Challenges of TP in Ghana(final)

ADDRESSING THE

CHALLENGES OF TRANSFER

PRICING IN GHANA

SPEAKER:

WILLIAM KOFI OWUSU DEMITIA MTP(SA), LL.B (Hons), BL, LL.M (Int. Tax), MBA (Fin)

(Senior Associate Consultant)

WTS Ghana

(Tax Legal Consulting)

E-mail: [email protected]. william.owusudemitia.wts.com.gh

The then Minister of Finance in Clause 85 of his presentation of the 2012 Budget Statement to the Ghanaian Parliament stated inter alia “it is estimated that developing countries lose about US$160 billion every year through transfer pricing fraud. Recent studies in the mining sector showed that Ghana loses about US$36 million a year through transfer pricing.”

Transfer Pricing Abuse in

Ghana

This statement highlights the pervasive nature of transfer pricing fraud and these revelations provided the catalyst needed to jumpstart the consultative process, which culminated in the Ghanaian transfer pricing regulations.

Transfer Pricing Abuse in

Ghana

The 21st century has seen a lot of foreign direct investment (FDI) in African countries including Ghana. Africa is rich in resources and income generated by MNEs in the extractive, retail and services industries are usually sourced in Africa.

The desire of MNEs to repatriate returns on their investment provides an incentive for transfer pricing manipulations within the group.

Relevance of Transfer Pricing

in Ghana

Although transfer pricing is mainly associated with cross-broader transactions, the existence of industry concessions and location savings in the domestic laws of Ghana gives room for domestic transfer pricing manipulations


in Ghana

Section 11 of the Internal Revenue Act, 2000

(Act 592) of Ghana contains industry concessions

that enable taxpayers in these industries to enjoy

specific tax holidays. The First Schedule to Act

592 also provides tax incentives for

manufacturing enterprises located outside the

cities of Accra and Tema.


in Ghana

Section 22 and 28 of the Free Zones Act, 1995

(Act 504) also provide tax exemptions on imports

and tax holidays for Free Zones entities.


in Ghana

By manipulating the transactional prices among members in the same group, income can be shifted from one company operating in an industry without tax concessions to another company enjoying tax incentives thereby eroding the tax base. This may either give a temporary or a permanent deferral of tax on that income.


in Ghana

Intragroup financing arrangements also create high interest rates on loans and since interest payments are deductible for tax purposes, it reduces the chargeable income of the company in Ghana thereby reducing its corporate income tax.


in Ghana

Also since the withholding tax rate on interest payment is 8% and the corporate income tax for companies is 25%, (but 35% for mining and petroleum) there is a tax incentive to strip income through interest because for every Ghana Cedi of corporate income that the group can re-characterizes as interest payment, it makes savings on taxes.


in Ghana

Similarly, the use of intragroup services including management and technical services and intragroup supply of raw materials to subsidiaries in Ghana provide enormous opportunities for transfer pricing manipulations with its attendant tax savings to companies and revenue losses to the state


in Ghana

Management and Technical Services fees are subject

to a final withholding tax of 20% while the corporate

income tax for companies is 25%, (but 35% for

mining and petroleum) and given the fact that these

payments are deductible for tax purposes, it reduces

the chargeable income of the company in Ghana

thereby reducing its corporate income tax.


in Ghana

In addition, the creation and use of intangibles such

as intellectual property rights by MNEs give rise to

royalty payments, which are deductible for tax

purposes and therefore provides an avenue for

transfer pricing manipulations.


in Ghana

Royalty payments are subject to a final withholding tax of 15% while the corporate income tax for companies is 25% (but 35% for mining and petroleum) .

Also, Ghana’s Double Taxation Agreements (DTA) either reduce withholding tax rates on passive incomes or in some cases allocate the income to the residence of the owner which denies Ghana the ability to tax the income.


in Ghana

Reduced withholding rates on passive incomes such as royalties, interests, technical and management services in tax treaties and the harmful tax competition (race to the bottom) adopted by most African countries including Ghana to attract FDI also encourage transfer pricing.


in Ghana

Regulation 2(1) of L.I. 2188 provides that for any transaction entered into by persons in a controlled relationship , the profit and loss arising out of such transaction should be computed using arm’s length standard.

Transfer Pricing Regulations,

2012 (LI 2188)

Arm’s Length Standard

A transaction is conducted at arm’s length if the terms of the transaction do not differ from the terms of a comparable transaction between independent persons


2012 (LI 2188)

Arm’s Length Standard

Persons who engage in a transaction with related persons must compute the price of the goods to be sold or the services to be rendered based on the following methods:

(a) the comparable uncontrolled price method;


2012 (LI 2188)

Choosing an appropriate TP method

(b) the resale price method;

(c) the cost-plus method;

(d) the transactional profit split method; and

(e) the transactional net margin method.


