Over the past three decades, the expansion of world trade has been at the forefront of the economics of international trade. The term globalisation was coined and an increase in the number of cross-border or multinational firms emerged. With the expansion of multinationals seeking opportunities to increase productivity and to maximise profits, they realised the differences in corporate tax rates could have a tremendous impact on the company’s bottom line. In an attempt to reduce their worldwide tax payments, one area of focus was on ways to structure transactions between entities within the same controlled group but located in different countries.
The concept of Transfer Pricing
Although this basic concept can be viewed as good management practice, the problem occurs when a company intentionally over or under values the price of goods and services sold by one division in a company to another (a transaction referred to as not at arm’s length). The prices are then used to determine the individual companies’ profit or loss. The range of corporate tax rates in different countries can be viewed as an incentive for companies to shift profits from highly taxed countries to more lightly taxed locations.
It is the practice, however, of multinational companies’ arbitrarily establishing prices for goods and services for the sole purpose of minimising tax payments in the countries in which they operate which has caught the attention of tax administrators worldwide. This practice has been referred to as ‘transfer pricing’.
An Illustration of Transfer Pricing
Consider a profitable parent company, Y, located in a tax haven country (a location where either rates of taxation or levels of enforcement are low) which has subsidiary companies in countries A and C respectively. The parent company acquires raw materials below the arm’s length price from company X.Due to the fact that company X sells its raw materials below the normal price; it will either incur losses or will generate very little profits. Parent company Y will have the raw materials manufactured and sell the finished goods to company Z at above arm’s length price. Because Z purchases the goods at very high prices, the company will either experience losses or will have very little taxable profit.
• Since company Y acquired the raw materials below arm’s length price and sold manufactured goods above arm’s length price, Y would be accumulating profits. However, because it is located in a tax haven country, they will pay little or no taxes.
• Since X sold the raw material below the arm’s length price thereby reducing its income, it will incur a loss or show little profit. Therefore, it will pay little or no taxes.
• Since Z purchased the finished products above the arm’s length price thereby increasing its cost of goods sold, it will also incur a loss or show little profit. Therefore, it too will pay little or no taxes.
Why should developing countries like Liberia notice?
The issue of transfer pricing was once only addressed by tax administrators in developed countries. However, developing countries like Liberia are now taking notice. As multinational companies look for the next emerging market, countries like Liberia with its vast natural resources provides an attractive business opportunity. Liberia houses one of the largest rubber plantations in the world. It contains deep virgin forest full of tropical timber. It has a mining sector for gold and diamonds.
It has a vast iron-ore mountainous range. With the recent discovery of oil in neighboring Sierra Leone,the exploration of oil and gas has caught the attention of major companies.While Liberia is aggressively cultivating direct foreign investments, lawmakers recognise Liberia could be vulnerable to having its natural resources transported to other countries through unfavourable transfer pricing transactions. As a result, tax administrators and policy makers are carefully evaluating whether they are securing the proper amount of tax revenue badly needed to aid in the rebuilding of a country torn apart by years of civil war.Lawmakers began by addressing how policies and procedures can be strengthened in the area of transfer pricing.
The Republic of Liberia recently issued the Consolidated Tax Amendment Act of 2011 which contained provisions aimed at strengthening its policies in an effort to minimise risk associated with structured transfer pricing transactions.
First, the aim was to make Liberia a more attractive option for multinational companies by reducing the corporate tax rates from 35% to 25%. In conjunction with the rate reduction, the act provides strategic tax incentive deductions for new capital investments – up to 100% of the cost of qualifying assets but in various categories.
Technical experts have been solicited to aid in the structuring of guidelines for advance pricing agreements in major sectors. This would include increased disclosure of financial reports and cross border transactions. Liberia is aggressively moving to establish practices in line with international best practices and utilising the Organization for Economic Co-operation and Development (OECD) as guidance. Liberia has signed 11 tax information exchange agreements (TIEA) with European countries and is in the process of concluding signing TIEA arrangements with its neighbour, Ghana.
In the area of enforcing compliance, the Ministry of Finance recently recruited approximately 70 new auditors and has embarked on an extensive training programme to enhance its skill sets in which to adequately focus on technical issues involving multinational companies.They have begun an aggressive programme to develop technical expertise in various sectors.These individuals will then serve as technical advisers to both internal and external stakeholders.
The new policies and procedures Liberia has adopted serve to promote balanced economic growth while protecting the tax base.Liberia is also building partnerships with investors to ensure the new policies and procedures provide a win-win situation for the citizens of Liberia and the investors.
Source: By Yassie Hodges (TaxTalk)