Uganda, like many other countries in the region and further afield introduced transfer-pricing regulations in 2011. The regulations became effective on July 1st 2011 and are based on the Organization for Economic Co-operation and Development (OECD) transfer pricing rules. The Commissioner General of the Uganda Revenue Authority (URA) issued a Practice Note guiding companies on how to deal with related party transactions. The authority for citation is S.90 and S.91 of the Income Tax Act, Cap. 340 read together with the Transfer Pricing Regulations 2011 and the Transfer Pricing Practice Note 2012.
Transfer pricing refers to the way in which prices for goods and services are set between associated or related parties. Associated enterprises are capable of setting their inter-company prices in a way that enables them to shift taxable profits to different jurisdictions. This presents challenges to tax administrations as it erodes the tax base. Therefore, transfer pricing rules require prices of goods and services between associated parties to be set at arm’s length that is as they would have been set between independent parties acting in the ordinary course of business.
Take for example a company trading in India and Uganda. It can overprice goods in Uganda or charge the Ugandan business for fictitious services. The effect of such overpricing is to transfer profits to the Indian tax jurisdiction without those profits being taxed. Hence the transfer pricing regulations.
The rules apply to controlled transactions for multinational enterprises (MNEs) or controlled transactions in aggregate equal to or exceeding 25,000 currency points in a year of income (500million Uganda shillings (UGX)). This includes transactions between related parties within and without the country. Such transactions must be at an ‘arms length price’ or they will be disallowed under the transfer pricing regulations.
But technically, there is no such thing as a correct arm’s length price. Even in transactions between independent parties, prices differ. Therefore, in terms of transfer pricing, people tend to refer to an “appropriate arm’s length price”. This is because transfer pricing is subjective and judgement is largely based on comparability with similar independent parties. Considerations such as economic factors, the nature of the goods or services transacted and the business strategies employed by the associate relative to similar independent enterprises are taken into account. A determination of the appropriate arm’s length price is arrived at after extensive comparisons have been undertaken.
The regulations empower the Commissioner (at URA) to make appropriate adjustments to a person’s taxable profits if the pricing is not considered to be arm’s length. A transfer pricing adjustment normally leads to an increase of the taxable profits. The likelihood of a transfer pricing adjustment presents significant risks e.g tax penalties Therefore, it is important to get it right.
For all transactions, which meet the transfer-pricing threshold, a transfer pricing study must be prepared to show that the pricing arrangements for each related party transaction meets the transfer pricing criteria before the company files their final annual tax returns for the given financial year. Mere failure to prepare a study can lead to penalization.
But are multi-national corporations operating in Uganda abiding by these rules? It appears that many have not heeded or understood the regulations and the expectations. While the URA seems not to have started proactively enforcing these rules, it is just a matter of time before the penny drops.
Many MNC’s have been engaging in related party transactions involving payment of professional, franchise and technology transfer fees. Others have arrangements under which group costs are termed ‘shared costs’ on the basis of revenues and employees.
But the transfer pricing issues around these schemes remain unresolved and the URA is starting to nose in. And now that the rules are in place, tax practitioners will recall the fate of Kenya Revenue Authority in relation to a transfer-pricing dispute with Unilever Kenya and Unilever Uganda. In that case (2005), Unilever carried the day essentially because transfer-pricing regulations were not clearly outlined in Kenya’s tax legislation. But the situation has since changed and such practice may not be looked on favourably.
For example, the media reported in October 2015 that one of the telecom companies had been accused of failing to provide evidence to justify shifting huge amounts of cash out of Uganda to a company located in another tax jurisdiction, potentially lowering its tax bill in Uganda. This matter remains the subject of a controversy and is an ongoing dispute with Uganda Revenue Authority and the telco. According to the report, these payments were for ‘management services’. However, after there were several open-ended questions regarding the transactions and these remain unanswered.
There are many MNC’s in the same boat. With tax revenue shortfalls beginning to bite as the economy takes a nose dive, it is only a matter of time before the tax authorities ‘get interested’. Some of the MNC’s have asked the URA to review their related party transactions but the URA has been reluctant to put its position in writing thereby committing itself. The situation therefore remains very fluid and unresolved. But once bitten, twice shy. Overstretched tax authorities are always not aghast to tax farming. The transfer-pricing bomb is ticking away.