Advance Pricing Agreements: An opportunity to avoid “financial alchemy”

“The Alchemist”, a book written by Paulo Cuelho, includes this famous quote which is a favourite of mine: ”... the world’s greatest lie is that at a certain point in our lives, we lose control of what’s happening to us, and our lives become controlled by fate”. OK, but what is the relevance to Transfer Pricing (TP) audits?  Well, although TP is not an exact science, taxpayers can still identify the implications of their transactions and seek to agree these in advance with the Tanzania Revenue Authority (TRA), and therefore not let their TP matters “become controlled by fate”.

Dispute resolution statistics released in November 2021 by the OECD (Organisation for Economic Co-operation and Development) indicated that, generally, TP cases continue to take more time with average case resolution times globally being approximately 35 months (varying significantly by jurisdiction, ranging from less than a month to 87 months): refer to www.oecd.org/tax/dispute.  Closer to home, the Performance Audit Report on Controls over transfer pricing in Tanzania business sector (issued by the Controller and Audit General in March 2021) stated that only 38% of the TP audits carried out by the TRA for the financial years 2016/17 to 2019/20 were completed. In addition, these audits were not necessarily completed within one financial year even though the normal audit cycle was 4 to 12 months.

In light of the above, any solution that can help prevent or minimise the risk of TP disputes should be considered by taxpayers for whom TP is relevant.  Of relevance in this regard, is that there is now an avenue for taxpayers to reach an agreement with the TRA on the mode of application of the arm’s length principle to their related party transactions on a prospective basis by entering into an Advance Pricing Agreement (APA) with the TRA.  Details of this process are set out in the Tax Administration (Transfer Pricing) Regulations, 2018 (TP Regulations 2018) and the Tanzania TP Guidelines 2020.

An APA is a binding agreement which a taxpayer may enter into with the TRA to determine a transfer price proactively and prospectively over a fixed period of time, generally for three to five years, or longer depending on the underlying transaction. An APA may be renewed for a five-year period upon agreement of the parties and change in the underlying conditions.

The agreement is based on mutual cooperation and discussions with the TRA in a collaborative manner and it may be made with only the taxpayer, or with a related party and/or with foreign tax authorities through a Mutual Agreement Procedure (MAP). Once the agreement is reached, compliance with the terms and conditions of the APA may be verified during the period of the APA. If the facts and circumstances underlying the APA change, it may be re-negotiated to align with the new situation.

In the event of a TRA audit, the taxman will not challenge whether the related party transactions covered by the APA have been conducted at arm’s length unless there are changes in the factual or legal circumstances relevant to the conditions of the transactions.

A common question from taxpayers is “what if I do not agree with TRA’s position in the APA negotiation?”. That always reminds me of the Michael Jordan quote that “You miss 100% of the shots you don’t  take”.  In this context, the point is that there is nothing to lose in trying; in particular, a taxpayer is not bound to follow the APA if they are not in agreement.

The benefits of entering into an APA with the TRA are essentially three-fold (i) minimising uncertainty, (ii) minimising unnecessary costs, and (iii) ensuring more cordial relations with the TRA.  The possibility of attaining upfront certainty on an agreed arm’s-length outcome will help avoid prolonged transfer pricing disputes with the TRA.  Ultimately, this will result in costs savings including (i) costs in terms of resources in pursuing such a dispute, (ii) cash flow costs, bearing in mind the minimum one third tax payable requirement to validate an objection to an assessment), and (iii) the risk of substantial interest and penalties arising from TP adjustments. Further, APA negotiations are done under a friendly environment, as opposed to a TP audit which can result in a process that is quite adversarial.

The need for more certainty is perhaps even more pronounced now given changes brought about by the COVID 19 pandemic.  In particular, many businesses have restructured their supply chains and the general way business operations are run, and all these changes may have an impact on the TP policies. Therefore, APA may be an effective tool to address that and give comfort going forward on the transfer prices.

While some companies may rest with their fingers crossed, hoping that TRA will not knock on their door or – if they do – will not ask difficult questions on their transfer prices, proactive companies might consider the option to use APAs as an insurance against unanticipated future TP adjustments.

The most effective management of a tax dispute is to prevent it happening in the first place. Taxpayers with related party transactions should therefore consider taking control of their TP fate by engaging with the TRA in relation to an APA - and thereby forestalling the risk of “financial alchemy” whereby an unexpected TP adjustment completely changes the financial wellbeing of a company.  

By James Magesa is a manager specialised in Transfer Pricing Manager at PwC Tanzania.