2012 (LI 2188)


A taxpayer has the option of using an unspecified method if that taxpayer obtains the permission of the Commissioner-General of GRA.


2012 (LI 2188)


Taxpayers who engage in controlled transactions in a year are required to maintain contemporaneous documentation covering these transactions

The documentation must provide information on the transfer pricing method selected by the taxpayer, any assumption made in applying the method, any adjustments made as a result of applying the method,


2012 (LI 2188)

Documentation & Audit

justification for use of the method, the comparables chosen and the screening criteria used in selecting the comparables and the comparability analysis made


2012 (LI 2188)


Information must also be provided on the calculations and price adjustment factors used in determining comparability, determination and use of any arm’s length range and justification for the determination and use of the arm’s length range.


2012 (LI 2188)


The taxpayer must also provide information on organizational structure of the MNE including the location and ownership linkages amongst associated persons;


2012 (LI 2188)


The nature of the business in which the transaction took place, the property used and the extent of any other commercial or financial relationship as well as details of the transactions including the terms of the contracts or agreements.


2012 (LI 2188)


The strategies and policies applied to ensure that the transaction is at arm’s length, the principal business activities of each person in the group including the business relationships among the associated persons and the consolidated financial statement of the group must be provided in the documentation.


2012 (LI 2188)


In addition, the documentation must include information on the industry dynamics, market, regulatory and economic conditions under which the associated party operates as well as information on the functions and risks assumed by the associated party and the assets employed.


2012 (LI 2188)


The requirement of preparing documentation to cover each transaction entered into between related parties imposes a huge burden on taxpayers and depending on the volume of these transactions in a given year, the taxpayer is likely to incur huge cost to build and maintain contemporaneous documentation to support intra group transactional prices.

Transfer Pricing Challenges

Transfer Pricing Documentation

The regulations incorporate the penalties imposed by the Internal Revenue Act, 2000 (Act 592) for offences relating to fraud, failure to file returns and underpayment of tax. A tax due as a result of a profit adjustment made by the Commissioner-General under the transfer pricing regulations is treated as an additional tax under Act 592

The penalty provisions incorporated into the transfer pricing regulations address both the substantive and the procedural aspects of non-compliance with the transfer pricing rules.


Inadequate Penalty Provision

For example, if a company fails to furnish the transfer pricing documentation within the time specified by the Commissioner-General in a notice, the taxpayer is liable to pay a penalty of four currency points for each day of default

The major problem with the penalties imposed for breach of transfer pricing regulations is that it is insignificant to deter MNEs from flouting these rules. The highest penalty unit imposed as penalty is 100 units and this amounts to GHS1,200 ($300).



This penalty will do little to deter taxpayers from engaging in aggressive tax planning



Finding comparable items and transactions to enable a taxpayer carryout comparability analysis and determine an arm’s length range poses a huge challenge for taxpayers.

The situation is worsened when a taxpayer has to find comparables for intangibles and other items that are trade secrets. For example, what is the comparable for KFC’s preparation formula for chicken or the formula for coke?


The Comparables Conundrum

Having an internal comparable uncontrolled price (CUP) helps reduce this tax compliance burden but it is not always easy to have an internal comparable uncontrolled price. This is because some intragroup transactions or services are provided solely to members within the same group.

Another burning issue is; do subsidiaries or sale representatives create marketing intangibles when they develop market for products thus making these sale representatives eligible to receive compensation?



The OECD states that “marketing intangibles include trademarks and trade names that aid in the commercial exploitation of a product or service, customer lists, distribution channels, and unique names, symbols, or pictures that have an important promotional value for the product concerned.”

However it is sometimes difficult to make a clear-cut distinction between advertising, which promotes the sale of the product, and marketing intangibles, which add value to the owner’s IP.



Again, since Ghana does not have a national comparability database, the tasks of conducting a comparability analysis becomes difficult. If a taxpayer lacks an internal comparable uncontrolled price and information on the transactional prices from other competitors are not readily available, a taxpayer has no option than to take a margin and defend it.


Lack of Comparability Database

When a transfer pricing audit results in a reallocation of income from another country into Ghana, there is a real likelihood that the MNE will suffer double taxation on that income reallocated to Ghana. Such transfer pricing adjustments are usually settled through mutual agreement procedures (MAP) between the competent authorities of the two countries.


