Emerging Transfer Pricing Trends in Africa: Insights from Dr. Daniel Erasmus at the 13th Annual Africa TP Summit

On September 13, 2024, Dr. Daniel N Erasmus delivered the opening address at the 13th Annual Africa Transfer Pricing Summit in Cape Town, South Africa. His address, rich with insights and practical advice, focused on emerging trends in transfer pricing across Africa and other developing regions, drawn from his extensive experience as an advocate in international tax disputes.

Dr. Erasmus began by acknowledging his connection to the African tax landscape, despite residing in the United States, where he continues to work on numerous African tax cases, including landmark transfer pricing disputes. The central case discussed was the ABD case, which involved intellectual property licensing from a South African parent company to subsidiaries across Africa and the Middle East. The taxpayer argued for a 1% royalty on the use of their brand, a point contested by SARS, leading to years of legal wrangling.

The key takeaway from this case, Dr. Erasmus noted, is the complexity of modern transfer pricing litigation, particularly when dealing with intellectual property. He emphasized the importance of having a robust defense, including thorough documentation and internal comparables (CUPs), to counter challenges from tax authorities. The ABD case is ongoing, but it has already shaped emerging trends in transfer pricing in Africa.

Dr. Erasmus highlighted the growing trend of tax authorities, such as SARS, shifting their focus from traditional methodologies to new, more aggressive approaches, such as the willingness-to-pay method. This shift often catches taxpayers off-guard, as seen when SARS changed their position just one month before the trial. The challenges faced by taxpayers in such cases underline the importance of tax steering committees.

He stressed the value of creating tax steering committees within multinational corporations (MNCs) to monitor and manage tax risks regularly. These committees, ideally led by a litigation lawyer to ensure attorney-client privilege, play a crucial role in preparing for audits and trials, ensuring that sensitive discussions remain protected.

Beyond transfer pricing, Dr. Erasmus touched on broader international tax issues that intersect with TP, including the digital economy. He mentioned that countries like Tanzania are adopting aggressive stances, attempting to tax foreign companies based on local economic activity, even if the companies lack a permanent establishment in the country. This exemplifies the global trend of revenue authorities seeking to maximize tax revenues from MNCs through expanded interpretations of tax laws.

He also shared his experience from Mauritius, where authorities are disallowing interest deductions on capital loans, further complicating the tax landscape for corporations operating internationally. Dr. Erasmus pointed out that navigating these challenges requires not only deep knowledge of local tax laws but also an understanding of international treaties, such as double tax agreements (DTAs) and investment treaties.

A key recommendation from Dr. Erasmus was the need for companies to be proactive in managing their tax risks. By understanding the legal framework in each jurisdiction and working closely with experienced tax litigators, companies can mitigate exposure to hefty tax assessments and potential penalties. He emphasized that taxpayers should not shy away from engaging directly with tax authorities, as open dialogue can sometimes resolve disputes without the need for lengthy court proceedings.

The address concluded with a discussion on the future of transfer pricing in Africa. Dr. Erasmus observed that more African countries are ramping up their transfer pricing enforcement efforts, often with guidance from international organizations like the OECD. While this represents a positive step toward harmonized tax policies, it also means that MNCs must be more vigilant in their compliance efforts. He identified intellectual property, financial transactions, and management fees as key areas of focus for African tax authorities moving forward.

Dr. Erasmus’ insights provide a valuable roadmap for multinationals operating in Africa and other developing regions. As tax authorities continue to evolve their strategies, staying ahead of emerging trends in transfer pricing will be essential for minimizing risks and ensuring long-term success in these markets.

FULL TRANSCRIPT

Transcript Disclaimer: This is an automatically generated transcript of the recording and may contain some grammatical/ spelling mistakes.  It is to be used for reference purposes only.

Dr Daniel N Erasmus 00:00
Come, sit with me. Thank you so much. Thanks for the opportunity. So I don’t often get to come and speak to an audience in south africa. Some of you may know I live in the US but I still practice predominantly in Africa. And most of what I do is, strangely enough appear as advocate in numerous transfer pricing cases in different African countries, Mauritius, Tanzania, Malawi, Zimbabwe, South Africa. I was the lead attorney with my team in the very well known and discussed ABD case, which will form part of some discussions later today, and also will be the trend center for what I wanted to talk about emerging trends.

