Valdis Leikus | Executive Director | Graphene Economics | mail me |
In the wake of the COVID-19 pandemic, industries and businesses across Africa are adapting, including rethinking business strategies and supply chains. For multinational entities (MNEs), business restructuring can have transfer pricing implications too.
A business restructuring does not necessarily relate to the sale or acquisition of operations, the Organisation for Economic Co-operation and Development (OECD) defines business restructuring as the cross-border reorganisation of the commercial or financial relations between associated enterprises, including the termination or substantial renegotiation of existing arrangements.
For instance, a transfer of a business unit (such as shared service centre operations) from a South African company to a related party in Kenya would constitute a business restructuring for transfer pricing purposes.
Some countries have specific business restructuring regulations and definitions embedded in their local legislation. Within Africa though, most of the countries do not have a specific definition or regulations on transfer pricing aspects of business restructuring embedded in their legislation.
Some countries, such as Zambia, have released a practice note containing a section about business restructurings. These guidelines are largely aligned with the OECD’s interpretation and guidance.
Important transfer pricing considerations
To understand transfer pricing consequences of a business restructuring arrangement, an MNE should start with a functional analysis to identify economically significant activities and responsibilities undertaken, assets used, and risks assumed before and after the restructuring by the parties involved.
Important considerations include:
- Understanding the risks assumed by the parties (because the transfer of risks from one entity to another is likely to impact the level of compensation).
- The business reasons for and the expected benefits of the restructuring. In most instances, business restructurings are commercially driven. They are initiated for a variety of reasons, including provision of a more centralised control and management of manufacturing, research and distribution functions, savings from economies of scale; efficiency and lower costs; integrations of newly acquired operations. The business restructuring needs to be considered from the perspective of the group as well as from the perspective of the individual entities to evaluate to what extent the parties are likely to benefit.
- Whether there are other options realistically available to the parties which may have been even more beneficial to that entity. This is important in evaluating what decision an entity would have undertaken if it was operating as a separate legal entity on an arm’s length basis.
All of the steps above enable the parties to identify whether there should be compensation for the identified transactions.
The OECD clarifies that when applying the arm’s length principle to business restructurings, the question is whether there is a transfer of something of value or a termination or substantial renegotiation of existing arrangements and that transfer, termination or substantial renegotiation would be compensated between independent parties in comparable circumstances.
A transfer of something of value might include tangible assets (for example, equipment), intangible assets (patents, trademarks, designs, copyrights, know-how, customer lists, and similar), or transfer of activity (functioning, economically integrated business unit). The compensation for transfer of these assets is usually determined by way of performing a valuation study.
Another important consideration, which became relevant during the COVID-19 pandemic, is the loss-making operations of MNEs. If the loss-making activity is transferred to a related party, there might be a situation where a transferee should be compensated by the transferor for taking over a loss-making activity.
Risks associated with business restructuring transactions
Business restructurings are complex exercises and require collaboration between commercial divisions of the business and the finance (tax) division, and there are several risks associated if business restructurings are not implemented correctly.
For example, an MNE may have set up operations in another jurisdiction but failed to move its employees performing these activities to that jurisdiction. In this case, the group is exposed to risk that any profits will be allocated to the country where the operational team is based.
Non-arm’s length compensation for the transfer of something of value could also create risks for MNEs, especially where no detailed analysis was performed at the time of the restructuring.
Over the last few years, several African countries have updated their transfer pricing documentation requirements, where taxpayers are required to disclose their business restructurings and transfers of intangibles in their annual transfer pricing compliance reports.
Globally, it’s common for multinational groups to approach tax authorities in advance and enter into what’s called an ‘advance pricing agreement’ (APA) where the pricing methodology is agreed and cannot be challenged for an agreed period of time (subject to certain terms and conditions).
Unfortunately, this is often not an option for MNEs operating in Africa, as in many countries the necessary regulations to manage APAs are not yet in place.
Other considerations
In addition to transfer pricing considerations of business restructurings, there are often various local factors and tax considerations that need to be taken into account. For example, local legislation in certain African countries does not allow for the transfer of licenses or intellectual property.
Exchange control regulations might also restrict business restructuring arrangements. Tax consequences of movement of personnel, in-country VAT regulations, and withholding taxes are other examples that MNEs should consider prior to entering into a business restructuring transaction. Multinationals should adopt a holistic approach by considering all of these aspects.
Given the immense pressure for tax authorities to collect additional tax revenues, we’re likely to see increased controversy around business restructuring in future. My advice would therefore be for MNEs to carefully consider any transfer pricing and other local tax and regulatory consequences before embarking on a business restructuring.
