Africa must address transfer pricing collectively

than a dollar per day.
Over the decades Africa has stood as a panacea for industrialised economies through the supply of raw materials.
All eyes are on Africa. In addition to numerous exploitative mechanisms on Africa such as smuggling of precious minerals, externalisation of monies and continuous trade in raw materials without any desire to add value, Africa has for a long time suffered from the menacing disease of transfer pricing. 
Transfer pricing works as follows:
A subsidiary of a multinational company charges goods or services at prices that are not market related to another subsidiary of the same multinational company with the aim of moving funds out of or into the chosen country. For example, Holding Company A has its head office in country X and subsidiary B in country Z.
Company A sells goods to company B worth US$1 000 000 but the invoices and shipping documents are altered to reflect a value of US$200 000. The net effect is that US$800 000 is siphoned to country Z. Income tax and duty values are also altered in contravention of the law. Hence the difference of US$800 000 is concealed from the tax authorities and nothing will be paid from it.
As the example above illustrates, transfer pricing is a strategy frequently used by multinational companies to make huge profits through illegal means. The transfer price could be purely arbitrary or fictitious, therefore different from the price that unrelated subsidiaries would have had to pay, that is the “arm’s length” one.
Since each country they operate in has different tax rates, multinationals can increase their profits with the help of transfer pricing.
By lowering prices in countries where tax rates are high and raising them in countries with a lower tax rate, multinational companies can easily reduce their overall tax burden, hence increasing their overall profits.
Painfully, over the past few years, many governments in Africa have been focusing their energies on finding ways of innovatively mobilising revenue from their own domestic sources. However, what is quite clear is the fact that revenues generated from these domestic sources are still way below the actual amount of revenue required to finance the infrastructure development projects and provision of public services particularly water and sanitation, health, education, electricity and public transport on the continent.
The general emerging consensus among tax planners, development experts and policy- makers in these countries is that a more viable option is needed to counter this. These options should be good enough to open up more fiscal space and stop the capital flight resulting from illicit revenue losses caused by rampant transfer pricing in these countries.
Transfer pricing is the price charged by one subsidiary of a multinational company to another subsidiary of the same company.
In other words, it is a term used to describe all aspects of inter-company pricing arrangements between related business entities, including transfers of intellectual property, transfers of tangible goods; services and loans and other financing transactions.
All types of transactions within subsidiaries of multinational companies are subject to transfer pricing including raw materials, finished goods, equipment, and payments such as management fees, intellectual property royalties, loans, interest on loans, payments for technical assistance and know-how, etc.
The rules guiding transfer pricing between two subsidiaries of a multinational company requires them to conduct their transactions on an “arm’s length” basis.
This means that any transaction between the two should be priced as if the transaction were conducted between two unrelated companies, with no over- or under-pricing being allowed to take place. Unfortunately, this does not happen most of the time. In actual fact, in recent years, inter-company transactions of the same subsidiaries of multinational companies across borders have experienced rapid growth and are becoming much more complex with consequent tax revenue losses resulting from illegal transfer pricing.
The removal of restrictions on capital flows in the majority of developing countries under the IMF and World Bank supported structural adjustment programmes has helped a lot in facilitating harmful transfer pricing.
According to the recent statistics, it is true that a number of Southern African countries have not been spared from revenue losses resulting from rampant illegal transfer pricing. 
Between the years 2005 and 2007 the five countries (Angola, Mozambique, Namibia, South Africa and Zimbabwe) have systematically experienced an escalation of capital losses resulting from trade mis-pricing of which transfer pricing contributes more than 60 percent. At an aggregated level, Namibia is the most affected experiencing almost a 232 percent growth in capital losses through trade mis-pricing. Mozambique and South Africa  follow it with 212 percent and 130 percent growth in capital losses respectively.
However, in all the cases percentage losses are more pronounced in the case of capital losses emanating from trading with the EU.
This is not surprising given the fact that the EU is an important trading partner of most Southern African countries.
The capital losses could be much worse if we take into account those arising from trading with the rest of the world, particularly emerging big economies like China, India, Russia and Brazil, and South Korea.
What this means is that while multinational companies and their subsidiaries operating in these selected Southern African countries are making huge profits through manipulative transfer pricing, the countries themselves are losing huge amounts of local revenue given the fact no tax is paid from the capital losses.
This is money desperately needed for social spending by these countries, particularly in the health sector were high HIV and Aids prevalence is causing many premature deaths and rapid fall in life expectancy.
Who are the key players in transfer pricing? Besides the multinational companies and subsidiaries, international accounting firms play a key role in facilitating abusive transfer pricing. Usually, these firms have a strong international network of dedicated transfer pricing professionals with advanced training in economics, accounting, law and project management, ready to work for multinational companies providing advice on matters related to transfer pricing. In addition, banks also assist in the concealment of the benefits accruing from illegal transfer pricing by providing false invoices and bills of lading.
Given the fact that banks are the ones at the core of the financial system, they have over the years been able to develop sophisticated products, which has added additional mystique to the already complicated global financial system that is supportive of abusive transfer pricing.
What can be done to minimise the harmful effects of transfer pricing? Abusive transfer pricing and the consequent tax revenue loss it entails is proving to be a big problem in many countries in Africa. To deal with this pest, African governments should start to do the following:
Enacting legislation that demands transparency and accountability from multinational companies in reporting their business activities and annual financial operations in their respective countries. The legislation should also impose heavy penalties for breach of the “arm’s length” pricing system. They should also engage the international community to stop multinational companies from engaging in transfer pricing from poor developing countries through the use of continental or regional trade agreements. For example, the institution of a new accounting standard that would involve country-by-country reporting would go a long way in enabling tax authorities, civil society and other regulatory authorities to monitor the activities of multinational companies located in their respective countries;
African countries can also lobby the United Nations Security for the establishment of an international tax police system similar to the global police body Interpol and Kimberley certification process for diamonds to curb trade in blood diamonds. This process works where there is suspicion that “arm’s length” pricing was not followed, which would involve exporting countries certifying that the exports in question have been exported with due consideration of the country’s tax laws.
In addition, they should intensify their capacity building efforts of tax personnel and investigators in the area of transfer pricing given the complex and rapid growth it has experienced in recent years. This could effectively deal with the documentation requirements, increased information exchange and increased audit or inspection these new developments entail; and
Another option is to undertake special tax audits from time to time to check and plug the leakages due to transfer pricing. In addition, they could also increase the participation of the locals in the ownership of the economy. As in the case of Zimbabwe, indigenisation and economic empowerment if successfully implemented will see greater strides being made in the eradication of transfer pricing. Obviously, every national would want to institute measures, which will make sure that the country is not short-changed. This is particularly so if he/she is a shareholder!
l Gift Mugano is an international trade expert based in Port Elizabeth, SA. He is studying for a PhD in Economics at Nelson Mandela Metropolitan University. He is a consultant and Programmes Director of Africa Economic Development Strategies. email: [email protected], cell: +2778 017 4112