What I like to do you all would have seen in your packs. I’m involved with middle sex university. Ii really believe in training and teaching. I’m happy to share my knowledge with whoever is willing to listen. I’m associated with a wonderful law firm that’s staged outside a court. Pieterse Sellner. and i’m the Erasmus in that. I’m an associate of that firm. They’re a specialist law firm, but other than that, I’m an independent, and I typically get briefed by different firms of attorneys to act for their clients. As I said, I love to share the information. What I’ve learned out of many of these cases I’ve been involved in. So if you all go to taxriskmnanagement.com, that’s my good old web page. There’s a copy of the ABD judgment. I’m not going to give you those facts. You can download it. And there’s a lot of very useful information, as well as a book that i’m trying to finish called Conducting a Transfer Pricing Trial, which is all about telling you about all the stuff behind the scenes and what goes on in preparing for such a trial and how much work and effort goes into it.

But let’s just focus a little bit on emerging trends. If you’ve read the ABD judgment, you will know something about it. You will know that it regards intellectual property and the licensing of IP from a parent company in South Africa to various subsidiaries situated throughout Africa and the Middle East.

The taxpayer argued that a 1 % royalty for the use of their brand name was sufficient.

And Sars challenge that i’ve now lived with this case from inception, and we are now running into over 8 years and the matter is going on appeal. But just to explain to you the complexities of what emerges, the matter started at about 7.5 billion. Rand. Think about that. 7.5 billion through the pleading stages. We wheeled that down to 1 . 2 billion, which is still in excessive sum of money. That’s what went to. Trial. Lo and behold, 1 month before we went was supposed to go to trial in 21. Sars changed their theory of how the taxpayer should be taxing its subsidiaries. So this is a case about the transaction, a profit split method, and backed up by the taxpayer who entered into subsequent transaction was able to show an internal cup.

And the court happened to favour and was a lot easier for it to look at the internal cup as being the basis on which or the correct comparable for the 1 % royalty charge. But we were all arguing off the same page transaction, net profit margin method. A month before we went to trial, they booted all their experts and brought in an entirely new expert with an entirely new methodology driven by the willingness to pay method. So i’m not going to go into the details of that, but just imagine for 7 or 67 years, you’ve been preparing to go to court. All the pleadings have now been done. The pleadings are closed done discovery. They then approach the court and say, no, we now want to amend our pleadings an entirely new set of pleadings. We act to re redo all the pleadings before we could end up going to trial at the end of last year.

Now just imagine the costs involved in doing that, and that those are the complexities that we face in transfer pricing. Today. You think that you’re actually on the same page, looking at a particular methodology. Lo and behold, they can come along and all they had to do was tender the wasted costs. Now, of course, they conveniently say what waste it costs, because you’d already prepared for what you were going to argue in court. And we are simply just putting forward another calculation, which is not quite as easy as that. You can imagine that a huge amount of effort went into that. And in terms of preparing for those cases, we all do transfer pricing studies. We’ve got these reports that we’re supposed to keep and keep them up to date. It’s not as easy as that.

When you go to, when you prepare particular audit and they challenge you, they will go and dig deep into the background surveys that were done. The research that was conducted to back you up on the particular methodology that you’re relying upon. You need to have your that information at your fingertips. Otherwise, I can assure you 8 years down the line, where are the people that gave that advice or direction or were involved in putting those methodologies together? How are you going to call those witnesses? And they are going to be challenged every single level. We had three experts, they had three experts as well, but as I said, got rid of the first two and then replaced it with the third expert. And you can imagine the time and effort that went into preparing for that particular matter. In this book that i’m writing, I share with you a lot of the insights into how you go about preparing.

