Non-compliance vs. differing approaches in Transfer Pricing

In transfer pricing disputes between the Tanzania Revenue Authority (TRA) and taxpayers, it is the wider business environment that absorbs the shock. 

The Tanzanian tax legislation empowers the TRA to impose penalties on any person who fails to comply with the arm's length principle. The penalty is 100% of the tax shortfall or 30% of reduced tax losses for companies in a tax loss position. This is the most punitive penalty in the Tanzanian tax legislation!

As the law is currently framed, penalties punish taxpayers who fail to comply with the arm's length principle. In practice, many transfer pricing adjustments arise not from deliberate non-compliance but from differences in approach, as transfer pricing is not an exact science. These differences often relate to selecting transfer pricing methods, comparables, or profit level indicators. Imposing penalties in every instance is not always fair nor does it meet the intended purpose of mitigating tax avoidance and base erosion.

Consider this example: a bottled water store in Buza Magengeni imports water from a related company in Kenya. The company compares the price charged by its Kenyan affiliate against prices that the same Kenyan company charges to other unrelated stores for the same product and concludes that they are at arm's length. When the TRA audits the business, it decides to examine the profitability instead. This divergence produces different outcomes. But this difference does not prove non-compliance or false statements.

With such hefty penalties, an important question arises: Where should we draw the line between deliberate non-compliance and legitimate differences in approach? This is particularly significant as unlike most tax legislation, the TP Regulations are descriptive rather than prescriptive regarding method choice as it recognises the complexities of transfer pricing.

When transfer pricing penalties are applied too harshly, it firstly discourages investment as it increases the perceived risk of the country which can deter foreign direct investment.

Secondly, excessive penalties create financial strain especially when combined with requirements to pay tax deposits to dispute assessments, they threaten business continuity and long-term sustainability.

To address this, Tanzania could adopt best practices from other jurisdictions. Kenya's Tax Procedures Act provides that tax shortfall penalties do not apply where shortfalls arose from taxpayers taking a reasonably arguable position on tax law application.  Tanzania could adopt a similar approach where adjustments arise from different positions rather than deliberate non-compliance.

Advance Pricing Agreements (APAs) offer another effective solution, allowing taxpayers and authorities to agree in advance on transaction characterisation, methods, and comparability analysis, reducing uncertainty and preventing disputes. Although Tanzania's legal framework permits APAs, to my knowledge, none have been concluded so far. Practical implementation could significantly enhance business certainty.

By reforming these provisions, Tanzania can ensure taxpayers are not punished simply because they have a different view from the TRA on a something that is subjective while protecting revenue without unfairly penalising compliant taxpayers.

After all, even the lion eats its prey in pieces and likewise, Tanzania must focus not only on immediate collections but on long-term business sustainability. Excessive penalties threaten business continuity and may ultimately reduce the tax base.