UNDERSTANDING TRANSFER PRICING

Transfer pricing is the general term for the pricing of cross‐border, intra‐firm transactions between related parties. “Transfer pricing” therefore refers to the setting of prices at which transactions occur involving the transfer of property or services between associated enterprises, forming part of an MNE group.  These transactions are also referred to as “controlled” transactions, as distinct from “uncontrolled” transactions between companies that, for example, are not associated and can be assumed to operate independently (“on an arm’s length basis”) in reaching terms for such transactions.    

In simple terms transfer pricing is the price at which related parties are assumed to transact, and if this price is subjected to tests, it is the same price at which independently trading companies would have transacted.

A simple explanation of transfer pricing is given below.

There is company A Inc which is incorporated in Turkey manufacturing shoes. The same company forms a subsidiary company B Inc in Uganda and it distributes the manufactured shoes in Uganda and East Africa.

Company A inc incurs a cost of production for one pair shoes of $150, however it has set a transfer price of $200 for each pair of shoes it sends to B Inc. Company B Inc also incurs additional operational costs of $50 per pair. The question is what would be the selling price of company A Inc and what cost should Company B Inc declare in its books of account?

Under normal circumstances Company A Inc would have a selling price of $200, and company B Inc would have total cost of $250, however since these companies are trading under controlled conditions, since the actions of company B Inc in Uganda are controlled by Company A Inc in Turkey, the selling price of $200 should be subjected to tests to see if an independent company would sale the same product (Shoes) to company B Inc at the same price.

Secondly since these companies are essentially the same, the shoes should be transferred to Company B Inc incorporated in Uganda at $150 and therefore the cost of production would be $200 and not $250.

For tax purposes to allow the transfer price it must be subject to tests to remove the effects of “arm’s length” transactions. Many companies have been involved in aggressive tax planning and taken advantage of multi-national trade to use the availability of differing tax treatments to reduce their tax obligations and also to pay as little tax as possible.

For example: let’s assume Turkey has an income Tax rate of 20% and Uganda has a tax rate of 30%. Under this assumption it is advantageous if more profits are apportioned to the parent company since the tax rate is low, and low profits in Uganda since the tax rate is high. How is this possible? The parent company A Inc would have to transfer products and services at high prices to B Inc in Uganda, so that they can reduce the effect of tax exposure due to the high tax rate.

For example A Inc sends 100 shoes to B Inc. The other costs of A include License Fees $200.

The Profit and Loss Account for A Inc the parent Company in Turkey would look like this at the transfer price of $200.

ItemUnitTotal ($)
Sales$200*10020,000
Cost of production$150*10015,000
Gross Profit 5000
Less: operating Expenses 200
Profits 4,800
Tax @ 20% 960
Total EAT 3,840
The Accounts of B Inc the subsidiary incorporated in Uganda receiving shoes at the transfer price of $200 with a selling price of $300 and operational costs of $50 per pair of shoes
ItemUnitTotal ($)
Sales$300*10030,000
Cost of production$20*10020,000
Gross Profit 10,000
Less: operating Expenses$50*1005,000
Profits 5,000
Tax @ 30% 1,500
Total EAT 3,500
If Company B Inc was to use the transfer price of $150, incurring operational costs of $50 per pair of shoes and having the same selling price of $300, this would be the effect.
ItemUnitTotal ($)
Sales$300*10030,000
Cost of production$150*10015,000
Gross Profit 15,000
Less: operating Expenses$50*1005,000
Profits 10,000
Tax @ 30% 3,000
Total EAT 7,000
Performance Report of A Inc.
ItemsTaxEAT (Earnings After Tax)
Transfer price to B Inc of $2002,4607,340
Transfer price to B Inc of $1503,96010,840

From the workings above, it is very clear that A Inc incurs a high tax exposure in Uganda; therefore what it would do is to ensure that it maximizes sales in Turkey and apportions more costs and costs of production to B Inc in Uganda so that the tax exposure is reduced. Therefore instead of setting a transfer price of $200 it can set a price of $400 so that profits are maximized in Turkey and reduced in Uganda yet the actual trading of goods, the actual value is added at the distribution level that is in Uganda which distributes the shoes to the final consumers and retailers.
Conclusion
Under OECD each company is taxed independently and it is very important that the Revenue Bodies carry out transfer pricing audits to verify the arm’s length principle in the transfer of services, products and rights among related companies of Multi National Enterprises (MNE).