One of the key things that you have to do today is to create a tax steering committee in your organisation. If you are big enough to face transfer pricing audits, you should have a tax steering committee in your organisation that should meet every quarter and review the tax risks that are emerging in that corporation. And that particular entity must be headed by a litigation lawyer to ensure that you have attorney client privilege on the information that is being discussed at that level. Otherwise, the Sars of the world and i’m just picking on Sars, but we looked at dealing with many different revenue authorities will attempt to attach those minutes. We’ll have a bird’s eye view on whatever the risks of the corporation are. That doesn’t mean to say you should now just kick it all under the carpet and ignore it. You need to get a handle on what your risks are. And that’s the best way to do it. I’ve i’ve run tax risk steering committees now for two decades for a couple of really large multinationals and they’ve worked exceptionally well. We’ve managed to really manage away a lot of tax exposure in many different countries.

That’s one of the things that definitely is emerging out of this focus, as you say, now, on transfer pricing, you’re a multinational. You’re going to be facing transfer pricing.

Prof Keith Engel 07:54
You just say you are a genius that is a genius. I just raised this question last night with one of your colleagues. And I said, if you’re going to talk about tax in the boardroom and that Sars is going to get a hold of that information, what do you do? Yeah. And you just solve that in 1 minute.

Dr Daniel N Erasmus 08:13
So that’s and it can’t be bs the chairperson must be. So what happens is I’ll typically be the chairperson because we are discussing exposures in a courtroom down the line. And so there’s no bs behind that. It’s real. It’s real exposures that you are discussing.

And then when you feed that information to your audit committee, you only feed them with that, which has finally been dealt with. So either there’s an opinion, and that’s when you decide, do I need an opinion to limit my exposure on penalties, et cetera? Or do we go cap in hand? Do we do a voluntary disclosure 20 years ago for one of the large groups before VDP we went to Sars on a frequent, they wanted to clean out all these skeletons, and we achieved amazing results by being able to go to Sars to say. Here’s the mistakes we’ve made. This is what we found out. This is why we made the mistake. This is why we’re not gonna make it in the future, all in a nice wrapped up little bundle memorandum so that they could feel comfortable that we weren’t going to expose them to any further risks. And a lot of those matters were settled on that basis.

And then the VDP program came in. But tax was steering committee, and I deal with that extensively. The book is made up with chapters. And then it’s got as many letters in the alphabet. It’s got 24 appendixes of significant detail backing up. When you read something, you don’t want to have to go and look at another publication and find out what that says. I’ve tried to all keep it, keep it together in the same publication to share with all of you what is recalled acquired at that particular level. And it’s become very sophisticated.

And it’s something that you need to spend a tremendous amount of time trying to manage that risk start.

Prof Keith Engel 10:11
Just wonderful. Let me just throw in a different one just to throw you off a little bit. You’re not only involved in this one, but i’ve also heard your name thrown around and mauritius. Yes. And there was a lot going on there, which really surprised me that mauritius suddenly decided to to go back 10 years and redo everybody’s interest charges. And i’m like, you forgot who you were. Otherwise we’ll be what went on in there.

Dr Daniel N Erasmus 10:37
In Mauritius, they’re looking at disallowing interest expenses on corporations that borrowed or accessed capital in order to advance the operations of their particular corporation. In this particular case, the corporation involved typically, these are businesses that have special licenses, and you can’t just walk into a jurisdiction and set up a company. You’ve typically got to have minority shareholders. You’ve got to be licensed in that particular territory. And the funds are then used for that international organisation to access its client base. It has to set up this local entity in order to access a client based to be able to sell the services that it does.

So Mauritius is looking to disallow the interest charges saying that is not in the production of income. So that’s what that whole thing is about. So they they gain a big time into nailing companies that are working under that particular model. And i’ve got, in fact, I will be arguing a trial. We anticipate in November where we’re consolidating a number of years of assessment. Tanzania is another jurisdiction where I successfully argued that funny enough, the same same entity did not have a permanent establishment.

And now they’ve, along with the pillar one and pillar two initiatives and the digital economy, they’ve now deemed that this company has source its income in Tanzania. And just to give you an example of how ridiculous it is, their theory is. If you are a Tanzanian company and you send your Tanzanian employee to the Hilton in New York, because you are paying the Hilton in New York with money that emanates from Tanzania. That Hilton in New York is subject to tax in Tanzania. That is effectively a parallel to the extent to which they are pushing the envelope on the digital economy and what and it’s just ridiculous.

