Are companies better off without reduced transfer pricing penalties?

By Cecilia Otaru

It is every country’s revenue authority’s goal to ensure that taxpayers comply with tax laws as this would eliminate the need to set and impose any sort of noncompliance penalties in order to enhance the relationship between revenue authorities and taxpayers.

A closer look at the transfer pricing industry in Tanzania demonstrates just how dynamic this relationship can be. With effect from July 1, 2021, the Parliament of the United Republic of Tanzania enacted the Finance Act, 2021 (the Finance Act) dated 30 June 2021 to impose and alter certain taxes, duties, levies, fees and to amend certain written laws relating to the collection and management of public revenues.

Among the amendments made, was the reduction of the penalty due to taxpayers; once the Tanzania Revenue Authority (TRA) determined through a tax audit that the prices applied by the taxpayers to their related parties did not comply with the arm’s length principle. Prior to this amendment, the applicable penalty was one hundred percent of the adjusted amount. This penalty was in addition to an adjustment of the taxpayer’s income, for the respective year of the tax audit, when it was determined that the arm’s length prices were not applied on related party transactions.

This penalty has now been reduced by the Finance Act to one hundred percent of the underpaid tax, arising from application of prices that do not confirm to the arm’s length principle.

This was the penalty in practise prior to introduction of the Tax Administration (Transfer Pricing) Regulations in the year 2018, which revoked the Income Tax (Transfer Pricing) Regulations 2014. Hence the Finance Act reinstated the previously applied penalty. This poses the question on whether taxpayers are better off with the reinstated penalty.

My quick survey of the transfer pricing environment in East Africa reveals that it is only in Tanzania that a penalty is charged for noncompliance with the arm’s length principle, in addition to the adjustment of the underpaid tax. Our neighbours in Kenya do not apply a specific penalty for transfer pricing adjustments as it is in Tanzania, rather a general penalty of 5 percent is applied for under paid taxes regardless of the type of tax together with interest for late payment of tax. This goes to show that transfer pricing is not given scrutinised closely compared to other types of taxes. Similarly, Uganda has no specific penalty applied for noncompliance with the arm’s length principle. This however does not eliminate the room for the Commissioner to adjust the tax computations in the respective years, to the extent that the transactions are not at arm’s length. This leaves Tanzania as the only country in East Africa that currently specifically penalizes for noncompliance with the arm’s length principle, in addition to the adjustment of the underpaid tax, making for strict and unique tax laws against base erosion and profit shifting.

One can conclude that the purpose of this penalty in Tanzania is to prompt taxpayers to engage in arm’s length transactions, such that revenues from these transactions are taxed in the appropriate jurisdictions. As transfer pricing is still a growing area in Tanzania, there still exists extensive number of ambiguities of what ought to be the arm’s length prices that related parties should apply that necessitates imposition of strict guidelines and penalties to motivate compliance, which is the approach adopted by the TRA this year.

The penalty for noncompliance with the arm’s length principle currently applied in Tanzania is better off compared to periods prior to the changes made prospectively from June 2021. However, it is still high when compared to other East African countries. Considering the issue of penalties (arm’s length principle) ambiguous; these penalties are a deterrent for investors with conservative appetite to risk, as the cost for noncompliance remains to be high in Tanzania.

Cecilia Otaru ([email protected].) is a senior associate of KPMG in Tanzania. The views and opinions are those of the author and do not necessarily represent the views and opinions of KPMG.