The Balance Between Borders: Navigating Transfer Pricing in Tanzania

Transfer pricing refers to determination of prices charged for intercompany transactions between associated enterprises, such as subsidiaries, affiliates, or divisions of a multinational company. In the intricate waters of global commerce, transfer pricing flows as a crucial current, steering the tides of cross-border transactions. As the legendary economist Adam Smith aptly said “Taxes are the price we pay for civilization,” a reminder that fair compliance keeps businesses secure in an ever-evolving global tax landscape. For Tanzanian companies engaging in international transactions, the challenge lies in navigating tax audits and adjustments through accurate pricing and thorough documentation. With proactive compliance and insight, companies can navigate the intricate waters of transfer pricing with clarity and precision, ensuring that their “catch” is both fair and sustainable amidst global scrutiny. 

As the global economy moves towards deeper integration, Tanzania has intensified its efforts to ensure that transactions between affiliated entities are fair, transparent, and, crucially, at arm’s length. This article will explore the intricacies of transfer pricing in Tanzania, legislative framework, methods, the challenges it presents, the broader tapestry of international standards and precedents, and uncover the lessons that businesses can draw to thrive within the shifting tides of tax scrutiny.

The General Basics of Transfer Pricing: At Arm’s Length

Transfer pricing involves intercompany transactions which encompass a broad range of commercial or financial dealings, including the sale of goods, provision of services, transfer of intellectual property, or financing arrangements like intercompany loans or guarantees. At the heart of transfer pricing, the principle that serves as the benchmark for evaluating intercompany transactions, is the “arm’s length principle”. This principle ensures that transactions between associated enterprises mirror those between unrelated parties. The term “arm’s length” is derived from the idea of maintaining a figurative “arm’s length” distance between parties to ensure objectivity and independence in transactions. This is the fundamental standard against which inter-company transactions are measured, ensuring they reflect market realities rather than artificial profit shifting and colluding or adjusting terms based on their relationship. In Tanzania, Section 33 of the Income Tax Act and Regulation 4 of the Tax Administration (Transfer Pricing) Regulations of 2018 captures this doctrine, requiring taxpayers and the Tanzania Revenue Authority (TRA) to assess whether intercompany transactions occur at market value. This principle resonates with Article 9 of the OECD Model Tax Convention and the Transfer Pricing Guidelines, 2020 which underscore that transfer pricing should be based on independent transaction conditions, protecting both revenue authorities and businesses from unfair tax burdens or profit allocations.

A Framework for Compliance in Tanzania

Under Section 33 of Tanzania’s Income Tax Act and the Tax Administration (Transfer Pricing) Regulations of 2018, businesses must uphold the arm’s length principle. The Tax Administration (Transfer Pricing) Regulations, 2018 introduced a structured approach to compliance. With requirements for documentation, functional analyses, and transfer pricing adjustments, the Regulations push entities towards transparency. These rules align closely with the OECD’s guidelines and the UN Model Convention, 2017 but are distinctively tailored to reflect Tanzania’s specific economic and regulatory environment. 

To comply, businesses must submit contemporaneous documentation with their tax returns to substantiate their pricing methods and functional analysis. The TRA evaluates if these elements align with what would be expected in an arm’s length arrangement, and whether any profit-shifting has occurred.

A. Contemporaneous Documentation: The Key to Compliance

Tanzanian businesses engaged in controlled transactions must prepare contemporaneous documentation to substantiate their transfer pricing arrangements as stipulated under Regulation 7. This documentation must be submitted alongside tax returns and retained for at least five years. Key documents include:

1. Financial Statements: Audited accounts reflecting the economic substance of transactions.
2. Income Tax returns: Representing the value of all controlled transactions in a particular year of income. They should be available for TRA inspection upon request.
3. Inter-company Agreements: Contracts and agreements between related entities specifying terms, prices, and obligations. 
4. An overview of the multinational group: Including its structure, business operations, and global transfer pricing policies.
5. Local File: Detailed information about the Tanzanian entity, including financial data, descriptions of controlled transactions, and transfer pricing methods.
6. Transactional Data: Invoices, contracts, and intercompany agreements that define pricing terms.
7. Functional and Risk Analyses: Documentation demonstrating the roles, risks, and asset contributions of each entity.