We now facing that it’s been difficult for them to raise assessments against the company, because we keep saying you can’t just attach us to some local entity and declare them as our agent. They are very decisive steps that need to be taken. And so we’ve alluded them as far as that goes. So they’ve had great difficulty trying to pin something on this particular client, and just to emphasise, again, as you’re preparing for these things.

So it’s not just transfer pricing. It’s different elements of international tax that come into play. You must pay attention to what the law says. You must pay attention to the dt as you must pay attention to the international provisions that emanate from the dt as or other agreements that will assist you in combatting very aggressive stances taken by the revenue authorities. They are desperate for money. And the moment they see that you are a profitable entity, you become a target. Unfortunately, that’s just the way it is. And then you’ve got to rely on people like us to get you out of that pickle. But it’s a lot cheaper. If you set up that tax risk steering committee and you get the likes of me involved there, because I then have a bird’s eye view of what’s going on in the organization being fed information from different places in the organization. And one then is able to at least direct what should happen to in order to ratchet that down. So again, I emphasise that side just one point.

Prof Keith Engel 14:22
because you’re raising about Africa. I they’re a very cash basis group. So if they see cash flying out, it doesn’t really matter what the law says.

It’s sort of a form of exchange.

Dr Daniel N Erasmus 14:32
and they’re very creative in how they just Justify why they should be taxing you. It’s very challenging.

Prof Keith Engel 14:42
And I think companies before they go into these countries, really know that their risk is a lot higher, it is very high. And a lot of times they just look at the IBFD book and they think brought to and great. But one of the questions that comes in also in the battle line is the pay. Now regulator. I know we complain about it in an essay. But in Africa, it’s a far more serious threat. It’s a very serious threat. And are you able to mitigate that? Because usually people are pleading and begging. That’s their usual answer. So typically.

Dr Daniel N Erasmus 15:09
in a lot of the jurisdiction, you actually have to pay a percentage of that, which is being levied against you in taxes in order to advance to the objection and appeal stage. Although most of them have waiver provisions and the waiver provisions are always usually attached to some form of financial embarrassment, but that’s not the only mitigator.

There are other factors that come into play, such as this is a ridiculous interpretation of the laws. We have one of those scenarios emerging in Tanzania at the moment. Only enough, but that is a big challenge. And once again, you do have the opportunity to address them on it and to apply a for a waiver. But once again, very challenging. And as I said, if you stick to the law and you hold them to the law, they the it will inevitably they make a myriad of mistakes because they’re tripping over themselves to get at the money. They make lots of mistakes, and that’s where the opportunities lie to get them to back off.

So I can’t over emphasize that, and as I said, that all comes out in the mix of these tax for steering committees. In managing.

Prof Keith Engel 16:22
That’s the first time i’ve heard some hope for the taxpayer on those, because it has been pleading and begging. Yeah. And if you can do something, but it really comes down to civil tax civil procedure, and that being absolutely crucial. Yes. And I think the problem is we focus on the substance and all of that, but the procedural issues really are the most.

Dr Daniel N Erasmus 16:40
most of you sitting here know your subject, but I can assure you when it comes to administrative law and constitutional legal provisions, and you’ll think what the hell that got to do with tax. It’s got everything to do with tax. My practice in the last 30 years, that’s what my doctorate was on, has made leaps and bounds in what i’ve done achieved for taxpayers because of that developing that element of litigation in my particular practice in my approach.

In addition to that, I will say this a lot of a lot of revenue authorities have employees have been students of mine over the year through the teaching. I now have taught now nearly for two decades, and that does help with create capability.

Oftentimes, when we are facing a problem, I suggest, depending, for instance, malawi is an example. Let’s go and see the commissioner, see his team, do aa full presentation on why we think you are wrong. And they listen, and they have at times backed off and back down. So don’t think that approaching them in that particular situation is a waste of time. It does work from time to time. You then you don’t have to go into the courtroom and wait for years, literally. And the frustration I i’ve been. I i’ll get on a plane fly to Tanzania, and then the judge and his assessors are not available. Because somebody forgot to tell us that there was some conference that they were attending in the in the capital I that happens. And then you’re there and tough luck. So we’ll come back in a couple of months time.

