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Published On: Fri, Oct 31st, 2014

Shifting Tax Monies – The Transfer Pricing Phenomenon

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TAXBy Embuka Anna

When a subsidiary of Coca-Cola in Ghana transfers (that is, sells) goods, services or know-how to a Coca-Cola subsidiary in Nigeria, the price charged for these goods or services is called ‘transfer price’ and the transaction is referred to as a transaction between ‘connected persons’. The transfer price may be purely arbitrary (i.e. unrelated to costs incurred, operations carried out or to added value) or it could be different from the price which unconnected persons would charge for similar transactions in an open market. Where the latter is the case, both the taxman and the treasury are content. In the former circumstances, the taxman is drawn into investigating the operations involved.

Transfer pricing has become a buzz word, steeped in controversy and not very well understood. However, transfer pricing per se is not illegal or a crime. This is because, tax planning is allowed by law. It is transfer manipulation or mispricing that puts the taxpayer on the wrong side of the law, where the venture effectively lowers or completely erases the tax burden of the taxpayer.

The attention transfer mispricing is getting is justified on account of the volume of international trade within the control of multinationals. With transfer mispricing, transfer price is set at a level which reduces or even cancels out the total tax which has to be paid by the multinational. Research available on a UK website, estimates that about 60 percent of international trade happens within, rather than between multinationals; that is, across national boundaries but within the same corporate group. Suggestions have been made that this figure may be closer to 70 percent. In addition to the foregoing, the attention cannot be dissociated from the current orientation towards payment of ‘fair tax’.

Transfer mispricing is of importance to governments because it provides multinationals a means of depriving the government of the needed revenue. Estimates vary as to how much tax revenue is lost by governments due to transfer mispricing. Global Financial Integrity in Washington estimates the amount to be several hundred billion dollars annually. Christian Aid (March 2009) estimated that about $1.1 trillion in bilateral trade mispricing came into the EU and the US alone from non-EU countries from 2005 to 2007.

Transfer mispricing is embarked upon by multinationals because of the variance in tax rates and policies amongst nations. Though the object is the same: a reduction of the tax burden by the adoption of transfer prices not determined by market forces, i.e. transfer mispricing comes in different forms. It can be achieved by paying some tax, paying no tax or even getting tax rebates.

Paying Some Tax

Case 1

‘A’ which is a subsidiary company in Uganda buys goods at N100 each, repackages and exports them to ‘B’, a parent company in Nigeria at a selling price of N200 each. The profit is N100. Company B then resells for N300 and makes a profit of N100. The group’s assessable profit is thus N200 (N100 in Uganda and another N100 in Nigeria).

Ordinarily, these transactions are harmless. However, considering the tax rates of the respective states, the conclusion could be different. Assuming that companies income tax for company A is 20% (amounting to N20) and companies income tax in company B is 60% (amounting to N60), this effectively makes the group’s net profit N120 (i.e. N200 – N80). The subsidiary company in Uganda contributed N80 to this profit, while the parent company in Nigeria contributed N40. The profit after tax generated by the parent company is smaller because they paid a company’s income tax of 60% as against the 20% paid by the subsidiary company.

Case 2

Assuming the transfer price is now N280 while B’s selling price still remains N300. The effect of this is a shifting of profit before tax from B’s home country (i.e. Nigeria, which has a company’s income tax of 60%) to A’s host country (i.e. Uganda which has a company’s income tax of 20%).

This implies that A and B would pay N36 and N12 respectively as tax in their countries of incorporation; bringing the total tax paid by the group to N48 (i.e. N36 + N12). With the profit before tax still N200; the profit after tax becomes N152 (i.e. N200 – N48). To this end, A contributes N144 while B contributes N8. By increasing the transfer price from N200 to N280, the overall profit after tax has increased by a staggering 27% i.e. from N120 to N152.

