September 2017: Transfer Pricing Risk Assessment in the Mining Industry

The African Tax Administration Forum (ATAF) and the German Federal Ministry for Economic Cooperation and Development (BMZ), through the Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) GmbH, have developed this toolkit for African tax authorities seeking to assess transfer pricing risk in the mining industry.

The purpose is to strengthen authorities’ capacity to determine whether they should audit particular high-risk “related party transactions.â€

The toolkit employs a specific risk review approach, which focuses on particular transfer pricing issues that present a high risk to revenue (as distinct from a comprehensive risk review, which tax authorities use when they cannot detect where transfer  pricing issues are likely to arise).

A loss of even 1 percent of the value of these transactions is likely to be significant for developing country revenues. These issues are also very prevalent: many African tax authorities report corporate services, including procurement and management, as common causes of tax loss.

The four issues of focus are:

1. Marketing arrangements. A related company, for example a marketing hub, buys mineral products from the mine. The key issue is whether the mineral products are transferred to a fully fledged related party marketer that takes ownership of the product, performs value-adding functions and assumes entrepreneurial risk, or, more commonly, a hub that merely provides a support function.

2. Intercompany debt. A subsidiary receives debt from a parent or an affiliate company, often a corporate treasury located in a low-tax jurisdiction, to finance geological exploration or mine development. Debt generates interest payments, which are tax deductible. Most African countries currently limit the maximum amount of debt on which deductible interest payments are available, by way of a debt-to-equity ratio. However, the cost of related party debt (i.e., the interest rate) is difficult for tax authorities to price, leaving the tax base vulnerable to excessive
interest deductions.

3. Procurement services. A company purchases mining goods and services on behalf of its subsidiary; the price charged to the subsidiary will include the direct cost, plus a “mark-up.†Usually in such cases the cost base should be the cost of providing the service, not the value of the goods.

4. Management services. The subsidiary pays a fee to a related party in return for a range of administrative, technical and advisory services.

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