Now you must understand that’s a whole team of people being flown in from the states and south africa. And wherever the case may be same thing in Mauritius. So it is very frustrating. The system is effective once it’s working, but there’s a lot of issues in getting into court and just a lot of laxness and real africa time issues. So it’s very frustrating, and it then makes.

Prof Keith Engel 18:47
just before we take questions. I don’t know if they’ll take question, but I think that people will have. How much of a trend are you seeing across Africa and actually raising tp audits and pushing them to court? I know that it’s been sporadic, but where are they on that journey? I know that they’ve got the legislation.

Now they’ve got the guides. They’ve even have teams that come up and down. But how much activity are we seeing? And then what areas are they’re focusing on interest? Are they focusing on certain things? Just your general chance to definitely.

Dr Daniel N Erasmus 19:22
a there’s a push to towards getting the matters into court. There’s been a lot of assistance from people out of Europe through ATF and places like that. Sometimes I think the guidance has been misapplied, but we’re definitely seeing an emerging trend on IP because you can imagine there’s a lot of IP issues. I say as much as Sars lost ABD it’s a great case for them because the reverse scenario is the more popular one where you have companies paying from South Africa, royalties to peering companies outside South Africa.

And there is a limitation on that. And I would have thought that Sars would be happy with that outcome, because it would be very, very nicely applied in what is typically the South African scenario, but definitely ip definitely financial structures, but it’s broad at sports, big Keith. As I said here, we’ve got the interest deductions in Mauritius, the deemed the digital economy issues in Tanzania, in Zimbabwe, it was management fees was a big thing.

So it’s all the areas that you typically will come across in transfer pricing.

And so whatever your particular wheel house is, you need to be on top of your game, and you need to have, you’re in not just that study really and available. You’ve got to have layers of that of information available to combat and to deal with any order that might arise.

And it’s difficult.

Prof Keith Engel 21:01
I think also, just to note, I think that some of the african countries do look at these things as gold pots, one of the down sides. And I think we’ve lost it in treaties is there really should be non discrimination against foreigners, but transfer price encompass and open door for them, right? Because all it does is that.

Dr Daniel N Erasmus 21:20
Yep, but again, remember, there are lots of other treaties. There are investment treaties that come into place. So the field of international law, so it’s one of the courses we run through middle six. And my introduction to transfer pricing is setting up the legal landscape, and it’s very important to know the countries working with what investment treaties are in play, what double tax treaties are in play.

How do they approach the oecd guidelines? What is the what is the level of participation? All of that plays into how that particular revenue authority is going to deal with a particular issue? And if you understand that landscaping, you understand how important their constitution might be, or the administrative legal provisions might be oftentimes based on english law. It gives you aa tremendous insight into how to combat these audits.

So when they start asking you for irrelevant information, you can put them into their place, and you can say to them, let’s focus on what are the issues here. Let’s agree on what the audit process should be, and let’s not waste each other’s time. And you don’t always have to sit there cap in hand. If your law, and you speaking from a position of authority, you will take control of that audit. And that’s what you want indirectly. You want to participate and you want to give them the right information. And if you’ve done your work properly, the order should terminate with a zero result and quickly.

Don’t discount the ability for you to address them when it’s not just they have tremendous powers, but they are a creature of statute. And they cannot cannot work outside those statutory laws that give them the powers that they have.

Prof Keith Engel 23:17
And they need to be reminded of that. It’s absolutely because they just.

Dr Daniel N Erasmus 23:21
just human beings. I they’re given this tremendous power, and they think they can just walk all over you. It’s nonsense, not the case. If one once the parameters of what you’re working with, you really can control the outcome of that audit. So take a lot of that pain away.

Prof Keith Engel 23:38
It’s nice to hear these african countries actually operate under law. After all, they do. No. They do. That’s a good note to know, because you don’t normally hear that, but I guess we’re not, we’re not reminding.

Dr Daniel N Erasmus 23:48
them of that.

