Transfer pricing is not an exact science. It involves the pricing of goods or services outside normal commercial parameters so as to gain some tax advantages. Transfer pricing is anchored on the principle of the arm’s length. The arm’s length principle requires that compensation for any intercompany transaction should conform to the level that would have applied had the transaction taken place between unrelated parties, all other factors remaining the same. As the walls of the economies continue to be transparent through digitalisation, this has presented opportunities for tax avoidance and shifting of profits to lessen tax burdens. Multinational Entities (MNEs) are engaging in tax avoidance measures by shifting profits to jurisdictions with low profits due to variances in the rate of charging taxes across the different tax jurisdictions. Tax authorities worldwide are scrutinizing transfer pricing more closely than ever to ensure that tax is paid in the country in which the business activity has generated profits.
Transfer pricing: Zimbabwe perspective
Governed by the Income Tax Act, transfer pricing was introduced in Zimbabwe in January 2014. No specific transfer pricing regulations were in place before then. The country used to rely on other provisions of the Income Tax Act which govern carrying on of business which extends beyond Zimbabwe, rules on sale of any property, movable or immovable, at less than fair market price and rules for where there are business or financial relationships between interconnected parties here and outside Zimbabwe to mention but a few. These provisions were at the aid of the Commissioner to try and deter profit shifting by companies. However, a major pitfall was proving that transaction was entered into with the main or sole intention of avoiding or post pone the payment of tax.
The introduction of transfer pricing methods was through Finance Act no. 2 of 2015 when Zimbabwe first adopted the OECD transfer pricing guidelines for Multinational Enterprises and Tax Administrations. At this point the OECD transfer pricing methods focused on giving rules for determining the arm’s length price. This became the cornerstone of the Zimbabwe transfer pricing rules as enshrined in the Income Tax Act. Since the first adoption in 2016, the transfer pricing in the Zimbabwe Income Tax Act have remained the same despite the changes that have happened on the international arena with regards to transfer pricing through the OECD and other organisations such as the United Nations (UN).
Transfer pricing: An International perspective
Transfer pricing world over is governed by specific methods as set out in the Organisation for Economic Co-operation and Development (OECD) transfer pricing principles for Multinational Enterprises as well as the United Nations (UN) transfer pricing guidelines. The OECD enables co-ordination of creation of domestic and international policies through guidelines which are non-legislative but sets out commonly agreed principles. The UN produces a manual with principles for transfer pricing which is also principles based. Countries basically rely on these guidelines for development of legislation for transfer pricing. Although Zimbabwe is not a member of both, the transfer pricing rules currently incorporated in the Income Tax Act were developed with reference to both the OECD “Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations” and the UN Manual On Transfer pricing and this has been declared in the Income Tax Act.
Tax laws, along with the nexus and profits attribution rules, were built around traditional business forms and rely on their physical presence in a country. The existing international tax rules are based on agreements made in the 1920s and are enshrined in the global network of bilateral tax treaties. However, business models have evolved as a result of digitalisation and globalisation. It is imperative that the current international tax laws be reformed to address how the digital economy is taxed. The OECD, through the Inclusive Framework (IF), has in recent times worked on new measures to avoid tax avoidance by multinationals in a digital world. The OECD’s framework is focusing on addressing tax planning strategies known as Base Erosion and Profit Shifting (BEPS). BEPS refers to tax planning strategies used by multinational enterprises that exploit gaps and mismatches in tax rules to avoid paying tax. The OECD has on record that BEPS practices cost countries 100-240 billion USD in lost revenue annually, which is the equivalent to 4-10% of the global corporate income tax revenue.
The OECD has introduced a two-pillar approach (pillar one and pillar two) to help address tax avoidance, ensure coherence of international tax rules, and, ultimately, a more transparent tax environment.
Pillar One and Pillar Two
Pillar 1 focuses on rules for taxing profits and rights, with a formula to calculate the proportion of earnings taxable within each relevant jurisdiction for MNE groups with an annual global turn over €20 billion and 10 percent profitability. This will reallocate certain amounts of taxable income to market jurisdictions, resulting in a change in effective tax rate and cash tax obligations, as well as an impact on current transfer pricing arrangements. Pillar 2 looks at global minimum tax levies of 15% for Multinational Enterprises with a turnover of more than EUR750 million to discourage companies from shifting profits to lower-tax countries through international trading structures. Developed countries are entering into political agreements on Pillar 1 and Pillar 2 accepting the two-pillar solution. With increasing globalisation and the upsurge of transactions with multinational companies, Zimbabwe stands to benefit if it continues to benchmark its transfer pricing rules to the international standards by adopting the OECD proposed two pillar approach.