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Tax revenue from multinational enterprises: Determining transfer pricing

MS Siddiqui | Published: January 11, 2020 20:51:19 | Updated: January 19, 2020 21:02:45


National Board of Revenue (NBR) has recently asked 921 multinational enterprises (MNEs) operating in Bangladesh to submit detailed information about their business profiles and related activities to scrutinise their international transactions for finding out whether they have evaded taxes. Most of the MNEs, including branches and liaison and representative offices, reportedly do not file statements of international transactions with their income tax returns as per law.

Nowadays, a significant volume of global trade consists of international transfers of goods and services, capital (such as money) and intangibles (such as intellectual property) within MNEs located in different countries. These transfers are called "intra-group transactions". This intra-group trade is growing steadily and accounts for more than 30 per cent of all international transactions.

This pricing of mis-invoicing within the MNEs is called transfer pricing (TP), which refers to setting of prices for transactions between associated enterprises involving transfer of property or services. These transactions are also referred to as "controlled" transactions, as distinct from "uncontrolled" transactions between companies that are not associated and can be assumed to operate independently ("on an arm's length basis") in setting terms for such transactions.

Many MNEs allegedly evade tax through transfer mispricing by over-invoicing and under-invoicing during transactions of goods and services within their associated companies. They also evade taxes and drain capital from the country through transfer of dividend and profit to its parent companies located in tax havens or low tax regime.

TP is adapted for optimum segregation of revenues and cost among different divisions in MNEs. Reasons of use of transfer pricing in MNEs include performance measurement facilitation and trade-off purpose. They always try to transfer profit to the country where tax rate is low from the country where the tax rate is significantly high, to minimise their overall tax burden.

TP may be transacted through arrangements such as (1) International transactions; (2) Associated relationship; (3) International transaction exceeding Tk 3 crore in a year; (4) Negotiated/intentional pricing arrangement; (5) Head office expenses; (6) Charge for intellectual property or intangible assets (eg royalty, technical know-how, copyright, franchise, patent etc); and (7) Sharing of common cost.

Such transactions allow companies ample scope to fix transaction prices at their best advantageous terms considering tax regimes.

Transfer pricing methods that are mentioned in Bangladesh law are: Comparable uncontrolled price method, resale price method, cost plus method, profit split method, transactional net margin method (TNMM); and, any other method, if defensible.

These are in line with the Organisation for Economic Cooperation and Development (OECD) Guidelines of transfer pricing calculation methods and Transfer Pricing Legislation - 'A Suggested Approach 2011 issued by OECD'.

The Bangladesh tax law provides that "the amount of any income, or expenditure, arising from an international transaction shall be determined having regard to the arm's length price." Arm's length pricing is applied when the buyer and seller of a product or service agree on a price by acting in their self-interest. The Income Tax Ordinance 1984, in section 107A (1) has defined that "arm's length price" means a price in a transaction, the conditions (e.g. price, margin or profit split) of which do not differ from the conditions that would have prevailed in a comparable uncontrolled transaction between independent entities carried out under comparable circumstances.

United Nations Development Programme (UNDP), in a 2011 report, placed it on the top of the list of developing countries' suffering financial outflows. Globally, over 70 countries have adopted TP rules recently to monitor substantial amount of related party transactions, which is about 60 per cent of transactions are executed among affiliated companies/members of group companies.

When the MNEs do transactions among themselves in cross-border nature, it falls under the rules of transfer pricing regulation. The TP guidelines are a part of Chapter XIA of the Income Tax Ordinance 1984 of Bangladesh as amended by the Finance Act, 2012, which came into effect on July 01 2014. The law targets international transactions between two associated entities, either or both of whom are non-residents; hence transfer pricing regulation will mostly affect multinational companies or foreign companies having direct or indirect transactions with their subsidiaries, associates or other legal form of entities (e.g. branch office, agent, etc.) in Bangladesh.

In 2014, the NBR set up the cell, which was almost non-functional until 2016 due mainly to lack of logistic support including database of comparable international transfer pricing, experts and dedicated manpower and proper initiative of the tax authorities.

NBR is concerned about TP. MNEs in Bangladesh are required to file a statement of international transactions when one has entered into cross-border international transaction. Every person who has entered into an international transaction shall furnish, along with return of income, a statement of international transactions in the form and manner as may be prescribed.

Under the new rules, any international transaction above Tk 30 million by an MNE or its associated entities from Bangladesh will come under scrutiny of the NBR. A report from a chartered accountant will have to be submitted to the NBR for transactions of the said amount in a financial year.

The NBR has also adopted Customs Valuation (Determination of the Value of Imported Goods) Rules, 2000 in a bid to determine the arm's length pricing of any transactions (i.e. price actually paid or payable - the transaction value) instead of using discretionary practices of determining prices. The Customs authorities also ask for supporting documentation to confirm the information contained in the value declaration.

To enable customs administrations to deal effectively with the issue of relationship between customs valuation and transfer pricing, the World Customs Organisation has developed a Guide to Customs Valuation and Transfer Pricing.

A study conducted by the United Nations Conference on Trade and Development (UNCTAD) showed that developing countries are losing tax revenue of about $100 billion from such illegal international transactions among associated entities. To fight against the mispricing, developed as well as developing countries have incorporated the transfer pricing regulations in their own countries.

The Washington-based research and advisory firm Global Financial Integrity (GFI) came out with the findings by analysing the data of trade in goods of 148 developing countries with advanced economies.

On the basis of the IMF data, GFI said an amount of $2.36 billion entered Bangladesh in 2015 and the outflow was $5.9 billion the same year. According to the GFI, the illicit outflow was $2.67 billion from Bangladesh using the United Nations Comtrade's trade statistics dataset, and inflow was $2.79 billion, meaning the inflow was higher by $0.12 billion. TP to evade tax through international trade is one of the reasons of inflow and outflow of foreign currency.

The Transfer price cell at NBR has started working with MNEs. In FY2019, seven entities, including one mobile operator, four readymade garment companies and a branch office of a global brand in the electronics sector, 'voluntarily' paid an additional Tk 100 million in taxes to the NBR after checking their cross-border transactions in compliance with the transfer pricing guidelines of the cell.

Under the arm's length principle, it is in principle necessary to conduct a comparability analysis of third party transactions. When the taxpayer fails to provide the tax authorities with required data to compute an arm's length price in particular circumstances, some countries have adopted a presumptive taxation method. This is normally subject to rebuttal by a taxpayer, who may present counter-evidence to show the results as being at arm's length.

TP and evaluating the arm's length principal are a new subject for authorities in Bangladesh. The NBR may consider investing time and energy in skills development/competency building of tax officers.

The regulations should be seen in the light that it has been brought for more transparency, accountability, and best practices. For example, the liaison office of MNEs in Bangladesh are not in import/export business of 'goods and services' between their branches as per permission given to them by Bangladesh Investment Development Authority (BIDA). They are in trade promotion on behalf of their overseas parent or sister companies. They don't have 'arm's length' and should not be brought under transfer pricing regulations. Since Bangladesh is one of the fastest growing economies in the world, it is a welcome move to address profit/revenue shifting before it harms the economy.

MNEs in Bangladesh, however, feel that TP regulations are a tool to curb capital outflow from the country. The NBR has a mindset to apply all regulations to increase collection of revenue. The revenue officials have huge discretionary power to determine tax of local taxpayers and that power should not apply to MNEs. Any arbitrary step with intent to collect additional revenue may tarnish image of Bangladesh as an attractive investment destination.

MS Siddiqui is a legal economist.

e-mail: mssiddiqui2035@gmail.com

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