B. Thresholds for Contemporaneous Documentation

Regulation 7(3) provides the threshold of filing documentation. Entities whose total transactions amount to TZS 10 billion, must file transfer pricing documentation along with the Income Tax Returns for the particular year of income. For other businesses below this threshold, the documentation must still be maintained and submitted upon request.

C. Functional Analysis: A Cornerstone of Compliance

A functional analysis forms the basis of transfer pricing compliance by examining the roles and responsibilities of each related entity in a transaction. It must answer three critical questions:

1. Functions Performed: What economic activities (e.g., manufacturing, distribution, or R&D) does each entity undertake?
2. Assets Utilized: What tangible and intangible assets, like intellectual property or brand value, are employed?
3. Risks Assumed: What operational, financial, and market risks does each entity bear?

In Tanzania, this analysis forms the cornerstone of compliance especially with intellectual property as provided under Regulation 11(2). For instance, if a local affiliate is responsible for significant manufacturing functions but retains minimal profit, the TRA may investigate whether the transfer pricing arrangement truly reflects its economic contributions. In this realm, TRA also evaluates the methods used ensuring they align with the arm’s length principle.

Transfer Pricing Methods: Ensuring Equilibrium in Transactional Values

Tanzania under Regulation 5 of the Tax Administration (Transfer Pricing) Regulations, 2018 endorses several primary transfer pricing methods, echoing the OECD guidelines:

1. Comparable Uncontrolled Price (CUP) Method: Compares the price and conditions of products or services in a controlled transaction with those of an uncontrolled transaction between unrelated parties. This is preferred when there’s adequate and reliable data on comparable transactions between unrelated parties.
2. Resale Price Method (RPM): Pricing is calculated by subtracting a comparable gross margin and related costs (e.g., customs duties) from the resale price of a product or service. Employed when goods are purchased from related parties and then resold to independent parties, this method calculates the margin earned in comparable transactions.
3. Cost-Plus Method: Pricing is determined by adding a market-based markup to the supplier’s costs in a controlled transaction. To apply this method, companies compare the markup to those in similar transactions between unrelated entities. Commonly used in transactions involving services or production. 
4. Profit Split Method: The Profit Split Method (PSM) allocates profits in controlled transactions by analyzing how independent third parties would divide them in similar circumstances. It offers a holistic view of profit allocation, making it particularly effective for evaluating intangible assets or complex, multi-transaction scenarios.
5. Transactional Net Margin Method (TNMM): Evaluates whether a controlled transaction’s net profit aligns with that of comparable transactions by unrelated entities under similar circumstances. Often a fallback when other methods lack available comparable data. 

While these methods reflect international best practices, the TRA in the Transfer Pricing Guidelines, 2020 and Regulation 12 has prioritized the CUP method for determining the arm’s length price of controlled transactions involving the sale or purchase of commodities or similar products. Nonetheless, the Tax Administration (Transfer Pricing) Regulations permit flexibility, allowing businesses to choose the most appropriate method based on the transaction’s specifics. Tanzanian businesses can draw from both local and global jurisprudence.

Judicial Insight: Lessons from Tanzania and Beyond

Tanzania: Two landmark cases underscore the judiciary’s stance on transfer pricing and rigorous path to compliance:

1. Aggreko International Projects Limited vs Commissioner General, Tanzania Revenue Authority (Civil Appeal No.456 of 2021) [2023] TZCA 17606
   In this recent decision, the Court of Appeal delved into the validity of the TRA’s transfer pricing adjustment against Aggreko. The TRA contended that Aggreko’s pricing with affiliated entities fell short of arm’s length standards. The Court upheld the TRA’s approach, underscoring that compliance with the arm’s length principle requires robust and verifiable documentation. It articulated a stricter interpretation of the Tax Administration Regulations. The decision exemplifies a clear judicial endorsement of strict compliance in transfer pricing.
2. Alliance One Tobacco Tanzania Limited vs Commissioner General (TRA) (Civil Appeal No. 118 of 2018) [2019] TZCA 242
   The TRA levied a significant transfer pricing adjustment on the company, arguing that its pricing did not adhere to the arm’s length standard. The Court examined the TRA’s reliance on international comparable, and. reviewed pricing methods. The Court found that the TRA had inadequately justified its method and had failed to substantiate its transfer pricing adjustments adequately. The decision reinforced that while international standards are critical, they must be backed by reliable data and emphasizes the need for the TRA to rigorously justify any transfer pricing adjustments, upholding principles of fairness and transparency.

