A transfer price is the price a good or service is exchanged at in domestic and international transactions.
In international taxation, transfer price issues are normally of concern in transactions between related entities in the same country where they are under one tax regime (domestic market) or in different countries where they are under different tax jurisdictions (international markets).
Transfer prices are for such transactions as those involving tangible assets (e.g. goods), intangible assets (e.g. transfer of intellectual properties), services, financial transactions (e.g. loans) etc.
Every government can choose to have in place any transfer pricing regime based on the operations of taxpayers. However, since the business environment is not uniform, transfer pricing requirements have different effects on each taxpayer.
Compliance with transfer pricing requirements is costly in terms of the number and complexity of documents required to be maintained, resources required in terms of money and time and tax expertise. Therefore, governments go out of way to ensure that there is equity in the application of the transfer pricing requirements.
For example, a government can choose to have a normal transfer pricing regime for companies with complex international operations and a simplified format for small-scale international operators which provides prescribed minimum price or return for specified transactions between related entities for fixed tax period.
Safe Harbour Rules
The simplified transfer pricing regime is normally in the form of rules that are commonly referred to as Safe Harbour Rules. The rules are equivalent to operating presumptive tax regime in a country together with the normal income tax regime. Safe Harbour Rules can be used for domestic and/or international transfer pricing requirements. Countries such as USA, India, Malaysia have specific provisions for Safe Harbour Rules.
The Safe Harbour Rules take into consideration several things namely:
- The size of the business in annual turnover terms.
- The nature of transactions.
- The cost of transfer pricing compliance.
- Cost of litigation in case of disputes.
Normally, the common factors for taxpayers expected to comply with Safe Harbour rules for transfer pricing purposes is annual turnover.
Safe Harbour Rules are normally specified in percentages that governments set as the bases for transfer prices. For example, the government can set a transfer price mark up of 20% and the tax will be based on that percentage.
Therefore, the method conflicts with Arm’s length principle on which normal transfer pricing requirements are based. Arm’s length prices are market-determined.
Challenges of Safe Harbour Rules
Safe Harbour Rules face several challenges. The following are some of the challenges experienced in operating Safe Harbour Rules in a country:
- The time taken to establish the rules.
- Ensuring incorporation of the rules into the tax statutes.
- Ensuring that the taxpayers are aware of the rules.
- Ensuring that the rules are not misused.
Role of taxpayers
Complying with transfer pricing legislation is expensive. For example, persons who transact with related entities across international boundaries are expected to have a Transfer Pricing Policy (TPP) document. Developing a TPP document is expensive in terms of time and money.
Also, the documents are complex in terms of the contents that are required to be incorporated. Many small scale business persons may not have the time, money or even the tax expertise required to develop the TPP documents. However, the taxpayers need to be in business and lack of a TPP document should not impede their operations.
Therefore, governments are dutybound to come up with simplified transfer pricing formats to enable taxpayers to comply with transfer pricing requirements.
Hence, in case the simplified rules do not exist, taxpayers can make representation to the government and lobby for the development of the safe harbour rules which are a relatively cheap regime for the small-scale operators in international taxation. This will enable taxpayers to comply with local and international tax legislation in the country. Also, this will shield taxpayers from potential non-compliance tax prosecutions and payment of extra taxes inform of penalties.
A look at various tax statutes indicates presence of Safe Harbour Rules though they may not be specified as such. It is important to note that Safe Harbour Rules are not only used in taxation but they are also used in other areas.
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Disclaimer
This post is for general overview and guidance and does not in any way amount to professional advice. Hence, www.taxkenya.com, its owner or associates do not take any responsibility for results of any action taken on the basis of the information in this post or for any errors or omissions. Kenyan taxpayers must always rely on the most current information from KRA. Tax industry in Kenya is very dynamic.
