Time for a transfer pricing “true up”?

With the financial year having just come to an end for many companies (namely, whose financial year end is aligned to the calendar year), taxpayers with related party transactions may face situations where their actual year-end  results may not be in line with predetermined margins (i.e. targeted margins supported by a benchmarking study and a transfer pricing policy).

A company's results can fall outside predetermined margins for a number of reasons - frequently, it will reflect commercial reasons such as market fluctuations etc. Accordingly, falling outside the margin does not necessarily mean that the taxpayer has applied an incorrect transfer pricing policy at the beginning; nevertheless, it might be worth checking whether the policy is appropriate. For example, have the actual functions and risks changed from those envisaged in the policy?.

In certain cases, there is in any case an automatic requirement for taxpayers to make “true up” adjustments to achieve the required margins.  In particular, related party charges for goods and services or royalties where based on budgeted costs will need to have true up adjustments so that only the actual costs of goods bought or services received is booked in the accounts. This is to align with Transfer Pricing (TP) Regulations which explicitly prescribe certain methodologies - for example, in the case of service charges, the fees should be based on actual costs incurred (and indeed the Regulations explicitly reject service fees based on budgeted costs or a percentage of turnover). 

Year-end adjustments may also be necessary for routine companies whose profits are benchmarked to a certain targeted margin (e.g. limited risk distributors or contract manufacturers). Royalties are often calculated based on prior year results or budgets and therefore it is important that a true up is made post year end based on actual results/turnover.

The year end adjustment needs to be reflected in the financial statements and this would normally result in credit/ debit notes being  issued. In this case, both parties to a transaction make an appropriate adjustment to the price of goods sold/ services rendered.

In the case of adjustments related to imported goods, customs implications of the adjustments on the transfer price should also be taken into consideration as TP adjustments can have an unintended effect of creating a risk from a customs perspective. Where the adjustment is an upward adjustment to a price of imported goods (i.e. if an importer is in a payable position), the importer will be expected to disclose and pay the additional customs liability and potential penalties. On the other hand, where the adjustment is a downward price adjustment (i.e. if an importer is in a receivable position), then the taxpayer will have overpaid customs duties. However, in practice, a refund claim in respect of overpaid customs duties may be a lengthy process, and indeed ultimately maybe more of a theoretical rather than a practical possibility.

In seeking to support pricing as being within the arm’s length range a taxpayer will typically make reference to a benchmark study, and in this case it is important that reference is to an updated benchmark study. The TP Regulations requires that the benchmark study should be based on comparable information not exceeding three years prior to the financial year.

An added complication this year is the unprecedented economic impact of COVID 19 on business performance in certain industries (with increased profits for some and losses for others) which would need to be reviewed. Benchmarking databases will have information from 2019 going backwards (if you are performing an analysis in February 2021) and therefore other approaches as suggested by the OECD would need to be looked at as comparable results would not be available.

Taxpayers should therefore review their related party transactions to confirm whether they meet the Tanzanian transfer pricing compliance requirements. To the extent any need for correction is identified, it is worthwhile to make year-end adjustments to minimise the risk of penalties for non-compliance - not least bearing in mind the significance of the potential penalty at 100% of the TP adjustment.

B James Magesa, Tax Manager at PwC Tanzania.