So I have americans asked me, so what’s the rule of law? Like? Is it? The court systems are great. I I really once i’m in court and I must have had some interesting experiences in zimbabwe, the same judge that I kept appearing in front of who’s very good at manipulating the tax law, very clever man who’s now a supreme court judge, but even with him that the the system worked well, the last time I was there that the judge was not an experienced tax guy and he had two assessors with him.

So which was great. So the rule of law does work and other countries that i’ve mentioned. I certainly can’t complain about the opportunity to present these cases. These cases in court, that’s great.

Prof Keith Engel 24:39
Let’s see if does anybody have any questions? It’s hard to see there’s this light that blinds you from over there. Any thoughts his early morning? Are we still waking up with some coffee? But it’s quite encouraging. I it’s a very different environment. This is that I think the real issues that are coming down to when you’re looking about tax rates in africa, really are coming down to a lot of procedure, but just turning back to tpi think the big change, for me has been, as I said there before, it used to be the almost never applied to the last line of defense.

Now it’s come the first line of defence. That is a bit of a problem because from 1914 taxes based on the realisation principle, and we seem to have lost that we have.

And so now you’re trying to defend pricing. How do you really do it? Because on the african side and maybe you’ve seen this is that we’re now fighting about where the value the intangible the market. Is it the consumer? That’s what really all the ueu is saying. It’s the consumer because we’re the consumer, or is it the producer and where that balance is going? Do you?

Dr Daniel N Erasmus 25:48
So that’s so just to sort of a sort of reverse out of that and then go back into it. Remember, transfer pricing is about creating fictitious income. Whenever we’ve dealt with anti avoidance provisions in the past. It’s always been about a pot of gold that existed and how to divvy that pot of gold in transfer pricing. They are creating the pot of gold. The pot of gold didn’t exist in the first place. Therein lies the problem, and therein comes the issue of what is the value? Is it in ABD on the willingness to pay? It was a a question of investigating what the consumer saw as value in the license that was being given to the subsidiaries in the different countries.

Ii said you valuing the intellectual property, you’re not valuing the use of the intellectual property, so be very careful. What it is that you’re attempting to value. And I think the mistake made by the Sars expert was that he was valuing the intellectual property itself and not its use and taking into consideration extra elements, such as goodwill, et cetera. If we go into the complexities of it. But there definitely is I how long is a piece of string? And they are creating fictitious income that never existed therein. You must test their law, because for them to write that into the tax act, their tax act has got to be worded to allow them to do that. In some jurisdictions. The revenue authorities have even attempted to apply their age old tax avoidance provisions based on the old 103 as a means of generating by manipulating certain lines in what I call the coding.

And that’s I understand. And if i’m right, and I believe that that’s something that was advanced by lee corrick, but I might be speaking under correction.

Prof Keith Engel 27:55
I’ve heard that one before, and I guess just because one of the other points about tp and it started in the us 1917 or 1918, there’s a little bit of debate on that. But the point was, unlike business substantial reform and all of that, there is no motive test.

No. And that’s, I think, part of the problem. I know that violates what some people believe, but there is no mode of threshold. So even if sometimes and this is part of the problem where you’ve got too high DAX jurisdictions, nobody cares anymore. No. So we raise that.

Dr Daniel N Erasmus 28:30
We’ll raise to the court and say there’s no advantage here. The tax rates are identical. There’s nothing there’s no profit shifting that’s happening here. But you’re right. That’s irrelevant.

Prof Keith Engel 28:42
But a it is a global issue.

The moment.

Dr Daniel N Erasmus 28:47
establishing those values is. And hence, I don’t know how many of you here are economists. And so this is the wheel house of economics and economists. And they failed to be able to agree on anything, because a it’s such a broad topic. So it makes it difficult. Like so difficult. That was quite interesting.

Prof Keith Engel 29:10
I think our time is up. They were a little over, but excellent and thoroughly enjoyed it. And you’re gonna be around for today. I will. So that’s wonderful. So any questions?

Dr Daniel N Erasmus 29:20
You can also EMAIL me, but I will be here and be happy to meet you.

Prof Keith Engel 29:24
And we will have a session specific on ABD we will. That’s perfect. Thank you. Great job.