated. Overall, double taxation is detrimental to economic development and is more likely to occur if there are mismatches in country approaches to TP. Harmonization of TP helps to facilitate bilateral and multilateral cooperation (e.g. in the area of exchange of information) and reduces the risk of double taxation through the promotion of advance pricing agreements (APAs‟) and MAPs. It also provides MNEs with more certainty for estimating what kind of consequences their activities and transactions trigger in terms of local taxation. International adherence to the OECD Guidelines may help foster development through investment.

The U.N. Model: Double Taxation Convention

Many developing countries, like Ghana, felt that the OECD Model was more appropriate for negotiations between developing countries and less suitable for capital importing or developing countries.

In 1979, the United Nations published a draft model tax agreement for use between developed and less developed countries.

The U.N. Model contains several articles related to transfer pricing issues. It is updated periodically, although not as often as the OECD model.

A major difference between the United Nation’s model agreements and the OECD Model is that the latter preserves more of the taxing rights of the country in which income arises, which tends to favor less developed countries.

Similar to the OECD model, Article 9 of the U.N. Model has, as its basic underpinnings, the principle of the arm’s length transaction.

The first paragraph allows a contracting state to make transfer pricing adjustments in the event that any pricing was not at arm’s length.

Ghana Regulations

Ghana has largely imported the international tax regime as envisaged by the United States, OECD model, and U.N. model.

Ghana’s income tax regime is governed by the Internal Revenue Act, 2000, Act 592 (―Act 592).This Act is structured as a code under which all taxation laws administered by the Ghanaian Revenue Authority.

Act 592 currently covers income, gift, and capital taxes.

A. Internal Revenue Act, 2000 (Act 592)

Under Act 592, the Commissioner of Income Tax is allowed to adjust transfers between associated enterprises that are not at arm’s length, where the prices that an agency or branch charges to its head office, or another related agency or company, do not reflect the prices that are charged among independent companies for similar operations.

Research with many officials of the Ghanaian Revenue Authority indicate that the Commissioner of Income Tax uses references in making the transfer pricing adjustments. These references are similar to the U.N. model and Section 482 of the U.S. Internal Revenue Code and include the comparable uncontrolled price method, the resale price method, and the cost plus method.

The three methods have widespread support, not only in Ghana, but in many developing countries. In case there are not comparable items in Ghana, Officers of Ghanaian Revenue Authority reference prices of goods and services in Arm’s length

In a bid to avoid such problems, current OECD international guidelines are based on the arm’s length principle – that a transfer price should be the same as if the two companies involved were indeed two independents, not part of the same corporate structure.

The arm’s length principle (ALP), despite its informal sounding name, is found in Article 9 of the OECD Model Tax Convention and is the framework for bilateral treaties between OECD countries, and many non-OECD governments, too. The OECD Transfer Pricing Guidelines provide a framework for settling such matters by providing considerable detail as to how to apply the arm’s length principle. In the hypothetical French-Dutch bicycle case, the French MNE could ask the two tax authorities to try to reach agreement on what the arm’s length transfer price of the bicycles is and avoid double taxation. It is likely that the original transfer price set by the MNE was wrong because it left all the profit with the manufacturer, while the Dutch proposal erred on the other side by wanting to transfer all the profit to the distributor.

But all of this assumes the best possible world, where tax authorities and MNEs work together in good faith. Yet transfer pricing has gained wider attention among governments and NGOs because of another risk: that it could be used to shift profits into low tax jurisdictions even if the MNE carries out little business activity in that jurisdiction. This leads to trade distortions, as well as tax distortions.

No country – poor, emerging or wealthy – wants its tax base to suffer because of transfer pricing. That is why the OECD has spent so much effort on developing its Transfer Pricing Guidelines. While they help corporations to avoid double taxation, they also help tax administrations to receive a fair share of the tax base of multinational enterprises. But abuse of transfer pricing may be a particular problem for developing countries, as companies might take advantage of it to get round exchange controls and to repatriate profits in a tax free form. The OECD provides technical assistance to developing countries to help them implement and administer transfer pricing rules in a broadly standard way, while reflecting their particular situation.

The government’s desire to increase revenue should be targeted. Quote from Obama’s affort to fighting transfer pricing “We plan to shrink a “tax gap” the IRS estimates may be as high as $345 billion.

US President Obama proposed to raise taxes on the overseas profits of U.S. companies and to go after evaders who abuse offshore tax shelters. The report states that under his plan, companies would not be able to write off domestic expenses for generating profits abroad. The goal is to reduce the incentive for U.S. companies to base all or part of their operations in other countries.

The main aim of this piece is to encourage Governments, Policy makers, Judiciary and Ghana Revenue Authority to make and implement laws, plans and programmes to fight these loopholes and gaps in revenue collections for our tax network system.

Written by Joshua Quashigah-Sowu, Freelance Journalist and Member of Institute of Finance and Economic Journalists (IFEJ) and Research Director at Development Data Group (DDG), a Policy Research and Advocacy Organization.

Joshua.Sowu@accamail.com/jsquashigah@gmail.com

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