Global Comparative Analysis: In Coca-Cola v. Commissioner (2020) and the Facebook case, U.S. courts also demanded a high standard of proof for related-party transactions, mirroring Tanzania’s insistence on evidence-backed adjustments. These cases collectively highlight that while jurisdictions may differ in transfer pricing frameworks, the principle of rigorous documentation prevails globally.

Coca-Cola v. Commissioner (2020)

In a landmark U.S. case, the IRS challenged Coca-Cola’s transfer pricing method, arguing that its inter-company arrangements diverted taxable income from U.S. operations. The Tax Court sided with the IRS, asserting that Coca-Cola’s pricing structure failed the arm’s length standard, resulting in a massive tax adjustment. The case underscores the importance of consistent, economically justified methods, a lesson that Tanzanian businesses can heed to avoid costly audits.

Facebook and International Transfer Pricing Disputes

Facebook’s global transfer pricing disputes echo the challenges of accurately valuing intangibles like technology and data. The U.S. IRS scrutinized Facebook’s licensing practices, contending that profits from U.S.-developed intangibles were diverted to low-tax jurisdictions. Similar disputes have arisen globally, underscoring that valuing intellectual property in cross-border transactions is complex and high-stakes.

The Cost of Non-Compliance: Fines and TRA Actions

When intercompany pricing does not adhere to the arm’s length principle, the Tanzania Revenue Authority (TRA) steps in. Non-compliance with transfer pricing regulations can cast a heavy net of penalties:

1. Failure to Submit Contemporaneous Documentation: A fine of 3,500 currency points (TZS 52.5 million) in accordance with Regulation 7(4).
2. Tax Adjustments:  The Commissioner General has mandate under Section 33(2) of Income Tax Act and Regulation 15(1) to make adjustments consistent with the arm’s length principle. For example, if a Tanzanian company sells goods to its foreign affiliate at below-market rates, the TRA may adjust the pricing to reflect market realities.
3. Severe Repercussions: The TRA can initiate audits, adjust tax returns, and even impose penalties of up to 100% of the additional tax liability if intentional evasion is suspected.

The TRA’s net can sweep far and wide, leaving businesses exposed to financial losses and reputational damage if they fail to navigate these waters with care.

Conclusion: Finding Balance Between Borders

 Transfer pricing compliance demands a proactive approach. Documenting each transaction’s commercial rationale and economic substance, along with using a suitable transfer pricing method, remains critical to effectively mitigate audit risk. Practically, this means:

• Choosing the Best Method: Where comparable are available, CUP remains the gold standard. However, method selection should suit economic reality and evaluated for its ability to capture the economic substance of the transaction. Businesses engaged in unique or high-value transactions may benefit from using the profit split or TNMM methods, provided they align with economic substance. In cases of intangible asset transfers, such as intellectual property, the Profit Split or TNMM methods are often more appropriate.
• Ensuring Regular and Accurate Functional and Risk Analyses: An accurate functional analysis forms the backbone of a compliant transfer pricing strategy. This reveals how entities contribute to profits based on their operational roles and financial risks. The TRA expects robust analyses to support pricing methods, a requirement emphasized in Aggreko and Alliance One.
• Robust and judicious Documentation: Documentation should be meticulous and contemporaneous, reflecting not only transactional data but also the strategic intent behind inter-company pricing. Documents like financial statements; invoices and transactional data.
• Inter-company Agreements: Contracts and agreements between related entities specifying terms, prices, and obligations. These agreements should be clear and enforceable, like those that would be drawn up with unrelated parties.
• Regular audits of transfer pricing arrangements
• Adopting a Global Mindset: Keeping up-to-date with OECD and UN guidelines helps Tanzanian businesses align with international best practices.

Closing Thoughts: Casting Your Nets Wisely

In transfer pricing, businesses must set their nets in the waters of compliance, knowing that accurate documentation and the right methodology are the keys to avoiding hefty tax adjustments, keep businesses afloat and their nets full. Companies must find balance, precision, and insight to avoid an unwieldy catch of penalties. The path to compliance, like transfer pricing itself, is complex. But with careful consideration of the applicable laws and best practices, companies can navigate the Tanzanian transfer pricing with greater confidence.