Transfer pricing rules could discourage social impact investors

By Matsiko Godwin Muhwezi

Uganda Revenue Authority (URA) has boasted of surplus collections despite many businesses facing the ferocious brunt of the ongoing pandemic measures.

This trajectory in revenue collection by the tax body in the absence of clear business rescue stimulus packages to struggling businesses, points to an ambitious tweak in collection measures by new management.

Doris Akol, the former head, had attributed the URA’s low performance on unrealistic targets.

Doubtless to think, this is not the problem for Mr. John Musinguzi Rukoki, the current Commissioner General. This milestone may not be celebrated by multinationals stranded due to lockdown measures.

We are seeing the exit of big investors such as GEMS Cambridge from Uganda and Kenya, Shoprite from Kenya among others.

“As a result of these circumstances, we have been forced to make some very difficult decisions and it is with great sadness that I am writing to advise you that CIK will close after the first term of the new academic year with 31 December 2020 as a tentative closure date,” GEMS Chief Operating Officer Riz Ahmed, said in a letter to parents and teachers.

Operations of some businesses have been completely stifled due to shortage of commodity inputs and supply chains for business continuity.

This also affects their transfer pricing plans and despite the aggressive collection stance at URA. Transfer pricing refers to the way in which prices for goods and services are set between related parties, with one of the parties being a non-resident for tax purposes.

Associated enterprises are capable of setting their own prices for services or goods exchanged within the group. This may be advantageous for sustainability of struggling subsidiaries operating on the clutches of a strong group or holding company.

Associated companies view transfer pricing as an opportunity to competitively and efficiently allocate resources, source goods and services and manage their supply chains for goods and services within the group in a manner to maximise competition.

Although Uganda has for close to a decade enforced measures to mitigate tax avoidance by way of transfer (mis)pricing; blanket assumptions from the Regulations may negatively impact businesses post Covid 19.

The Income Tax (Transfer Pricing) Regulations of 2011 mandates that prices set for goods and services should follow the Arm’s Length Principle (ALP), meaning the prices that would apply to businesses which are not “closely related”.

This was pivoted off Article 9 of the Organization for Economic Cooperation and Development (OECD) Model Tax Convention and is the framework for bilateral treaties between OECD countries and non-OECD governments.

Although a helpful tool to reduce capital flight, the Regulations do not specially cater to Impact Investment ventures and Not-for-Profit entities while taxing related companies. Impact investment refers to the allocation of capital resources to socially oriented entities with clear and measurable social and environmental impact, alongside financial returns.

Financing such ventures carries with it, the promise of social returns such as reduction of inequality, environmental protection, gender mainstreaming among others. Impact investment is based on the idea of “doing well by doing good”.

Invariably, it becomes difficult to separate nuanced circumstances of associates with long term revenue targets whose sustainability can only be guaranteed by intra group transfer pricing models.

From the perspective of the multinational involved, it presents an opportunity to make capital savings by reducing the tax liability, with the objective of reinvesting the capital into socially impactful projects.

It is also difficult to estimate the impact of Covid 19 on associated companies in real time, given the shifting landscape of lockdown and business resumption measures in different countries.

An empirical study published in 2018 by the IMF (At a cost: The Real Effects of Transfer Pricing Regulations) concluded that transfer pricing legislation had the effect of reducing investments by multinationals by more than 11 percent, and even larger if the transfer pricing legislation is enforced strictly.

According to the study, this could be due to a higher cost of capital for the multinational resulting from the transfer pricing regime, or re-allocation of investment to affiliates in other jurisdictions.

One of the implications of the study is that countries like Uganda have to choose between one of two evils; base erosion of taxable profits, or reduction of investment by multinationals.

Although it may be difficult to account for the long term social impact of investment for short term public revenue targets, the need for tax obligations to follow business realities cannot be overemphasised.

On 17 March 2020, the UK government announced that £330 billion would be made available to support the UK economy, including property tax relief and loan repayment deferral. The USA announced a US$ 1 trillion programme.

Tax measures being adopted by many countries including cuts in VAT, payroll and individual income tax, and deferring reporting and payment deadlines to assist cashflow.

For typical tax obligations, there is an array of legal leeway to implement stop-gap measures and mitigate cash flow shocks for businesses such as extending due deadlines, liberally interpreting force majeure clauses for cancelled contracts and extending time for clearance of goods.

Most multinationals operating in Uganda would likely be doing so as part of associated entities with symbiotic transactions as part of routine business.

It is imperative that URA takes an inclusive approach with stakeholders to develop umbrella measures towards business continuity for strategic investment in Uganda.

The Writer is the Managing Partner at Cymbell Advocates