Paying No Tax

Case 3

Assuming again that the transfer price is N300 and that after repackaging, B resells at N300. This means that A sells to B at N300 making a profit of N200, while B makes no profit. The companies’ income tax due from A at 20% is now N40 while B will be charged nil tax since it did not make profit from the sale. Thus, the group’s profit after tax becomes N160 (i.e. N200 – N40). To this, A contributes N160 and B contributes nothing. This implies that all the profits have been shifted to the subsidiary company in Uganda. Hence, B does not pay tax in Nigeria. With this arrangement, B has effectively shifted its profit to a lower tax jurisdiction by declaring a loss.

Getting Tax Repayments

Case 4

This case shows what happens if the transfer price is increased to N400. Company A makes a profit of N300 and B makes a loss of N100 if it resells at N300 (i.e. N400 – N300). This loss can be carried forward by B and used as set-off against future tax liability. Thus, A pays a company’s income tax of N60 on their profits while the B has the capacity of reducing its future tax bill by N60. The effect of this is that the group gets a tax rebate of N60. The overall result is that the profit after tax becomes N300 (i.e. N240 + N60 rebate).

Case 5

We can take this one step further by making the transfer price N500. Company A now makes a profit of N400 and B makes a loss of N200. Company A pays companies income tax of N80 on its profit while B earns the capacity of reducing its future tax bill by N120 and in effect getting a rebate of N120. In the circumstances, the group gets a tax rebate of N120 in Nigeria, pays N80 companies income tax in Uganda and is left with a gain of N40 (N120 – N80) on this transaction. Adding this to the profit increases the profit after tax from N400 to N440.

Conventional Approaches to Confronting Transfer Mispricing

The conventional international approach to dealing with transfer mispricing is through the ‘arm’s length’ principle. This implies that a transfer price should be the same as if the two companies involved were unrelated parties negotiating in a free market and not part of the same corporate structure. The Organisation for Economic Co-operation and Development and the United Nations Tax Committee have both endorsed the arm’s length principle, and it is widely used as the basis for bilateral treaties between governments.

In August 2012, Nigeria enlisted itself amongst the countries that are eager to curtail the incidences of transfer pricing when it published and gazetted the Income Tax (Transfer Pricing) Regulations No. 1, 2012. The regulation is aimed at addressing the problems associated with profit shifting by multinationals as well as incidences of tax evasion that are entrenched in ‘over’ or ‘under’ pricing of controlled transactions between associated enterprises. The regulation takes effect from the basis period beginning after the 2nd day of August, 2012.

Transfer Mispricing Shifts the Tax Obligation and Leads to Deprivation

The government of every country or state spends money on behalf of its citizens for the provision of social goods and services, amongst other things. And one of the sources of such money (revenue) is taxation. Government collects some of this revenue from citizens and companies by means of an equitable tax on income. A tax is equitable when it treats all taxpayers equally and at the same time takes into cognizance their difference. The latter ensures that those who earn more pay more than those who earn less.

Where a multinational has increased its profits by the employment of tax avoidance strategies like transfer mispricing, it shifts taxable income. Since government’s expenses have not changed, it must make up this shortfall in revenue from other tax bases or taxpayers. Therefore, transfer mispricing has the potential of increasing the burden on other taxpayers while the multinational’s profits increases. Where the government chooses not to increase the burden on other taxpayers to complement the revenue shortfall, the consequence is a revenue – expenditure gap. This eventually would lead to depriving the citizens of social goods and services or a reduction in the quantity and quality of goods and services.


From the foregoing, it is safe to conclude that transfer mispricing by multinationals increases their profits at the expense of other taxpayers as the venture effectively imposes a tax on other taxpayers. This is a far cry from earning reasonable profits in an open market where the market forces hold sway.

Transfer mispricing does not result in more efficient or cost-effective production, transport, distribution or retail processes in the real world. The end result of transfer pricing is that revenue ordinarily due to governments are converted into higher profits for multinational companies when they are shifted artificially away from the jurisdiction entitled to it to another (often times a jurisdiction with low or zero tax rates).


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