Risk of Transfer Pricing Adjustment

However, under the Practice Note on Transfer Pricing Regulations issued by the Commissioner-General, mutual agreement procedures (MAP) for corresponding adjustment in the other country can only be activated if Ghana has a Double Taxation Agreement (DTA) with the country. Since Ghana currently has only nine (9) DTAs in force, with The United Kingdom, The Netherlands, Switzerland, Denmark, Belgium, France, South Africa, Italy and Germany, there is a real likelihood that taxpayers whose countries do not have DTAs will suffer double taxation.


The transfer pricing regulations do not provide guidance on “package deals”. Package deals often involve charging a single price for the transfer of intangibles, the provision of technical and management services as well as the leasing of production facilities in a single transaction


Package Deals

These package deals provide enormous benefits to MNEs since the tax rates for each of the items differ significantly. It is arguable that the Commissioner-General can employ the G.A.A.R. provisions to defeat such an arrangement but failure of the transfer pricing regulations to provide detailed treatment for these complex but common transactions is a source of concern.


The transfer pricing regulations is also silent on the tax treatment of cost contribution agreements. The OECD defines cost contribution agreements as a “framework agreed among business enterprises to share the costs and risks of developing producing or obtaining assets, services or rights and to determine the nature and extent of the interests of each participant in those assets, services or rights.”


Cost Contributions

Penalty provisions are designed to make non-compliance costly than compliance. Therefore, if the cost of non-compliance is negligible or insignificant to the taxpayer, the penalty provisions lose their essence. The current penalty provisions, which are borrowed from the main Internal Revenue Act are not attuned to address cross border transactions which involve huge sums of money.

Recommendations

Improve Penalty Provisions

The US enacted exclusive penalty provisions for breach of its transfer pricing provisions. There is a substantial valuation misstatement penalty (20%) and the gross valuation misstatement penalty (40%).

Recommendations

Improve Penalty Provisions

The transfer pricing regulations do not specifically address cost contribution arrangements. Detailed regulations on cost contribution arrangements should be provided in the transfer pricing regulations.

Recommendations

Guidance on Cost Contributions

Guidelines should be provided on “package deals”. The OECD guidelines recommend that such transactions should be evaluated using principles on aggregation and segregation. This may involve segregating the entire transaction into individual elements to determine whether the individual components conform to arm’s length principle or in other instances evaluating the entire transaction to determine whether it conforms to the arm’s length principle.

Recommendations

Guidance on Package Deals

Safe harbours can be provided for transactions recurring every year thereby reducing the need for building documentation every year.

Transactional values of the previous year will only be adjusted to compensate for economic conditions to enable us determine current year prices.

Recommendations

Develop Safe Harbours

In addition, Technology Transfer Regulations, 1992 (LI 1547) provide permissible margins for technology transfers. These margins could be used to develop safe harbour provisions thereby eliminating the need for a full-scale comparability analysis.

Recommendations

Develop Safe Harbours

The Discussion Draft on Action Plan 10 defines low value-adding intra-group services as:

• services performed by one member of an MNE group on behalf of other group members which are of a supportive nature;

• are not part of the core business of the MNE group; do not require the use of unique and valuable intangibles and do not lead to the creation of unique and valuable intangibles; and

Recommendations

Create Low Value Intra Group Services

• do not involve the assumption or control of substantial or significant risk and do not give rise to the creation of significant risk.

The proposal is limited to services such accounting and auditing, human resources activities, information technology, internal and external communications, legal services and activities with regard to tax obligations.

The mark-up on such services should range between 2 – 5 %.

Create Low Value Intra Group Services

The Risk assessment manual developed by the Transfer Pricing Unit of the Ghana Revenue Authority, which will be used for determining whether the transfer pricing return submitted by a taxpayer should be selected for transfer pricing audit is a positive and commendable step.

There is a need for broad based consultations on the content of the manual to enable taxpayers know what they ought to do to comply

Recommendations

Implement Risk Assessment Manual

There is the need for concerted efforts to develop a national comparability database to serve as a guide to both tax administrators who will undertake transfer pricing audits and taxpayers who engage in related party transactions that require the preparation of transfer pricing documentation.

Recommendations

Develop a Comparability Database

Although transfer pricing manipulations have eroded Ghana’s tax base in times past, there is the need for us to pursue strategies, which provide relevant information to tax authorities while reducing the burden of tax compliance on the taxpayers.

A balanced approach to solving the issues will aid voluntary compliance by taxpayers and reduce the need for enforcement by tax authorities.

Conclusion

Challenges of TP in Ghana(final)

Documents

Transcript of Challenges of TP in Ghana(final)