UNDERSTANDING SECTION 40D OF THE Tax Procedures Code (TPC)6 tips to retain your top sales talent

The Tax Procedures Code (Amendment) Bill, 2023 has introduced a tax incentive for taxpayers who can have their interest and penalties waived as at June 2023, under section 40 D. However, this is premised on the condition that the taxpayer pays up all or part of their Principle Tax, in the scenario where part of the principle tax is paid then the waiver is also applied pro rata.

It is very important that the taxpayer understands how they are to benefit from this tax incentive. Uganda Revenue Authority needs to clarify what it actually means by payment of Principle Tax. The Revenue Body with time will come up with clear explanations to this section, but we have tried to use the available legal frame work and work procedures to try to explain this to the taxpayers as much as possible. This article therefore is intended to break down the key components under section 40D and how one benefits from this incentive.

“Section 40D Waiver of interest on payment of Principal Tax

“The Commissioner shall waive the payment of interest and the penalty by a taxpayer, where the taxpayer voluntarily pays the principal tax outstanding at 30th June, 2023, by 31st December, 2023.”

The basis of a taxpayer’s liability is the taxpayer’s Tax ledger. The tax ledger includes all tax transactions of a taxpayer and it is made up of 5 components, these include the following; Returns, Assessments, Penalties, Interest and Tax paid.

Principle Tax has no definition as per the Income Tax or VAT Act, and the ledger as it is currently has no distinction between principle Tax, Penal tax and interest. However, we shall derive the definition/ explanation of Principle Tax from Section 39 (4) of the TPC which states that “For the avoidance of doubt, where interest due and payable under a tax law as at 1st July, 2017 exceeds the aggregate of the principal tax and the penal tax, the interest in excess of the aggregate is waived.” This section clearly differentiates the different components of the ledger that form the taxpayer’s liability into three elements, principal Tax, Penal Tax and Interest.

If we consider the current lay out of the ledger it has returns, assessments, penalties, interest and tax paid, therefore from section 39 it can be inferred that Principle Tax is the sum of Returns and Assessments, Penal Tax is the sum of penalties, and Interest payable.

Therefore, principle Tax is the summation of Total Returns filed and Total Assessments raised (Assessments where objections have not been raised or objections have been raised and rejected by URA), let’s take an example of an Income Tax Ledger;

Tax PeriodReturnsAssessmentsPenaltiesInterestTax paidBalance
July 202005,000,000600,000112,00005,712,000
July 20211,000,0000020,0001,000,0005,732,000
July 20222,000,0000200,00080,00007,972,000
June 20232,000,0000002,000,0008,012,000
 5,000,0005,000,000800,000212,0003,000,000 

From the above example this taxpayer’s ledger shows that their outstanding balance
is Ugx 8,012,000, a breakdown of this liability is; Principal Tax (10,000,000), Penal Tax (800,000) and Interest (212,000) and Tax so far paid is 3,000,000. According to Section 40D TPC, if this taxpayer pays their principle tax by 31st December 2023, the entire Penal Tax and Interest will be waived. However according to this ledger the Taxpayers’ Principal tax is 10,000,000, does it mean they have to pay 10 M
to be entitled to the full waiver? If this taxpayer pays 10 M, he will have paid 1,988,000 more than their total liability. Therefore, by inference under section 40D the principal Tax should be less any tax already paid, URA needs to clarify on this though. In the above example the Principle Tax Liability would
be Principal Tax (10,000,000) less Tax paid (3,000,000) which translates to 7,000,000. So if the above taxpayer pays the whole 7,000,000 then the penal tax (800,000) and
interest of (212,000) should all be waived. What happens for partial payment of the principal tax? This will come in our next
edition of understanding section 40D. however we implore URA to come out with a
clear position on how the section 40D will be administered.